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Decentralization– Blockchainapplicationsandcasestudies
2016
Overviewofblockchain applications
• Buildingtrustbetweencounterparties• Makingdistributedmarketsmoreeffective• Reducingtransactioncostsinunderwritingtitleinsuranceandotherfinancialtransactions• Streamliningclearingandsettlementofcashsecurities• Improvingefficiencyinanti-moneylaunderingcompliance
Advantagesofblockchain applicationBlockchain hasthefollowingadvantagesoveraconventionalcentralizeddatabase:1. Security:Blockchain relies onencryptiontovalidatetransactionsbyverifyingtheidentitiesofparties involvedinatransaction.
Thisensuresthata“false”transactioncannotbeaddedtotheblockchain withouttheconsentofthepartiesinvolved.Acomplexmathematical calculationknownasa“hash”isperformedeachtimeatransactionisaddedtotheblockchain,whichdependsonthetransactiondata,theidentities oftheparties involvedinthetransaction,andtheresultofprevioustransactions.Thefactthatthecurrentstateoftheblockchain dependsonprevioustransactionsensuresthatamaliciousactorcannotalterpasttransactions.Thisisbecause ifprevioustransactiondataischanged,itwill impactthecurrentvalueofthehashandnotmatchothercopiesoftheledger.
2. Transparency:Byitsverynature,blockchain isadistributeddatabasethatismaintainedandsynchronizedamongmultiplenodes– forexample,bymultiplecounterpartieswhotransactwitheachotherfrequently.Inaddition,transactiondatamustbeconsistentbetweenpartiesinordertobeaddedtotheblockchain inthefirstplace.Thismeansthatbydesign,multiplepartiescanaccessthesamedata(insomecaseslocallywithintheirorganizations)– thussignificantlyincreasing theleveloftransparencyrelative toconventionalsystemsthatmightdependonmultiple“siloed”databasesbehindfirewalls thatarenotvisibleoutsideasingleorganization.
3. Efficiency:Conceptually,maintainingmultiplecopiesofadatabasewithblockchain wouldnotappear tobemoreefficient thanasingle,centralizeddatabase.Butinmostreal-worldexamples(includingseveralofthecasestudiesweexamine incapitalmarkets),multiplepartiesalreadymaintainduplicatedatabasescontaininginformationaboutthesametransactions.Andinmanycases,thedatapertainingtothesametransactionisinconflict– resultingintheneedforcostly,time-consumingreconciliation proceduresbetweenorganizations.Employingadistributeddatabasesystemlikeblockchain acrossorganizationscansubstantiallyreduce theneedformanualreconciliation, thusdrivingconsiderablesavingsacrossorganizations.Inaddition,insomecases(seeourdiscussionofAML)blockchain offersthepotential fororganizationstodevelopcommonor“mutual”capabilities thateliminate theneedforduplicationofthesameeffortamongmultiple organizations.
Overviewofablockchain verificationsystem
Groupsverifytransactionsbyconsensus
Party5hasdifferentdatafortransaction3thantheother5parties,whichwillchangeviatheconsensusalgorithm
CaseStudy:Reducingtransactioncostsinrealestatetitleinsurance• TitleinsuranceisanichebutsizeablemarketintheUS,with$11bninpremiumspaidin2014• Titleinsuranceexistsmainlytoprotectapropertyownerand/ormortgagelender’sfinancialinterestinarealestatetransaction(residentialorcommercial)againstlossfromtitledefects• Titledefectsinclude,butarenotlimitedto,outstandingliens,easements,orotherencumbrancesunaccountedforatthetimeofthetransaction.Importantly,titleinsurancepremiums,ascomparedwithotherinsurancelines,arelargelydeterminedbytheinsurer’sunderwritingcostfactorsasopposedtoactuarialriskofexpectedlosses• Blockchain applicationscouldmeaningfullylowertransactionalriskassociatedwiththeexistingpropertyregistrationsystemintheUS,introducingsignificantcostefficienciesthatwouldbenefittheendconsumer
Titleinsuranceindustryexpense/lossration
Titleinsurersabsorbsubstantialcostsconducting propertytitlesearchestoreducelosses
Breakdownoftitleinsurancecoststructure
Titleinsurers’operatingcoststructuremainlyconsistsofheadcountcosts
Titlesearchprocess
Titlesearchisamanuallyintensiveprocessbecauseabstractorsandcuratorsmustprocessandclearpaper-basedproperty records
Blockchain titlesearchprocess
Estimatedindustryheadcountoperatingexpensescomparedtoblockchain savings
Blockchain applicationscansave$2.3Binheadcountsavingsfortitleinsurance
Estimatedinsurancelegalandclaimsexpensescomparedtoblockchain savings
Blockchain applicationscansaving$550Minlegalandclaimsexpenses
Estimatedindustryoperatingexpensecompositioncomparedtoblockchain savings
Labor-intensiveunderwriting expensescoulddeclinesignificantlyasapercentageofpremiums
CaseStudy:Capitalmarkets– UScashequities• TheUScashequitiesmarketisthelargestandmostactiveequitymarketintheworld,tradinganaverageof7billionshares,or
approximately$277Bofnotionalvalue,perdayin2015• Throughoutthelifecycleofanequitytrade,anumberoffinancial intermediaries arerequired: stockexchanges/tradingvenues
(NASDAQ,NYSE),broker-dealers,custodybanksandtheDepositoryTrustCompany(DTC,asubsidiaryoftheDTCC)• Blockchain couldfurtherstreamline thepost-tradepartofthetradecyclebyeliminating duplicativeconfirmation/affirmation
steps,shrinkingthesettlementcycle,andreducingtradingrisk,whichinturnshouldlowertheindustry’scostandcapitalneedsPlacesforimprovement:• Multipleversionsofthetrade.Whenmultiplepartiesareinvolvedacrossasingle transaction,multiple versionsofthetradecan
berecordedacrossthevarioussystemsthateachpartyuses.Thisintroducesanelementofuncertainty,whichcanrequiremanualinterventionwhenpartiesdisagreeontradedetails
• Thesettlementprocessislong.While stocksintheUStradeinfractionsofseconds,thesettlementprocesstakesthreedays(movingtotwoin2017),whichtiesupcapitalandliquidity
• Accountinformation/instructionsareconstantlychanging.Overtime,accountinformationandsettlementinstructionschange(newaccountsareopenedorclosed,accountnumberschange,custodianschange,etc.)resulting instaleinformation(particularlyforstandardsettlementinstructions)requiring increasedcommunicationandmanualintervention
• Operationalrisk.Firmsencounterextraoperational riskinconnectionwithtradesettlements thatcouldbeeliminated withpre-tradechecksviablockchain technology
IllustrationofUScashequitiestrade
Globalequityoperatingmodel
Blockchain save$9BinUScashequitiestrading
ListofselectBitcoinblockchain technologycompanies
Listofselectnon-Bitcoinblockchaintechnologycompanies
Conclusions
Futurechallenges:• Criticalmassofcounterpartyinformation.Criticalmassofinformationisneededinorderfordatatobecommerciallyreliable.Forexample,incaseswherethereisascarcityofvalidatedcounterpartyinformation(e.g.,validatedonlybyasinglesource),weexpectbankswouldstillneedtoruntheirownKYCchecksand/ortransactionsurveillancetoindependentlycorroborateclientinformation.
• Regulatoryreform.Regulatoryreformthatsupportsblockchain-basedapplicationswillbeneededbeforefinancialinstitutionsareabletoembracethetechnology.Whileblockchain willlikelynotremovebanks’AMLliability,blockchain-baseddistributedledgerswillneedtobelegitimizedbygoverningbodies(i.e.,fiatcurrency)inorderforbankstocomfortablyrelyonthemasasourceofcounterpartyinformation.
• Infrastructuredevelopment.Thedevelopmentofblockchain-basedinfrastructurethatoperatesinconjunctionwithexistingindustrystandardsisneededforcommercialadoption.Forexample,wenotethatwiretransferinformation(e.g.,ABAroutingnumbers)willneedtobetiedtoablockchain indextoimprovethesecurityofmoneymovementtransactions.Assuch,webelieveconsiderableinvestmentisneededtoimplementrequisiteinfrastructure.
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