Blockchain – disrupting the future of banking and legal services?
April 2016 | SPOTLIGHT | BANKING & FINANCE
Financier Worldwide Magazine
Most people have heard of Bitcoin, the modern electronic currency that operates outside the traditional auspices of state control. However, few have heard of Blockchain, the technology which underpins Bitcoin, which has the potential to revolutionise the provision of legal services, compliance and regulatory enforcement.
Whilst it was Bitcoin that initially hit all the headlines, there has been a more recent realisation that the public database upon which Bitcoin was built, Blockchain, can be used for far more than just a currency as any type of data can be shared on the ledger. Major banks, global companies and start-ups are now investing millions of pounds into exploring the possibilities of developing this new technology for their own purposes.
What is Blockchain?
Blockchain is essentially a decentralised, distributed public ledger that can be spread across multiple sites, institutions or jurisdictions. Entries into this database are stored in blocks of data, chained together using digital cryptographic signatures. These entries are immutable with subsequent entries built upon previous records, giving a perfect timeline of events, amounting to a recorded factual chronology or audit trail. Changes in one block are reflected in all blocks and modification requires access permission as well as a digital signature. This combination of ‘time-stamping’ with digital signatures allows, in theory, ‘the middle man’ to be removed from many types of transactions, ranging from the settlement and clearing houses which act between major financial institutions, government registries which confirm transfers of land, to lawyers who confirm and settle contractual arrangements.
In January 2016, R3, a consortium of investment banks, announced that 11 major banks – including Barclays, HSBC, Credit Suisse, UBS, Royal Bank of Scotland and Wells Fargo – had simulated trading on a decentralised platform, directly, without using settlement or clearing houses. The potential benefits for the global financial services industry are clear both in cutting costs and labour – middle and back offices could be slashed with the time it takes to process a transaction being seconds rather than days.
However, from a UK regulatory perspective, many questions remain unanswered. If Blockchain provides the perfect, incorruptible record of events, should the regulator have unfettered access? Are regulators ready for these potentially fundamental changes in payment systems, settlement and technology? From a practical perspective, it may take many years for legal frameworks to catch up. The operators of Blockchain systems may need to seek exemptions under the Financial Services & Markets Act 2000 if they are deemed to be central counterparties or clearing houses. Further, if the technology is used as a mechanism for making payments (like Bitcoin), there may be scope for authorisation as a payment services provider under the Payment Services Directive (in the UK, the Payment Services Regulations 2009). Where Blockchain is used in relation to the sale and purchase of financial instruments, consideration needs to be given as to whether regulation as a multilateral trading facility or systematic internaliser is needed. Perhaps, most importantly, Blockchain needs to be considered in the context of the current clearing requirements in MiFID. With MiFID 2 and the Payment Services Directive 2 on the horizon, the opportunity for change and to embrace Blockchain is there, if governments and industry bodies are willing.
The Walport review
The UK’s chief scientific advisor, Sir Mark Walport, has recently urged the government to lead the way in the use of digital ledger technology, in order to make the delivery of government services more immediate, personal and efficient. He suggests that the technology can help governments “collect taxes, deliver benefits, issue passports, record land registries… and generally ensure the integrity of government records and services”. He recognises the benefits that can be brought to both public and private sectors, and emphasises the need for the UK to be at the forefront of adoption of Blockchain, given the UK’s reliance on the financial and service sectors to support the economy.
Some governments have already made strides in this area – Honduras and Estonia are using Blockchain technology for land registrations and government records and in the US the state of Vermont is in advanced consideration of using the technology to track its public records.
Blockchain is already pushing the boundaries of traditional legal services. The technology has brought about the advent of ‘smart contracts’, where contracts are executed based on the fulfilment of conditions logged on a shared database. Working on the basic premise of “if conditions A, B and C are satisfied, X can happen”, examples of contracts that seem, initially, suitable include wills, trusts, title registries and shareholder agreements. A trust, for example, could be arranged to automatically pay out to specified benefactors when a death is registered. Contracts placed on the Blockchain are easily accessible by those that are entitled; they are not hidden in a filing cabinet. The potential implications include reduced costs, more automation in the legal sphere, more certainty and less litigation.
The potential disruption to traditional banking and legal models is apparent. If we consider the way technology has rapidly changed how a broad range of business is conducted from the introduction of Uber, Netflix, Twitter, social media and the internet generally, to the rise of Amazon and the fall of general retail, there is no reason why financial and legal services should be an exception to these changes. Of course, the use of shared ledgers with all the benefits outlined above and myriad other possible uses, which are only on the cusp of being explored, may sound too good to be true. As with any information space, it relies on the correct information being uploaded in an honest fashion. There will always be those who wish to keep their transactions offline and in the real world, the human element creates ambiguity and often confusion, mistakes are made, checks and balances are not implemented correctly. For these reasons, the creation and maintenance of such systems needs to be carefully managed. The robustness of technologies will always be challenged by those with both good and bad intentions so, whilst change is inevitable, there will always be contention and litigation, rule-breakers who need regulation and enforcers to curtail them.
What is clear is that as technology and its application moves forward, bankers, lawyers, politicians and regulators need to keep pace. The potential of Blockchain is obvious, but it remains to be seen if it leads to seismic change.
Karim Bouali is a partner at CCG Legal. He can be contacted on +44 (0)207 760 7590 or by email: firstname.lastname@example.org.
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