Considering a Pragmatic Approach to Blockchain Implementation

March 15, 2017 - Blockchain
Considering a Pragmatic Approach to Blockchain Implementation


Henry Hilska is Founder and Managing Principal at Convexity Solutions, a consulting firm created to assist clients in financial services apply emerging technology to improve business processes.

The current implementations of distributed ledger technology clearly are not the Blockchain that underpins the virtual currency Bitcoin. The tools and platforms such as the offerings from Digital Asset Holdings and R3 Corda are offered as a pragmatic answer to a set of current business, technological and regulatory challenges. By implementing the appropriate use cases, firms can avoid the current challenges exhibited by the Bitcoin example – including scalability, latency and privacy – that make the current public Blockchain model a non-starter for banks.

There is an increasing amount of conversation related to the emerging technology called by the now over-used name Blockchain. It seems an ironic use of that name, since much of the actual news these days concerning solutions under development is likely not a Blockchain solution at all, but a different form of distributed ledger technology (DLT). If we can put semantics aside, the basis for the excitement is based on the Blockchain concept which underpins the Bitcoin platform for a distributed and immutable ledger facilitating the exchange of the virtual currency.

There are several DLT platforms that are receiving interest from the financial services community that leverage some aspects of Blockchain. Among them is Corda, which is being developed by R3, a fintech focused on DLT. A visit to the Corda website finds that they do not call their platform Blockchain, as that word does not seem to even exist on their website. The message is clear that the platform is designed for financial services – not surprising, as R3 has been heavily funded by several large banks and others. The platform is designed to not share all transaction data across the network, as the access to transactions is restricted to only those needing to view or validate them on a case-by-case basis. This access is limited to the parties to the transaction and potentially regulators or central authorities. This form of private ledger does not share the vision of Bitcoin, the public network where the transactional history is shared by all nodes. Corda supports multiple consensus algorithms, which provides flexibility to comply with different regulators but also differs from the use of miners found in the Bitcoin world.

Another example are the tools being offered by Digital Asset Holdings. Digital Asset utilizes a form of private DLT, Hyperledger, which is not a true Blockchain. Like Corda, Digital Asset exists to support banking and capital markets and central authorities such as exchanges and CCPs. Like the Corda platform, not all the transaction data stored on the Digital Asset platform is replicated across all the nodes. This data is shared only by those involved in the transaction. Digital Asset differs from other platforms as it employs a form of XML called DAML (Digital Asset Modeling Language) utilized to develop Smart Contracts, which automate the execution of contract terms related to the exchange of assets that interact with the Hyperledger.

However, a common thread among these platforms and Blockchain is the use of cryptography and some form of consensus algorithm, such as Practical Byzantine Fault Tolerance (PBFT). PBFT is effective in asynchronous environments such as the Internet, where the need to maintain high availability and provide the capability to recover from bugs, errors, and malicious cyber-attacks is critical.

There is some debate about the development of these private networks, as the focus moves away from Bitcoin to a continuous stream of new ventures, alliances and projects on different platforms. It seems these days that everything, even technology, can be prone to hyperbole. The groundswell of excitement for a technology such as Blockchain has created an unsurprisingly opposite reaction as well from skeptics who are beginning to line up to rain on the parade. However, both arguments seem to suffer from the same hype.

The issue is that they are both looking at Blockchain as something being either black or white. Some supporters of this emerging technology believe, unequivocally, that we are on the cusp of a disruption that will change the world as we know it. On the other hand, there are the skeptics. While I would not want to lump them all together, there are certainly some skeptics who are threatened by the new technology. This includes those who may have some vested interest, professional or financial, in alternative or legacy tools and technology, as well as those who fear the focus is moving away from what they believe is the promise that a true public Blockchain can provide. Legitimately, there is reason to be skeptical from a technology perspective. After all, science is built on healthy skepticism and experimentation.

In the discussions about how the implementation of these private networks, such as Corda and Digital Asset, are moving the focus away from the true value of Blockchain, one very important point can be missed: Currently, there are several serious challenges that create headwinds for the large-scale implementation of a true public Blockchain. There are issues with scalability and latency with the Blockchain model that utilizes cryptographic algorithms and shares the entire transaction history across every node in the network. Currently, there is no solution to this problem, as Blockchain does not provide the speed that is available using current technology. Use cases involving equity trading execution or card processing require execution cycles that DLT cannot currently provide. This explains why the current focus has been on creating post-trade processing solutions, such as for securities or derivatives settlement.

Another challenge for the technology relates to privacy laws. Several nations maintain data residency requirements. This means that any data that includes personally identifiable information (PII) may not reside outside of their national borders. Some other countries are not as restrictive but still limit access to personal data requiring strict role-based permissions, data masking and other techniques. These rules have an impact on the potential architecture, functionality and the ability to implement a public Blockchain solution. Additionally, if we consider the use of a public Blockchain that includes no central authority and is anonymous, how can sanctions and anti-money laundering regulations be monitored and maintained? This creates a major hurdle to obtain regulatory approval of any solution having this issue.

Is half an apple better than no apple at all?

Obviously, there are several technical and regulatory issues that remain to be solved before a true public Blockchain model will become viable. So what becomes of the work developing private networks that is ongoing with Corda, Digital Asset and others? There is much potential value to be gained from the implementation of a private DLT platform. The implementation of some form of DLT and Smart Contracts for the appropriate use cases may provide advantages in efficiency and maintaining audit trails over other alternatives. However, when considering any IT implementation, it is important to choose the appropriate technology for the business problem you are trying to solve. The solution should never try to find the problem.

Thus, banks and other institutions must avoid considering use cases where latency and other technical or regulatory limitations would affect the success of the project. This may include maintaining the status quo by utilizing a central authority to avoid additional and unnecessary regulatory entanglements. Currently, regulators are providing varying degrees of support for the implementation of DLT. The Monetary Authority of Singapore (MAS) is directly promoting both securities settlement and cross-border payments using DLT technology. On the other hand, while some regulators have voiced concern for existing rules such as AML, most seem to be taking a more wait-and-see stance. It is critical to perform the appropriate planning, including viability and readiness assessments, prior to any potential rollout to ensure that the appropriate use cases are considered and that the integration to legacy systems is thoughtfully designed and executed. Institutions must be aware that business operating models and processes will be affected. Change management will also be an important consideration.

The discounting by the skeptics of efforts being made by those as varied as DTCC, the recently announced Enterprise Ethereum Alliance or MAS truly miss the point that this will be an evolution and not a revolution. The fact that these platforms do not provide what many consider a pure Blockchain or are being implemented with a profit motive seems to bother some in the Blockchain community. Any new technology that is to be implemented successfully on this scale will need investment from many parties. It will need that investment in start-ups and by established players, such as Microsoft and IBM, to overcome the current technological challenges. It will need investment from large institutions to spend portions of their IT budgets already strained from maintaining legacy systems and trying to keep up with emerging requirements of digital banking and changing regulations.

If we look back at the history of other technologies that have brought a paradigm shift, many have taken time; even years to replace legacy business models and systems. The development of a mature DLT platform will take time as well. The current implementations of DLT clearly are not the Blockchain that underpins the virtual currency Bitcoin. The tools and platforms such as the offerings from Digital Asset Holdings and R3 Corda are offered as a pragmatic answer to a set of current business, technological and regulatory challenges. By implementing the appropriate use cases the potential impact of the current challenges inherent in the Bitcoin example – including scalability, latency and privacy – will be reduced. These challenges make the current public Blockchain model a non-starter for banks.