Generation Z is the newest generation – currently coming of age. They were born between 1999 and 2015. Alone in the US, there are now more than 60 million Generation Z individuals.
Gen Z’s predecessor, the millennials, have been thoroughly studied by marketing
departments worldwide and the media have created an obsession around them, the
newest generation is still under-researched.
The majority of Gen Z has not yet reached adulthood; some are not even school age. Still, we can already see behavior patterns. What do we know about Gen Z? Several studies have tried to shed light on this generation, such as those conducted by visioncritical, bpas and ey.
What Defines Gen Z?
was born and grew up in a world of “always on.” They have known the iPhone
since the early days of childhood, along with selfies, social media and
streaming. Gen Z’s most used device is the smartphone (15 hours per week),
whereas millennials spend most of the time in front of a computer (16 hours per
week.). Even one in five Gen Z do not watch TV at all, and most would prefer to
keep a streaming device rather than a TV if compelled to have only one. Social
media is not only the number one time-stealer, but for many, the foremost
source for news consumption and friend connections.
drinks less alcohol, spends more time connecting with friends via social media
and finds their partner more and more online (hello Tinder). Lastly, teenage
pregnancies are less common. Maybe, these are connected to each other. Who
takes place mostly online. Gen Z appreciates innovation and personalization.
Their brand loyalty is lower than that of earlier generations – especially for
apparel brands. Lure Gen Z into malls and other brick and mortar shops;
companies need to connect with this generation through various channels.
Implications for Banks
This is all
well and good but what does it tell us about how banks should address Generation
1. From mobile first to mobile only
Some years ago,
web development shifted from desktop only to mobile first. This put mobile at
the center of attention, but at the same time, there are still other devices
and screen sizes worth considering.
As Gen Z
spends most of the time with a small screen device –using it also as a primary
medium for shopping, information gathering and social interactions – banks must
be prepared that most user interactions will take place on mobile phones. This
does not only encompass the bank’s website but all other online touch points
with the prospective customer. Some neo banks have already developed mobile-only
banking experiences, meaning their online banking is only accessible through an
app. Generation Z are not mobile first, but mostly mobile-only consumers.
2. Attention span
Gen Z are
reported to be masters in multitasking, but they have only a short attention
span of less than 10 seconds. Content must be provided in a snack-sized format.
Long and unnecessary information can be trimmed down or shifted to an extra
page. Furthermore, Gen Z expects fast service – digital products are instantly
available after purchase, Amazon delivers overnight. The same must be true for
account openings and credit processes.
3. Innovative and Individual
ruthlessly apply customer centricity to product development. Gen Z expects
nothing less. This principle becomes even more relevant due to new competition:
challenger banks already put the consumer first and churn out all day product
improvements. How can banks be innovative and create individual products? They
need to leverage their vast amount of Big Data to create customized products
and anticipate needs based on characteristics in the data (tell the customer
what they need next before they are aware of their demand).
Being innovative extends to grander schemes, coupled with brave marketing. Companies must create more value and more touch points for their products, making banking a central part of Gen Z lives – by starting cooperations, creating ecosystems and navigating Gen Z marketing channels – social media and, in particular, influencers.
The cryptocurrency bitcoin has not only popularized blockchain technology but overshadows it to such an extent that for some people bitcoin and blockchain are synonymous. Others brush the blockchain aside for ostensibly lacking a meaningful use case beyond cryptocurrencies.
This is a shame. Blockchain technology, even without cryptocurrencies, has many wide ranging applications of possibly revolutionary consequences for governments, financial services, insurances, organizations in general, trade and the supply chain, energy and infrastructure – to name only the main areas.
This article presents blockchain applications for these and other areas.
Governments can be the driving force or a stumbling block in popularizing blockchain technology and reaping its benefits. Bringing governmental services and documents into the blockchain can help cut red tape, corruption, costs and time, leading to an increase in efficiency and transparency on multiple levels. This contributes to a healthier bureaucracy, higher investor confidence and positive effects on the economic growth and the well-being of the country’s citizens. On the other hand, legislature might try to outlaw crypto currencies and stifle blockchain technology in the private sector.
An IBM report distinguishes two categories where the blockchain can bring efficiencies: 1. processes that improve efficiency in operations and substantially reduce risk and 2. areas that support more seamless personalized public services. In the same report, nine areas of government blockchain initiatives are laid out: asset management, identity management, regulatory compliance, voting systems, citizen services, contract management, financial services and borderless services.
China has added this blockchain technology as a priority to its Thirteenth Five-Year National Informatization Plan in 2016 – as evidence of its determination to apply the blockchain in developing the country.
First Dubai transformed itself from a fishing village into a global trading hub. Now the second transformation has the blockchain at its core. The city announced in 2016 of becoming a blockchain government by making 100% of applicable government services happen on the blockchain until 2020. Dubai is at the forefront of the this technology – both in regard to scope, determination and execution. The Dubai Blockchain Strategy aims to bring government documents and transactions to the blockchain, including the land registry, health records, business registrations, transfer of ownership and trade finance.
A blockchain-based notary system is crucial for many government use cases. Notarizing a document could entail the following: verifying the identity of a person, verifying a signature, certifying a document or taking an affidavit. All of these steps can be recreated in the blockchain, providing proof of the time the data was created, proof of the authenticity of the data and proof of ownership. For the last point, it would be convenient to have a blockchain-based digital identity.
Even though there are some companies offering blockchain-based notary services, such as stamped and poex.io, they do not offer a public notarization of documents comparable to a public notary. Elevating the blockchain to an official notary is only possible at the governments initiative, with changes in legislation as a prerequisite (and overcoming the notary lobby).
Estonia, with its e-residency program, is one of the first governments to allow its citizens to notarize marriages, contracts and birth certificates on the blockchain.
Legalization is the big brother of notarization. Whereas the later is applied in a domestic context, legalization is understood as the certification of documents for international use.
Legalizing documents requires several steps. First, the services of a domestic notary, where the document is issued is necessary, second the foreign ministry (or a similar institution) certifies the notary’s seal and lastly, the embassy of the country where the document is ought to be used must verify and recognize the document. This short explanation shows that legalization can be a lengthy, even months-long, process and legalized documents are for use only in a single country. (An easier process applies, if the two countries are signatories of the Apostille Convention.)
If notarization can be brought on the blockchain, from a technological standpoint at least, then it can also be done for legalization. However, this requires mutual recognition of a blockchain-based notarial system on an international level. The first step could be the establishment of such a system for countries that are part of a trading block and already closely cooperate, such as the countries of the European Union. In a second step, The Apostle Convention could be extended by a (voluntary) blockchain aspect, and finally, the remaining countries are invited to participate in blockchain legalization.
Birth, Marriage and Death Certificates
Vital documents for major life milestones, such as birth, marriage and death, the accompanying certificates can be moved to the blockchain. This gives the citizens authority over their identity, and others an easy means of verification and indestructibility, as a decentralized storage cannot be destroyed by fire, flood or tampering.
The state of Illinois is testing with evernym a blockchain-based system to digitalize birth certificates. The tools to be developed will allow doctors and parents present at the birth to log and register the birth (and other information, such as the blood type) on a permission blockchain, accessible only with a crypto key. This pilot program could eventually lead to a comprehensive tool set for identity verification free from a centralized repository.
The first “blockchain marriage“ took place in 2014 at Disney World in Orlando, Florida. The couple had already been married in a civil ceremony. The blockchain was used to submit their nuptials as a “smart contract“ to the blockchain, receiving a QR code as a proof. Marriage certificates in the blockchain are a possibility in the future, similar to birth certificates. However, unlike births, marriages are not immutable. After finding the proof of marriage in the blockchain, a further search for an update, i. e. divorce, is still necessary.
After the public notary has been substituted or enhanced by the blockchain, and birth certificates are digitalized in the same way, there is only a small step left for digital identities issued by the state and recognized by public and private institutions.
On a local level, the Swiss city of Zug, with a population of less than 30,000, plans to offer its citizens a digital identity on the Ethereum blockchain. The user sets up the identity in an app and later verifies it by the city administration. The digital identity can be applied to debt collection, room rent and e-voting.
On a national level, there is e-Estonia, the digital identity system of Estonia. This is a secure digital identity card powered by a blockchain-like infrastructure, allowing its citizens digital signatures, online voting and others. Estonia is quite serious in digitalizing and connecting its government services. Already in 2003 the country demanded that every government agency must be connected to x-road, a data exchange layer, by 2005.
To bring the digital identity even further, there is the „World Citizen on the Blockchain“ which comes with a printed ID card. There are admittedly only few benefits, but the future might bring more use cases for world citizenship.
Dubai announced plans to launch a real estate platform by 2020, to record all real estate transactions in the blockchain. Its core is the „decentralized“ land registry that records all real estate contracts, and connects them to electricity, water, telecommunication and other property related utilities. This will allow investors and tenants to verify property data and make property related payments electronically and instantly from anywhere in the world.
Sweden also works on bringing the land registry into the blockchain. Registering property transactions in the blockchain will eliminate paperwork and reduce fraud, leading to annual savings of 100 million Euro according to a consultancy (PDF) working on the project. Other countries that work on blockchain-based land registries are Ghana and the Republic of Georgia. The latter in cooperation with the company Bitfury.
Even though blockchain-based land registries already create greater efficiencies for developed countries, the benefits are far greater in areas where the status of land rights is unclear. 70% of the world population lack access to land rights, according to the World Bank. Improving land titling in these areas will greatly increase economic opportunities of the affected people.
In September 2017, the first house was sold on the blockchain, in Ukraine for $60K, with ethereum smart contracts via the startup Propy. The company works together with Ukraine, Dubai and California to adopt the „Propy registry“ as the official property registry to make transferring property via this registry a legal transfer of ownership.
Thinking in a broader way, why bringing only real estate on blockchain? This technology could also be beneficial for other asset classes.
There are many product categories benefiting from a registration on the blockchain. Ranging from tangible, such as land, vehicles and property to intangible assets, documents and intellectual property.
Even though it is necessary to consider the regulatory landscape, land registry is in terms of regulations at the higher end, meaning the set up for other asset classes is mostly easier to accomplish. To take into account the product characteristic, owners’s needs and state’s requirements, it is best to either create a single-product category blockchain registry or design a system versatile enough for different types of products.
IBM worked with the Netherlands Vehicle Licensing Organization on a blockchain for electric bikes. The goals are to reduce theft and optimize the insurance claims for a stolen bike. Electric bikes would receive a GPS locator and remove-controlled lock. The private ledger is accessible by the police, local government and insurance company.
Asset registration does not stop at simple cases or regulated assets such as bikes and land, respectively. A blockchain could also be set up for complex assets: oil rigs, and ships where the realm of complex asset management is entered. This can be divided into 9 phases: procurement, receiving, depreciation, maintenance, service, barcoding, contracts, storage and disposal; all of which need to be recreated in a blockchain.
Blockchain can also extend to voting. To prevent election fraud and have the counting finished immediately after the polling stations have closed, blockchain technology can help with voter registration, voter confirmation and vote counting. Further, as the votes are stored in the blockchain, poring over the election minutiae can be done in perpetuity. There are several startups, such as Follow My Vote,Democracy Earth and XO.1 offering their help to governments for blockchain-based elections.
A secure and tamperproof election system can also lead the way to online (including mobile) voting. This might help to increase voter participation. Companies such as votem work on bringing elections to the mobile phone.
Australia is one example that plans to allow its citizens to vote online, on the blockchain. As a first step, this should be tested on a local level before scaling up to national elections.
Unfortunately, countries where election fraud is the highest and would therefore benefit the most from transparent elections might certainly not introduce blockchain-based voting technology, as there is hardly any incentive for these governments to make the elections harder to rig.
At the World Economic Forum in 2016 the majority of the 800 interviewed experts agreed that in 2025 or earlier a government would collect taxes with the blockchain. Bringing tax collection on the blockchain can lead to swifter tax payments, lower rates of tax evasion and less effort in tax audit.
Already one year later China announced that it will use blockchain for taxation and electronic invoicing. If such an endeavor can be accomplished in the wold’s biggest economy and most populous country of 1.4 bn people, probably most other countries could move to a blockchain-based tax system with ease. With the second highest tax volume (after the United States), tax collection as a blockchain use case could prove to be very beneficial to the state coffer.
An area prone to tax evasion is VAT, which makes it a possible early adaptor of the blockchain. This could immediately reduce the VAT gap by 50 billion to 60 billion per year in the European Union, according to report (PDF). Even real-time VAT payments are on the horizon. Vertex has plans to do exactly that by integrating blockchain technology into the point of sales to collect tax immediately deliver it to the government.
Social Welfare and Benefits
The United Kingdom’s Department for Work and Pensions partnered with GovCoin and others in a proof-of-concept with volunteering claimants to support the distribution of social welfare payments. The money is received and spent via smartphones. The transactions can be recorded, on a consent basis, in the blockchain. This is to reduce fraud and analyse the spending pattern, and finally optimizing handouts.
A step further takes it the hypothetical NutriCoin where claimants can spent the welfare benefits only at registered merchants for certain goods. Healthy food might be allowed, alcohol and junk food less so.
Even though the blockchain might mean a more efficient distribution of welfare, its potential in tracking and policing welfare recipients might not be welcomed by everyone.
Registering a business can take anywhere between 1 day in New Zealand and 190 days in the Central African Republic according to the World Bank’s Doing Business Ranking. A myriad of government departments might be involved, each with their own procedure, required fees and issued licenses.
If the notary service and asset registry is already on the blockchain, it is a natural extension to include the registering of business in the decentralized ledger technology.
Melanie Swan muses in her book „Blockchain – Blueprint for a New Economy“ about blockchain governments where, besides bringing current government services and documents into the blockchain, also new ways of governing and novel government services are thinkable.
A slim and transparent bureaucracy would make answering to individual demands feasible. For example, a citizen pays extra for a more frequent waste disposal, or cars automatically compensate residents for the noice pollution.
In the end, blockchain smart contracts might even (partly) displace human government representatives.
More than 90 central banks (PDF) are looking into blockchain technology, from countries as diverse as the United Kingdom, Canada, China, Singapore and even Papua New Guinea. Typically as cooperations between central banks or a central bank and several national banks.
National digital currency
The Bank of England concludes in a research report (PDF) that a central bank issued digital currency could permanently raise GDP by 3%. Digital currency of course refers to a blockchain based currency. (the majority of currency in a modern economy is already in an electronic form.)
The Bank of Canada set up in 2016 with R3, a blockchain consortium, and several Canadian banks project Jasper, to test a DLT-based wholesale payment system. The study concluded that a DLT-based system could yield cost savings and efficiency gains, but still requires centralized features that are opposed to the distributed part of the blockchain.
Real-time gross settlement
A real-time gross settlement system (RTGS) settles transfers between financial institutions for their own and their customers’ accounts – in real-time and irrevocable. It is managed by the central bank and incurs higher fees than a national payment system.
In most countries RTGS is used for large money transfers. In some countries, RTGS is also used for mass payments of small amounts. If not, then a national payment network is the choice. The central banks and the bank of international settlement (the central bank of the central banks) are driving forces in the adoption of RTGS. The system is known by different names in the respective countries. In the USA the system is called Fedwire, in the Eurozone it is TARGET2, in Australia RITS and in China CNAPS.
A natural extension of digital currencies are real-time gross settlements. Singapore’s central bank, the Monetary Authority of Singapore (MAS), works on adapting distributed ledger technology (DLT) to improve the international monetary flow. MAS (PDF) to connect to other central banks via the blockchain – as a first step as a prototype network with other central banks from Canada and Hong Kong and Australia, Japan and India. The DLT-based monetary system should help settle cross-border transactions in real time. The DLT-based monetary system should help settle cross-border transactions in real time, at a lower cost than current RTGS.
Precise monetary and economic policy
The last use case is of an dystopian kind: If all money is made electronic, in accounts at the central bank, negative interest rates could not be escaped – hoarding cash under the mattress is not possible anymore. The bank would conveniently remove from each account the interest rate. On a brighter side, demographics and regions can be better targeted. Helicopter money, as an alternative to quantitative easing, could be precisely distributed, say to all woman of particular region, household composition and income level.
Blockchain applications with the greatest disruption potential lie in finance. Major banks, governments and central banks work with blockchain platforms, most notably R3 and IBM Hyperledger, towards implementing blockchain technology to all parts of the financial system: from payments to identity management, lending and financing, post trade processing, automated accounting and compliance, and trade finance.
The applications are not only of conceptual nature or pilot studies, but real implementations to make the processes faster, cheaper and in the end revolutionize a whole industry. Distributed ledger technology can streamline infrastructure processes and cut out intermediaries. IBM reports that IBM global financing could resolve trade disputes 75% faster thanks to the blockchain. Post trade processing could be reduced from 2 days to real-time, saving annually $20bn, according to Santander. Automatic issuing of the letter of credit in trade finance might soon become a reality and spur global trade.
The killer app for the blockchain, which brought this technology to centre stage – are payments without an intermediary (read without the need for banks and central banks, therefore completely circumventing the financial system) – using currency that is created for the blockchain, on the blockchain and lives only in the blockchain. Of course, banks and central banks can also make use of blockchain payments. But first focus on private P2P payments.
As there is no intermediary necessary, costs could be lower, clearing faster and, depending on the blockchain protocol, transparent, pseudo-anonymous or completely anonymous; which is a good or a bad thing – depending on one’s perspective.
With the bitcoin blockchain comes a pseudo-anonymous peer-to-peer network for storing the eponymous virtual currency and executing payments – where the transaction history of each bitcoin can be followed back to the creation date of a particular bitcoin. For a transaction, all that is needed is the bitcoin address of the recipient. Its downsides are the long time for the payment execution (verification necessary by so-called notes and with a maximum of 7 transactions per minute) and the volatility of the bitcoin – making it highly impractical as a tool for storing value. Besides, recently it received negative publicity as the payment of choice for ransom demands by hackers.
Fortunately bitcoin is not the only cryptocurrency. The highly popular site coinmarketcap lists currently more than 1.250 different cryptocurrencies (so-called altcoins). With vastly different protocols that can be very dissimilar to bitcoin, for example: payments can be completely anonymous, pegged to a fiat currency, having all cryptos already mined and even coming with their own programming language.
The choice of not using the monetary and financial system for transferring and storing value seems like a luxury and thus unnecessary decision for some – but for others it might be the only way to receive payments at all. The use case for it, if we want to call it this way, was the Ukrainian revolution in 2014 where protesters held posters with QR-codes into the cameras for bitcoin donations. (A word of caution: The wallet address reveals the sum stored and a list of transactions it received – with the value and the senders’ addresses – showing that the protesters received only $2,000 in bitcoin.)
There is a myriad number of startups employing the blockchain for (mobile) p2p payments, for example circle, bitwala and abra.
What is the smallest possible value of a dollar transactions? – A hundreds of one dollar – i. e. one cent (if we leave out the obscure Mill). Even though one cent transactions are possible – they are economically not feasible as the transactions cost would be a multiple of its value.
What is the use case for transactions lower than one cent? The venture capitalist and avid blockchain investor Andreessen Horowitz writes about two applications for micropayments. The first one is the transmission of emails – sending an email for one tenth of a cent does not make a dent in anyone’s pocket – but would curtail spam emails. Spammers think twice before sending out millions of emails advertising Canadian pharmacies. Another use case is the payment for online content. Newspapers can hardly charge only one or two cents for reading an article. Here the payment provider’s fee is higher then the amount paid, meaning the newspaper would make a loss with each payment received.
Frankly speaking, bitcoin, the most popular cryptocurrency is not suitable for micropayments. Its soaring price, the necessity for validating transactions, and compensating the validators, leads to prohibitively high transaction fees. The IOTA coin, focused on the internet of things, is a cryptocurrency more suitable for micropayments.
International money transfers in euro within 28 countries (European Union and some countries states), are as convenient as domestic payments thanks to SEPA, the single euro payments area and TARGET2, the real-time gross settlement system for the Eurozone. The fees are low or even non-existent for the two parties of a transaction; the end-to-end payment settlement can be accomplished within one business day; the paperwork is the same as for domestic transfers. And with instant payment coming in 2018, if banks support it, the money must be credited to the recipient’s account within ten seconds, 24/7.
This sounds all great, however, global payments beyond the Eurozone utilize the SWIFT network. Here things look rather bleak. Settlement takes 1-3 days, sometimes longer and the fees can be quite steep – up to 5% of the sum, with a minimum starting at 10 Euro, depending on the bank, or even higher if correspondence banks are involved. (Albeit there are startups with substantially reduced fees or no fees at all, such as transferwise, revolut, azimo and OFX. The last one also catering to business customers.)
Faster international money transfers, even to recipients without bank accounts are offered through financial services companies with branches all over the world, such as Western Union and MoneyGram, or startups such as remitly.
As the blockchain is borderless by design, everything written in the section about P2P payments also applies to global payments. Though, the use case for global payments is much stronger due to the fees and time involved.
Enhancing global payments can go along four ways:
First, cryptocurrency P2P payments that completely circumvent the international payment network, banks and other financial institutions. (Joe sends Jane money via his mobile bitcoin app.)
Second, banks themselves use the blockchain for cross border payments – in this case for fiat money. The Spanish bank Santander, often seen at the forefront in terms of European banking IT, used the Ripple blockchain technology in their app for international payments. Ripple also partnered with SAP and a Japanese bank consortium in this area.
Third, SWIFT, the global payment network, explores ways to use the blockchain to optimize liquidity in the global payment context. This should in the end lead to a reduction in costs. McKinsey writes that the costs for an international transaction is between $25-35 (this includes payment operations, nostro-vostro liquidity, claims and treasury operations, compliance, FX, network management and overhead). To stay competitive, a reduction by 90-95% to $1-2 is necessary. The blockchain might be the right technology to accomplish that.
Fourth, creating a brand new cross-border payment network. See for example IBM. The company announced in October 2017 a blockchain network based on Hyperledger Fabric, a blockchain framework hosted by the Linux foundation and being heavily promoted and supported by IBM. This new payment network is already up and running across the Pacific, Australia, New Zealand and the United Kingdom. This is only one of many IBM’s blockchain initiatives. They have currently 1.600 staff working in this field.
Lending refers in this context to individuals borrowing money. Online P2P lending is quite a new phenomenon, with zopa, founded in 2005 as one of the oldest company in this area. Talking about blockchain and lending can entail two things: First, lending and borrowing cryptocurrencies. To continue on this path, inconvenient questions must be asked, such as: how to tackle a high volatility in cryptocurrencies (borrowing 100 bitcoins where each bitcoin is worth $1 is one thing, but if the value of the bitcoin jumps to $5000, the debtor suddenly owes $500,000), or where to actually spend the borrowed cryptocurrencies. Second, lending cryptocurrencies is certainly a use case. But more interesting is the utilization of this technology to improve many back office processes such as KYC checks and onboarding, loan processing through smart contracts and automatic compliance.
Celsius offers the „future of consumer credit“, built on top of the ethereum blockchain. It tries to get a stake in the US consumer credit market, of which 50% is controlled by 6 banks. The startup aims to build a community of lenders and borrowers that includes social data. The credit score is based on the users’ digital identity. Cryptocurrencies and the US dollar can be borrowed.
A syndicated loan connotes a loan provided by two or more banks. The loan is handled by a syndicate of banks due to the loan size or its complexity. The borrowers are corporations or the government.
Credit Suisse estimates blockchain-based syndicated lending could decrease the costs by as much as 50%. This is through the automation of formation and disbursement of funds. The said bank leads an initiative to develop a distributed system for syndicate loans. The joint venture also includes, Ipreo, a fintech owned by Goldman Sachs and Blackstone. Currently they are in the proof-of-concept phase, but plan to go commercial in 2018.
In another cooperation, seven major US and European banks, such as State Street, ING, HSBC and BNP Paribas have partnered with Finastra, a fintech startup, and R3 Corda, a distributed ledger platform for the financial industry, to develop a syndicated lending system. The project is called Fusion LenderComm. It should help reduce operational risk and administer syndicated loans and exchange information in real-time. As the seven involved banks cover 10% of the global syndicated lending market, a successful move to the blockchain would be a strong signal to the whole market.
Blockchain technology can also lead to lower risks in small business financing which typically have very irregular cash flows. An example is the financial arm of Foxcom that partners with Dianrong, a major Chinese P2P lender, to use its platform, enhanced by blockchain technology, to help finance Foxcom’s suppliers. Payments will be subject to certain conditions, embedded in smart contracts.
Specialized in pharmaceutical companies is Yijan in cooperation with IBM. Their aim is to bring more efficiency and transparency into the Chinese pharmaceutical supply chain leading to a reduction in the payment period. Nowadays it can take 60 – 90 days for smaller pharmaceutical merchants to receive payment after the delivery of drugs to hospitals.
Blockchain technology can also help in countries where fraudulent invoices are common which makes banks reluctant to lend money. If a bank receives an invoice for export financing – how to tell whether the invoice is legitimate or has not been used already several time for receiving loans? On a blockchain network each invoice can be stored, given an identifier and checked against for duplicates and legitimacy.
It is no coincidence that ICOs, initial coin offerings, sound very similar to IPOs, initial public offerings. Both methods are used to raise capital. However, whereas IPOs are heavily regulated, with companies’ obligations and shareholders’ rights clearly defined, ICOs are less so. They can be best described as an unregulated means to raise capital by crowdfunding. The investors, receive for their money so-called tokens. These tokens can entail rights similar to company shares. But they might also be quite worthless. In this case, the investment is best characterized as a charitable contribution.
That most regulators regard ICOs with suspicion does not come as a surprise. Many jurisdictions are working on regulations regarding ICOs. In September 2017 ICOs where banned in China after a huge influx of funding and spectacular scams. The ban is in place at least until the regulators have set adequate rules for this kind of financing.
The SEC has a more nuanced approach to ICOs. As the characteristics of tokens can be freely defined by the company issuing them, it is necessary in the United States to evaluate each ICO independently. In some cases tokens might be characterized as commodities, in others as securities – with vastly different regulatory consequences.
In the first 10 months of 2017, 203 ICOs have taken place, with a total volume raised of more than $3bn. In contrast, in the whole 2016, 46 ICOs where registered, with a total volume of only $0.1bn which is thirty times lower. In 2017 Filecoin received the most cash, $257m (In 2016 it was Waves with $16m). 10% of the tokens were misappropriated by fraud or scam, the ether scam database currently lists 173 active IPO scams.
However, not all is lost with ICOs. Even though many predict the ICO bubble to burst and seriously damaging amateur investors who have no experience with anticipating and recovering from investment losses, a V shaped recovery, similar to the post dot com area is foreseen. As the internet brought us great companies such as amazon and facebook, the world might also experience blockchain-based and ICO-financed behemoths improving consumers’ lives. (See also articles in The Economist and medium addressing this issue.)
Decentralized Clearing and Settlement
In the context of securities, clearing refers to the activities necessary to settle a transaction – an important part of equity post-trade. This is organized through centralized organizations, so-called clearing houses. Their role is of an intermediary between buyers and sellers. Another important term is settlement, which means the transfer of cash to the seller and the securities to the buyer.
In the US, the maximum settlement time for securities is now two days (D+2), which is already an improvement. Before September 2017, the settlement period was three days. (European stock exchanges moved to the two day cycle a couple of years earlier.) Moving the clearing and settlement period to digital records and real-time clearing over the internet would save $20bn annually, according to Santander.
Settlement for other types, such as loans, can be very cumbersome and might take even weeks, as JPMorgan notes. In 2016 JPMorgan partnered with Digital Asset Holding, a blockchain startup, to explore ways to cut trading costs, also in the context of loan settlement. This startup already works together with the Australian Securities Exchange to explore ways to upgrade to a decentralized settlement system.
Almost any US security trade is settled through the Depository Trust and Clearing Corporation (DTCC). It handles 98 percent of all the world’s credit default swaps. DTCC is bringing its operations into the blockchain, which leads to a predicted cost decrease of 20-30 percent and faster settlement times. First, the blockchain will run in parallel to the current warehouse system hosted on a mainframe. But by end of 2018 it is planned to have only the blockchain settling trades. This will be a historical moment, as from then on, the whole $11 trillion global market for credit-default swaps will be settled on a decentralized system.
Other startups working in the area of clearing and settlement are setl and clearmatics.
Proxy voting gives shareholders the opportunity to cast their votes without attending the shareholder meeting. The shareholder sends a proxy card to an agent who votes on behalf of the shareholder. The issues to be voted on are specified on a proxy statement.
A consortium of central security depositories, the CSD working group, has developed a cross-border e-voting system based on the blockchain. The consortium consists of relevant players from countries such as the USA, Russia, Switzerland and Sweden. Also involved is SWIFT and IBM Hyperledger. The voting system is in line with ISO 20022 to use the financial messaging standard. Its aim is to increase transparency reduce time, costs and effort in the voting process – for voters, corporations and regulators. The system should be based on tokens that represent the voting power of the shareholders and automatically allow or disallow voting based on the rights of the particular shareholder. See also the product outline (PDF). Another industry initiative, with members such as Santander and JPMorgan, works on proxy voting as well.
A single-company approach by an heavy-weight in this area is planned by AST. This company manages nearly 20% of proxy votes for mutual funds in the US. From 2018 on, AST plans to offer blockchain-based proxy voting in cooperation with NuAcra, a blockchain-focused solution provider.
A Schuldschein, or a promissory note, is a German debt instrument (Bloomberg calls it by its German name). Is is used for short term financing to provide capital to businesses and combines elements of bonds and loans. The note states all lending terms, such as the sum, period, interest and repayment period. In 2016 promissory notes in Germany had a value of €25bln, with an estimated increase to €28bln one year later.
The car company Daimler, together with a regional German bank (LBBW) launched a one year Schuldschein with the volume of €100m. The whole emission process could be completed on the blockchain. Even though this constitutes only a proof of concept, the Schuldschein is a binding, with 4 banks as lenders, clear repayment terms and interests to be paid.
LBBW is convinced that a blockchain-based Schuldschein note could meet commercial requirements. The bank estimates that efficiency wins of 50% are possible which could give also smaller businesses access to this debt product. The next step would be to gain regulatory approval for blockchain-based Schuldscheins.
Promissory notes are just one example where the blockchain can help to make corporate finance more efficient or even revolutionize it.
Related to a Schuldschein is the commercial paper. It is also issued by big corporations, with maturities of between several days to several years. However, its terms are more standardized and the market volume is far greater.
In September 2017, three German financial service providers, Commerzbank, KfW and MEAG, worked together in issuing a commercial paper on the blockchain with a value of €100.000 and a maturity of 5 days. The settlement time was reduced from two days to basically real-time. This was possible thanks to the the blockchain and fewer intermediaries (a clearing house was not used). A reduction in costs for this and similar activities is welcomed especially in the current low-interest phase as it puts tremendous pressure on the banks’ margins.
Contingent Convertible Bonds
A convertible bond is a bond that can be converted into shares of the issuing company at a predefined ratio. The owner of the bond can execute this right until the maturity date. Usually companies with a low credit rating but high growth potential issue bonds. Investors in bonds are creditors and therefore are repaid before stockholders which reduces their risk.
Contingent Convertible Bonds (CoCo Bonds) are convertible bonds with a twist. The conversion from bond to stock is automatically executed when a predefined event takes place. A popular event for bank CoCo Bonds is the core tier one capital falling below a threshold. CoCo Bonds would help here to meet Basel III requirements to reduce the need for a bailout. Other events triggering a conversion are the company’s stock price.
A study (PDF) of the World Economic Forum suggests enhancing CoCo Bonds with blockchain technology. Here the conversion trigger could be written as a rule in a smart contract, then automatically executed and regulators and issuing bank notified in real-time. This can improve monitoring and increase investor confidence in the CoCo Bond market.
Hypothecation is a practice where assets are pledged as collateral for debt to reduce the credit risk. If the debtor foregoes payment, the bank might repossess the asset. A retail customer comes across this agreement usually when seeking a loan for an asset, such as a house or a car.
Rehypothecation refers to the practice where the creditor uses the collateral to back its own trades. In 2007 rehypothecation reached 50% of the activity of the US shadow banking system. $1trn collateral was used for $4trn of funding by rehypothecation. Meaning that in average each collateral was hypothecated 4 times (PDF). After Lehmann Brothers’ disaster banks were more reluctant using rehypothecation. Now the collateral velocity is only two times (PDF).
There is not much visibility about these collateral chains. This is where the blockchain comes on stage. The blockchain can create an immutable transaction history of the assets. Together with smart contracts, rehypothecated assets can be tracked, settlement time reduced and regulatory requirements faster met.
The blockchain would not only help creditors to make rehypothecation more transparent, but also regulators. Without efficient tracking of the collaterals’ transaction history, regulators are unable to check for compliance regarding the extend to which an asset has been rehypothecated. Blockchain technology helps to make the financial system more compliant and robust, in the end mitigating a possible financial crisis where a default could create a domino effect.
There are three critical conditions (PDF) for a DLT-based asset rehypethecation scheme to work: 1. the assets must be tokenized for tracking and linking them to smart contracts, 2. financial institutions must agree to participate in tokenized asset trading and 3. a blockchain must be developed for all aspects of rehypothecation.
About 2.4bn people in the world lack official documentation which makes it difficult to impossible for them to register property, establish a business or open a bank account. A blockchain-based, officially recognized and tamper-proof digital identity system can directly help alleviate poverty and spur the economic development.
Initiatives by the government to move the citizen’s identity to the blockchain were touched upon in the corresponding section. This can of course also be accomplished in the private sector, even though its scope might be not as far reaching. (Validating the identity for notarial services would probably still require a government-based identity scheme.) A digital identity on the blockchain can offer a tamper-free way for verification and, depending on the implementation, let the individual have control over the access to the identity and the extend of the information shared. This also means the customer needs to upload verifying documents only once. The digital identity can serve as a digital signature assigned to online transactions.
To approach digital identity from a different angle: the blockchain allows decentralized, digital transactions. This necessitates a verified and undisputed digital identity, which is robust against identity theft. A company that tries to accomplish this is civic. They verify the identity and stores it on the blockchain as a hash. When the user’s identity should be authenticated by a company, this can be done via civic. Civic checks the identity the user supplied against the hash on the blockchain.
Know Your Customer
Know your customer (KYC) is the verification of new customers and a regular reverification to prevent money laundering and terrorism financing. KYC regulation is the strictest in banking and capital intensive industries, such as real estate. The procedure varies in length depending on the kind of customer (small retail customers vs businesses vs politically exposed people) and countries involved (low risk vs high risk countries). KYC can be a lengthy and time-intensive process taking up to 50 days.
The blockchain can also be the seed for future bank services. Some financial institutions plot their future in providers of digital identity. Banks could share a KYC blockchain with digital identities of verified customers. The blockchain might even become the foundation for a universal and global digital identity system. This is what IBM is trying to accomplish. IBM and Secure Key Technologies are setting up in Canada a digital identity network for consumers in cooperation with various leading Canadian banks, such as Bank of Montreal, Royal Bank of Canada and Scotiabank. This is built on the Hyperledger Fabric blockchain framework. The digital network verifies the identity to open bank accounts or getting driving licenses. As common with these initiatives, users have control over their data and can determine which entity can access what kind of information. A similar system is in a proof of concept stage in Singapore. Other companies working in this area are Cambridge Blockchain and Blockchain Helix.
Anti Money Laundering
KYC answers the question about identity and AML is about analytics. Together they should prevent illegal money flows and income through illegal actions. Global money laundering is 2% – 5% of the global GDP or $800bn – $2tn in dollar value, estimates the United Nations Office on Drugs and Crime. Efforts to detect and prevent money laundering helps to drain criminals’ resources and reveal their identities. However, anti money laundering (AML) activities do not come cheap. Over the years, KYC and AML regulations has expanded so that compliance has become more and more time- and cost-consuming. The consultancy WealthInsight estimates that AML compliance will reach $8bn in 2017.
A KYC blockchain has been dealt with in the section above. It constitutes a crucial part of AML compliance and detection. As transactions on the blockchain are immutable, including the transaction parties, all transactions can be verified by authorized entities. Of course it is possible to use an open blockchain, similar to the bitcoin as a KYC and AML blockchain, but this would expose to the general public all transactions and parties involved. A feature not applauded in terms of banking secrecy and privacy in general. Therefore, a blockchain must be crafted with a protocol that allows access to the transaction details only for approved parties.
Lastly, KYC and AML processes on the blockchain require international agreement on documentation and verification standards.
The financial sector experiences more economic crime than other industries. More than 48% of all financial sector firms have suffered from cybercrime during the survey period of a PWC study (PDF). In other industries the rate was only 36%. The top 5 types of crimes were, in decreasing order: asset misappropriation, cybercrime, bribery and corruption, procurement fraud and accounting fraud.
A gross example of fraud exploiting the financial system is the Bangladesh Bank robbery from February 2016. With the help of malware, hackers instructed money transfers via the SWIFT network of in total $951m from an account at Federal Reserve Bank of New York belonging to the Bangladeshi Central Bank. Even though the Fed blocked most transactions, the perpetrators succeeded in stealing $81m. In previous years there were similar attempts, partly successful, at other banks in Bangladesh, Ecuador and Vietnam.
Blockchain’s characteristics make it more secure to fraud: it is decentralized and immutable, the transactions enter the ledger only upon agreement by all parties – thereby not having a single point of failure. Blockchain transactions are stored in batches, or blocks, with each transaction having a timestamp and linked to the previous one. Every transactions becomes „notarized“. This is less prone to fraud and cyberattacks than centralized databases, on which traditional banking systems are based on. But not all economic crimes can be prevented by the blockchain. Corruption and bribery would still be hard to uncover.
A further way to reduce fraud is with smart contracts (i.e. transactions are automatically initiated based on conditions) that follow accounting and business rules. For example, a credit line is extended or an invoice paid when certain conditions are met.
Automatic Accounting, Auditing and Compliance
If a blockchain-based financial system is set up with identity authentication for KYC regulations and AML analytics, it is only a natural step to expand this system for accounting, auditing and compliance purposes. Stakeholders having interest in this data are the company itself, auditors, tax authorities, banks, courts and regulators (the Federal Reserve, SEC etc.). In a first step, the company can set up an isolated blockchain for transaction and accounting purposes. However, more powerful would be a joint register for all companies of a jurisdiction.
As transactions are stored immutable in the blockchain, it can lead to a traceable audit trail, automated audit processes and authentication of transactions, see also this article.
For the quarterly reports, an auditor analysis accounting data and works closely with the institution’s top management and accountants to evaluate the company’s financial health (culminating in an independent audit report). This process is resource- and time-intensive and lacks technological integration.
A financial blockchain can bring clear benefits into this process. Financial material can be directly accessible to the auditor, without the involvement of the company’s resources and without manual processes. The auditor’s report can be stored on the blockchain together with the financial information and is readily available to the company and the regulator. This increases transparency, reduces errors and costs and can even lead to automatic reviews. Critical to this system is a blockchain solution that access rights distinguishing between the company, the auditor and regulator. See also the World Economic Forum’s report (PDF) on the future of financial infrastructure.
The Race to the Zero Middle Office
This term first appeared in a Microsoft presentation about the benefits of the blockchain. The middle office in a financial services company is part of the finance department and is in charge of risk management, profit and loss calculation and compliance. The middle office might also assist in trade structuring.
If a blockchain-based accounting system, trading and finance platform are set into place, many processes that are based in the middle office were standardized and automatically executed when certain conditions are met (smart contracts), If then more and more manual processes are sped up by straight-through processing, the need for resources in the middle office would shrink and eventually vanish completely.
The WTO estimates that 80% to 90% of world trade relies on trade finance, with an annual volume in 2016 of $11trn for manufactured goods exports.
In trade finance, risk between buyers and sellers is mitigated through third parties. The most popular trade finance instrument is the letter of credit, according to a survey (PDF) by the International Chamber of Commerce. (Other activities include supply chain finance (factoring and forfeiting), guarantees and documentary collections.) For a letter of credit a bank guarantees that the exporter will be paid when a certain condition has been met. Most commonly this is a shipment confirmation of the goods in the form of a bill of lading.
Trade finance covers not only liquidity but also the uncertainty and increased risk in trade where the exporter and importer reside in different countries and jurisdictions and the goods might take a month or longer to arrive at their destination.
Blockchain-based trade financing could lead to several benefits, culminating in the automatic issuance of letter of credits, such as: real-time review documents, automatic factoring, reduced counterparts risk, guaranteed proof of ownership, automated settlement and regulatory transparency (KYC, AML), see also (PDF).
There are several blockchain-based initiatives in trade finance. For example, IBM launched a global trade finance platform called Batavia with five participating banks, that are Bank of Montreal, CaixaBank, Commerzbank and Erste Group. The platform will allow tracking and observing the shipment progress from the warehouse dispatchment until the arrival at the port of destination. This should reduce the time and cost of providing trade finance. Smart contracts should release the payment based on specified rules. Access to the platform will be granted to banks, regulators, exporters and importers. In another IBM project, seven European banks are building a finance platform for SME trade within Europe. Especially for small businesses there is a need for trade finance, as they face difficulties to access trade finance instruments.
In another initiative, the blockchain consortium R3 together with 12 banks work on an open-account trade finance project. Its aim is to provide a repertoire of tools for all trade finance parties (such as exporters, importers, banks, insurers and logistic companies). This includes a core infrastructure, APIs and contracts.
Blockchain for trade finance can also help to mitigate fraud. A common platform for financed transactions by other banks would prevent the issuing of multiple loans for the same invoice. The DBS bank of Singapore works to tackle this problem with blockchain technology.