Banking, securities transactions, healthcare and financial services are among those most affected
By Robert C. Hackney
Financial Services
The financial services industry will undoubtedly be the first major industry to fully morph due to blockchain technology. In the past few years, the financial services sector has recognized the potential benefits of Blockchain technology and has begun to embrace it, more than any other business sector. For example, it is been estimated that 16% of all banks are either exploring the use of Blockchain technology or are actively attempting to implement it, and that 60% of all banks will be using some form of Blockchain technology by 2020.
Even though the United States has the largest, most developed, most sophisticated, and most pervasive financial markets in the world, they suffer from slow and sometimes unreliable back office technology. Delays in processing transactions are commonplace. For example, there is a system known as SWIFT which handles millions of transactions per day for thousands of financial institutions, but even according to their own website, it takes days to settle those transactions.
Most people are aware of the Automated Clearing House (ACH) system, which handles literally trillions of dollars of transactions every year, and which is also hampered by slow clearing. The worst of all are the trades involving bank loans, which take an average of 23 days to settle, according to Bloomberg. Most syndicated loans take weeks, and corporate and municipal bonds and stocks are on the three day settlement cycle known as T+3. Now compare all of those to any given bitcoin trade on the blockchain, which settles in ten minutes. These examples show why this industry is ripe for disruption.
Why is speed so important in these transactions? Simply because it eliminates or limits risk. Simply put, will the other side of the trade default? Do we really want to wait 23 days to find out? Or even three days? Time delays also contribute to the risk of middlemen making mistakes or of third parties perpetrating a fraud.
The first area that we should delve into is banking. Blockchain technology became such a hot topic in the banking world that nine of the biggest banks in the world created a consortium in 2015 called the R3 Consortium. The purpose of this group was to decide upon industry standards for Blockchain technology in banking. You know that this is serious when you can get JPMorgan, Credit Suisse, Goldman Sachs, Barclays and other similarly situated players to come together to work out standards. As of this writing, the Consortium has grown to approximately 200 of the world’s leading financial institutions.
In an interesting development in late 2016, Goldman Sachs and Santander both withdrew from R3. Some industry sources state that Goldman was unable to reach terms relating to a new R3 funding. Both Goldman and Santander are also investors in Digital Asset Holdings, which is viewed as a possible competitor to R3. At any rate, most sources feel that this is not a step away from Blockchain technology by either party.
In the corporate world outside banking, another group was formed known as the Hyperledger Project. Hyperledger is not designed to compete with R3, and in fact, many R3 members are also Hyperledger members. Hyperledger has tasked itself with designing a blockchain for business, and is an open source project.
One of the biggest players in the banking sector is Ripple Labs, Inc. Ripple has been extremely active in the banking area since 2013. Ripple, which started as OpenCoin, began by developing the Ripple Transaction Protocol (RTXP), which allowed direct transfer of money between two parties. This permitted the users to go around the correspondent banking system and to avoid fees and time delays. Ripple uses a consensus process that allows for payments, exchanges and remittance in a distributed process.
Focusing on payments and remittances, Ripple protocol was adopted by more and more financial institutions. The first bank to use Ripple was in Germany, followed by a US bank based in New Jersey, called Cross River Bank. In 2015, the company began implementing an international money transfer network.
Earthport, which provides a global payments service partnered with Ripple Labs in 2015, combining Ripple’s software and the Earthport payment services system. Earthport has operations in over 65 countries and has a client base that includes HSBC, Bank of America, and other large international banks.
One of the greatest benefits of the Ripple protocol is that it allows the many different systems used by different banks to communicate directly with each other. Ripple can simply be incorporated into a banks existing computer system.
The payments and remittances area is not just for global bank-to-bank transfers but any exchange of value over the internet peer-to-peer. Many industry sources believe that transfers between participants in Africa is highly likely to result in digital currencies being created designed to avoid the high exchange costs of remittance players like Western Union and others.
We mentioned the slow settlement process for certain types of debt. Digital Asset Holdings, a New York based company is developing a blockchain based system to settle syndicated, or pooled, corporate debt. They are also working on a system that would record and settle short term government debt using a distributed ledger process.
Clearing and settlement are a prime focus of many entrepreneurs in the banking sector. Clearing and settlement costs billions and it is estimated that digitizing this using blockchain technology over the Internet, will save the industry $20 billion a year in overhead costs. With settlement taking three days in many instances, all counterparty balances must be matched, reconciled and resolved across a global trading system on an intra-day, end of day and after three days system. This global trading system involves thousands of investors, day traders, pensions funds, market makers, and assert managers. This three day clearing system is why we have custodial services (CSDs), central counterparty clearing systems (CCPs) and complex collateral management.
Along with Digital Asset Holdings, other players today are Overstock, Epiphyte, Clearmatics and SETL. These companies, and perhaps even one that has not yet been formed will someday control a new clearing system based on the blockchain.
Healthcare Industry
While we are a few years down the road in the financial services industry with the acceptance of the concept of the Blockchain, it is only now beginning to resonate with the healthcare industry. As far as market size and effect is concerned, the healthcare industry is on par with the financial services industry (the tech side of which is commonly referred to as Fintech).
Computer services vendors dealing with the healthcare industry have now begun to understand the potential effect of Blockchain technology, and are exploring its uses. Cybersecurity is critical in healthcare just as it is in financial services. The interoperability issues that relate in financial services are similar to those in healthcare, where patient data transfer, as well as security, are key issues. Interoperability relating to insurance matters is another area of interest, and wellness programs and patient follow up procedures are all areas where Blockchain technology could be utilized. Can healthcare be streamlined by Blockchain technology?
How can we expect this wonderful world of Blockchain technology in the healthcare industry, when, as one industry source has noted, “many hospitals can’t even generate a PDF containing a single patient medical record?” The only answer to that is that the hospitals will have no other choice, it will be demanded by patients, by doctors, by insurance companies, and ultimately by the government.
Privacy is the key to healthcare records, and Blockchain technology has the potential to provide privacy like we have never had before. Will it be implemented? The assumption is yes, the question is when. The following is an example of one scenario.
Estonia is a very small country, but when it comes to digital solutions, it has a big footprint. Estonia has become known for its e-government services, which relates to a variety of information and services to its citizens. This e-government system uses a chip embedded ID card that give its holders access to over one thousand government services, including the filing of tax returns, and voting.
Part of this program was the creation of the Estonian eHealth Foundation. More than 10,000 professionals are now using the system, which contains 1.3 million patient records in the National Patient Portal. In the Portal, the patients have access to various medical documents, like physician’s notes, responses to referrals, e-certificates, ambulance cards, prescriptions, data concerning health insurance, and information about the family physician. The Portal may also be used to create instructions concerning blood transfusions, organ donation or donation of one’s body after death.
Recognizing the significance of Blockchain technology, the Estonian eHealth Foundation entered into a venture with Guardtime to integrate the keyless signature infrastructure blockchain developed by Guardtime, into the Foundation’s Oracle database. Guardtime believes that this will create tamper proof and secure electronic medical records for the 1.3 million users. To me, this is a massive real-time test for the application of Blockchain technology to the area of medical records. The world will be watching this project very closely.
In early 2016 the National Institute of Standards and Technology (“NIST”) announced the Blockchain Challenge for the healthcare industry. According to the Challenge “The Use of Blockchain in Health IT and Health-Related Research Ideation Challenge solicits white papers on the topic of Blockchain technology and the potential use in health IT to address privacy, security, and scalability challenges of managing electronic health records and resources.” In September of 2016, a total of 15 white papers received cash awards from $1,500 to $5,000, and 8 of them were invited to present their papers to a workshop with the NIST.
The papers cover a variety of subject matters. We will attempt to summarize some of the highlights.
Enhanced data sharing, through different methodologies, was the most addressed issue. Next was using Blockchain technology as an electronic medical record, with five papers focusing on that area. The access and free use of patient data by researchers was the topic of three of the white papers.
Protecting patient privacy was the subject of two of the proposals, and optimizing claims management was also the subject of two proposals. Other areas addressed were managing patient identities, measuring and documenting treatment outcomes and documenting and managing care plans.
Some of the papers were submitted by very large companies, for example, IBM submitted a white paper focusing on 16 prospective uses of Blockchain in the healthcare industry.
One of the more promising projects is known as MedRec, which had been created before the challenge. MedRec seeks to manage patient data, and its goal is for the system to be used on a lifelong basis. In what seems to be a non-sequitur, it seeks to provide maximum transparency while preserving patient privacy. The system is designed to allow patients to manage their medical records on the Ethereum blockchain, and give permission to family members, guardians, doctors and others to gain access to the records.
Another company in the healthcare field is Gem Health. Gem has partnered with Philips, to explore what they refer to as a “patient centric approach to healthcare.” The areas of focus for Gem appear to be electronic medical records, global patient ID Software, Wellness Apps, medical inventory management, and rehabilitation incentive programs.
How many times have personal injury lawyers suspected that notes on medical records were added, changed and deleted when they have obtained access to them in litigation? The elimination of that fear could bring a lot of certainty, and may even promote early settlement of some cases.
HealthCombix, founded in 2016, describes itself as an “incentivized, block-chain based community care platform supporting family, friends, and community-based care through patient “health challenges,” leveraging behavioral economics, social networking, cryptocurrency rewards, and nursing oracles.” Its intent is to reduce costs and improve patient outcomes. Its goal is to improve delivery of patient care and medication management. It coordinates between healthcare, pharma and insurance and eliminates middlemen.
It has been reported that even IBM Watson and the FDA are exploring the use of blockchain for secure patient data exchange.
The question remains, how long will it take before some of these systems are implemented? The answer to that is probably not very long, particularly if there is a major event that cripples a major company’s ability to access its medical records.
Effect on the Corporate & Securities World
Similar to the banking world, there is a lot of action going on in the corporate and securities world that relates to Blockchain technology.
We have previously alluded to Digital Asset Holdings, Inc., a New York company run by Blythe Masters. Ms. Masters, a brilliant former JPMorgan employee, is credited with creating what became known as the credit default swap. In an attempt to remove risk from the JPMorgan balance sheet, she got third parties to protect the bank from default by paying them a premium for taking on the risk. After serving as the head of JPMorgan’s global credit derivative unit, she left and soon after joined Digital Asset Holdings as CEO, after recognizing the potential of Blockchain technology. Digital Asset Holdings develops applications in a number of financial services areas including loans, securities, derivatives, and foreign exchange.
There are so many projects going on in this sector, that it is hard to determine which to discuss, but we will give you a sample of the kinds of activities that are in development, and keep in mind that there are plenty more.
If you are still not quite sure the world is changing in leaps and bounds, take a look at the stock offering for Overstock.com, which took place way back in June of 2015. The Securities & Exchange Commission, an organization steeped in tradition and never one to quickly embrace change, approved the issuance of securities by Overstock in a digital format on a blockchain distributed ledger. Of course, these digital shares are still subject to all of the traditional federal and state securities laws, but just to allow such a thing is mind boggling to anyone who has had to deal with regulators in this arena.
About a year later, the state of Delaware launched the “Delaware Blockchain Initiative” which is designed to incorporate the entire blockchain concept, along with smart contracts, into Delaware law. A review is ongoing to determine what, if any, updates and changes are needed to Delaware corporate law to facilitate the use of Blockchain technology and smart contracts.
In March of 2018, the State of Wyoming passed five pro-blockchain laws in an effort to become the leading state in promoting the use of blockchain technology in corporate and securities law matters.
From Overstock to Nasdaq in a year. Hard to believe, but in late 2016, Nasdaq launched Linq, which is designed to allow private companies to issue shares digitally using blockchain technology. Nasdaq sees this as a private network, and is focusing on the main issues of interoperability. Nasdaq has chosen the initial participant companies, some of which are involved in blockchain technology as part of their business model. Obviously, the technology is not perfected, but this pilot study has generated a lot of excitement about its potential.
One of the initial participants in Linq is Chain.com, which is a blockchain developer. Chain issued shares to a private investor using Linq, thus eliminating the need for a paper stock certificate and simultaneously embedding the digital ownership throughout the Linq network. By also permitting the completion and execution of all necessary subscription documents online, the settlement time on the transaction was reduced to minutes.
Since Nasdaq provides technology, support and assistance to many capital markets other than those based in the United States, it is seeking to have other capital markets use compatible versions of blockchain technology to address the interoperability issues up front.
Nasdaq owns the Tallinn Stock Exchange in Estonia. This exchange is the only regulated secondary securities market in Estonia, a country that is devoted to developing internet based operations for all of its government functions.
As is usual in growth industries, there are offshoots of entrepreneurial companies. One such case is Funderbeam, which is working on building a form of a stock exchange for startup companies. Funderbeam was founded by the previous CEO of Nasdaq’s Tallinn exchange in Estonia. Funderbeam is attempting to address the issue of the non-liquid nature of investing in early stage companies whose securities do not trade on an exchange. The way they see it, a young growth company continues to raise private funding, but there is no interim way out for an investor, they must wait for such a company to actually “go public” on a recognized exchange to have any chance of an exit strategy. Funderbeam wants to address the illiquid situation by creating a secondary trading market that is transparent and trustworthy, ie: a blockchain based system. Funderbeam not only permits trading of securities on a secondary basis, but also permits startups to raise funding on their site. As of the date of this publication, Funderbeam is operating.
When things like blockchain come along, organizations soon follow. The Wall Street Blockchain Alliance (WSBA) is a 501(c)(6) non-profit trade association created for financial market professionals. Its goal is to “guide and promote comprehensive adoption of distributed ledger technology across financial markets.” The WSBA describes its mission as standing “as a neutral, unbiased steward of education and cooperation between Wall Street firms.”
It is also interesting to note that the Financial Industry Regulatory Authority (“FINRA”) issued a 21 page report in January, 2017 discussing the implications of blockchain technology and seeking comments from the public. Their report is entitled “Distributed Ledger Technology: Implications of Blockchain for the Securities Industry” and can be found on their website at finra.org
Many in the world of finance believe that 2018 and 2019 will be the years of massive change and innovation relating to blockchain technology. This does not mean, however, that blockchain will be fully developed during those years, but its direction will become more identifiable.
What this means for you as a business owner is that you need to keep abreast of developments relating to the use of blockchain in your industry. Don’t become the taxi cab company owner that wakes up one day and has been put out of business by Uber.