Blockchain Standards for Financial Services Industry
The financial services industry is moving towards a blockchain-based future. It is hard to estimate current timelines, but the days of trials and experiments are over. NASDAQ’s Linq service is already live. Overstock’s T0 platform is ready for prime-time. Digital Asset Holdings likes to keep its cards close, but everyone expects the company to release a working real-market product soon.
Many consortiums, from R3 to Hyperledger, are trying to standardize elements of the blockchain industry for the financial services sector. Blockchain standards will become increasingly important in the future. It is essential for interoperability, which will be a huge challenge. How can you make atomic transactions between two private ledgers? If everyone built on top of a public blockchain like Bitcoin or Ethereum, the problem would be much easier to solve. However, the financial industry is taking a different approach with private blockchains.
The biggest challenge going forward would be the settlement guarantee. In a private blockchain, there is essentially no settlement guarantee mathematically like Bitcoin. The validation comes from the participants deciding what is valid. Presumably, many of these blockchains may even be “reversible” in certain situations. Therefore the idea of atomic transactions is tricky.
Consider a blockchain being run for a certain post-trade process by American banks, and another blockchain being run for another post-trade process by a Chinese consortium. Does it even make sense to assume “transaction finality” for an atomic transactions between these two blockchains? With Bitcoin the answer is a very simple yes, but with private blockchains, it depends on what the capabilities are of each system when it comes to reversing transactions, and the trust, externally, placed in each other mutually.
In addition to the issues of atomic transactions, the financial industry needs to work on blockchain standards. To be sure, there are two different and disparate types of standards that need to be worked on by the industry at large –
- Standards around blockchain itself (UXTO model vs. account-based model being an elementary one). Groups like Hyperledger presumably are working on this problem.
- Standards around the data represented in the blockchain. This is a problem that is being tackled every day today by standards committees and organizations like SWIFT.
The blockchain standards are an ever-evolving set of architectural trade-offs based on the requirements of the participants. However, any blockchain will also require standards or reference data on which it relies. For example, there may be multiple blockchains that trade a futures contract. However, what data is required to represent a futures contract is fairly standard and something that the industry already does. This has nothing to do with the architecture of the blockchain itself. In most cases, the existing reference data for financial transactions can be used for blockchain implementations of existing financial contracts.
SWIFT already specializes in this type of reference data. Even basic reference data like currency codes, country codes, etc. need to be standardized across various blockchain implementations if there is any hope of good interoperability. Standards like ISO4217 should be used. These should supercede any decision on blockchain architectural references themselves.
The second set of standards is tricky. There are many parties in the blockchain space today. It is still unclear whether we’ll end up with a mess of different blockchains, or whether there will be single universal blockchains. Given the scope of the problem, it may or may not even be up to the financial services industry to define the standards. The financial industry isn’t exactly known for its technical competence, and it is possible that a Silicon Valley will define blockchain standards much before the banks agree on anything.
Embedded within the idea of standardizing blockchain implementations is also the idea of standardizing smart contracts. If you would like to represent a call option on a bond with a smart contract, that implementation can be generalized for all blockchains, assuming there are multiple blockchains in play. We already have, fairly well-defined in the financial industry, what these financial contracts stand for, and what they do. Smart contracts can help automate business logic and reduce legal costs. The push to standardize smart contracts could come from the industry or from regulators. The global nature of this will also make it tricky to coordinate.
In conclusion, the financial industry should use existing standards for data whenever it can, instead of reinventing the wheel. For blockchain-specific technologies, they should take a longer term view that benefits the industry by utilizing standards instead of trying to do it alone.