Why blockchain could speed up payments

Lower costs, faster clearing and settlement, fewer errors… The big banks are doing it, so it’s time for community banks to start exploring blockchain’s potential to speed payments.

By Laura Shin

The internet has not yet seriously disrupted the financial services industry. Fintech might have made inroads, but the inner workings of the financial system—clearing and settlement and all the other processes that keep the world turning—remain much the same. Until bitcoin, that is.

Well, not quite. The cryptocurrency itself probably won’t replace our financial services, but the technology behind it—often called blockchain or distributed ledger technology (DLT)—has both piqued the interest of banks and frightened them. They’re interested because it promises to make their back-office processes more efficient, which could someday save the financial industry an estimated $15 billion to $35 billion annually, according to Bain & Company. But they’re also worried, because the peer-to-peer technology could, in certain cases, obviate the need for many financial intermediaries.

One of the most obvious applications for blockchain is in payments, particularly cross-border and business payments, including trade finance. That’s probably why nine of 10 bank payment executives are exploring the use of blockchain in payments, according to a recent survey by Accenture.

“How can you achieve compliance with the myriad of regulations within distributed ledgers? That’s the million-bitcoin question.”
—Cary Whaley, ICBA

“It’s important for any individual bank that they start to look at this technology,” says Rich Meszaros, connected commerce lead at Accenture Mobility, part of Accenture Digital. “When, for instance, the ability to move payments in this new way with faster clearing and settlement and greater transparency becomes something a competitive bank offers and they don’t, will that impact the ability for them to service their clients the way they wish to?”

Spreadsheet in the sky
The reason for all the fuss is that a blockchain is a single source of truth. It comes in the form of a tamper-proof, secure ledger accessible to multiple participants (hence the term “distributed ledger”), which can be a group as big as the entire world, as in the case of bitcoin, or one the size of, say, several departments within a bank. This one ledger replaces the multiple ledgers held at individual entities that must be reconciled whenever two or more transact. Because multiple parties maintain a distributed ledger, it doesn’t have a single point of failure. Plus, DLT makes it unnecessary, for instance, for each bank to keep its own record and for the banks involved to reconcile. When coupled with a cryptocurrency like bitcoin, the transaction can also clear and settle instantaneously.

$35 billion

The amount the financial system could potentially save by using distributed-ledger technology

The technology has implications for a range of financial services, such as post-trade processing, insurance, trading, mortgages and real estate. However, the area of earliest application is payments: international, corporate and p2p payments. To a lesser extent, firms are also looking at applying it in cash pooling, in which a national franchise or retailer with locations around the country moves funds to a larger regional or national account to fund operations. Other applications include trade finance and smart contracts, in which a program executes the financial terms of an agreement when certain conditions are met.

For cross-border payments, DLT “is a way to bring peer-to-peer connectivity circumventing today’s hub-and-spoke infrastructure,” says Cary Whaley, ICBA’s first vice president of payments and technology policy.

So a DLT might someday enable smaller banks to bypass the correspondent banking system. “With blockchain or virtual currencies, you can reach out directly,” Whaley adds. This results in lower costs, faster clearing and settlement (almost instantly, as opposed to three or more days for cross-border payments), reduced errors, and transparency for all players involved in that payment. In the current system, the total fees or foreign exchange rates associated with the transaction are variable and often unknown to the sender and can be difficult to predict.

Among blockchain companies, San Francisco-based Ripple specializes in cross-border payments. This spring, its SBI Ripple Asia venture formed a consortium of 47 banks in Japan using its cloud-based payments platform for real-time domestic and international money transfers. Another newer venture is the Enterprise Ethereum Alliance, which counts a number of megabanks, including JPMorgan Chase, Bank of New York Mellon and Credit Suisse, among its members. It is building a blockchain network that will be used for multiple purposes, including payments.

Other notable startups and projects using DLT for payments include Veem, a business-to-business payments provider targeting small businesses; Wyre, which focuses on the US–China corridor; and Visa’s B2B Connect network, a platform for banks to make business-to-business international payments, which is being piloted this year.

Pilots underway
While DLT has yet to take hold in any significant way, the pace at which larger, established financial institutions are researching and experimenting with it is rapid. They are moving beyond proofs-of-concept into pilots. And although it is early, community banks should be exploring blockchain.

“First and foremost, get a good understanding of the technology, spend the time with the different areas in the banks and look at potential use cases, develop that road map and pick one or two priority use cases to experiment with,” says Meszaros. “Do a deeper dive into that use case [and] understand the potential impacts to the organization, whether it be the operational impacts, regulatory impacts, etc.” From there, build a prototype and turn that into a proof-of-concept with which you can solicit feedback. Other areas where DLT could have an impact include payment processing, mortgages and mortgage servicing, capital markets and insurance.

Compliance questions
Meanwhile, be aware that much of the national regulation surrounding DLT has yet to be established. “How can you achieve compliance with the myriad of regulations within distributed ledgers?” asks Whaley. “That’s the million-bitcoin question.” For example, how would an immutable distributed ledger handle the right of rescission, or the right a customer has to claim that a payment was unauthorized?

On the other hand, waiting until all these questions are settled isn’t feasible in this competitive landscape, especially one in which the open-source software will be eating into all the incumbents’ market share. Plus, blockchain can do much more than just streamline existing products and services. It could also enable offerings simply not possible today.

Meszaros, who is part of Accenture’s Internet of Things practice, says, “One reason we’re keenly interested in blockchain is we look at the capabilities of these smart devices and asking, how will blockchain be a component of how these devices share data and conduct transactions? That’s an emerging area of payments: these low-value, high-frequency transactions.” Indeed, Gartner Research predicts that, by 2030, 30 percent of the global customer base will be devices or things transacting over blockchains. Now that sounds like a business opportunity.

Remind me: What’s a blockchain again?

The word “blockchain” comes from the structure of bitcoin’s distributed ledger. Transactions are grouped into blocks that are added to the ledger roughly every 10 minutes. Cryptography gives that group of transactions a unique identifier called a “hash” that would be completely different if an iota of the data were changed. It is easy to check if a set of data will result in the same hash but impossible to take a hash and reverse-engineer the transaction data. Because the hash of each block is then included as a data point in the next block, the blocks become inextricably linked, creating a chain of blocks—or blockchain. “Distributed ledger” or DLT is often the more popular nomenclature, particularly in enterprise settings, because many versions of the technology are not structured precisely like a blockchain.

Laura Shin is a technology writer in California.