Bank Consortium CEO Wants to Build the Microsoft of Blockchains
Royal Bank of Canada's chief executive, Dave McKay, says the company could roll out a loyalty system kept on a blockchain next year as it experiments with distributed ledgers and looks to enhance its mobile wallet.November 11
There is a time, a place and a customer base for pseudonymous cryptocurrency. For regulated financial institutions, other types of shared ledgers those whose validators are legally accountable for certain terms of service may provide unique utility.November 3
October saw the three main card networks invest in bitcoin-related companies, which comes on the heels of major banks exploring the use of bitcoin and blockchain technology to solve some industry pain points.October 29
Thirteen banks have joined an alliance to develop commercial applications of distributed ledger technology in the financial industry.September 29
The management team of R3 CEV thinks blockchain is going to revolutionize the financial services industry.
But before it can truly be built up, there is a need for a solid foundation. And that is what the consortium backed by some of the world's largest banks is looking to do. The group currently has 30 members and is expected to announce more in coming weeks.
Don't call it a standards board, though — it is at its heart a software developer trying to get all the stakeholders on the same page, said David Rutter, chief executive of R3. Rutter previously oversaw the electronic broking division of ICAP, a global interdealer brokerage.
Rutter, joined by Charley Cooper, managing director of business development and marketing for the group, recently sat down with American Banker to discuss the venture. The following is an edited transcript of that conversation.
What is R3's business model?
DAVID RUTTER: There are three broad things we want to do.
We are engineering a fabric layer — to build out a shared ledger architecture that is fit for global financial institutions. … If you think shared, distributed ledgers or blockchains are going to be a fundamental part of the way operations work in global finance for the next 20 years, it is a good exercise to make sure that the foundation layer can meet all the requirements. We hope others will build upon this base layer and we will eventually be putting that into an open-source foundation.
We are also creating a lab where we are supervising experiments for all of our members on various use cases. In the past, the banks have done a lot of work on their own, and in several instances, they've drawn different conclusions on the same experiments. We are going to have a structured lab for them to participate in with the supervision of R3, which brings a technical discipline to make sure the experiments are run in a controlled fashion.
The third component is to build solutions for various operational processes. We are taking a thoughtful approach to choosing our use cases in part because we are not venture-backed. We don't have to spin up some use case and promote how we are going to make billions of dollars in a short period of time. So, build the foundation first, then have a lab where very smart people come in and test proof of concepts. From there, we pick what we build to commercialize it.
What will this look like in five years?
RUTTER: Our hope is that R3 will be to commercial-ledger solutions what Cisco is to routers, Intel is to chips and Microsoft is to software. What Microsoft is to software is probably the best analogy because we are going to be providing software solutions. The point is that we hope to be one of the most respected in these types of solutions. There will be others, of course. But we hope to be best of breed in delivering software to increase efficiencies, reduce capital charges and lower costs and create new product opportunities.
CHARLEY COOPER: I'd add that the benefits that accrue to our consortium members also accrue to their clients. The idea is not to be a company that just caters to the banking community, but to change the way the financial services industry operates.
You started with nine members and the company now has 30. Was it a push or a pull to ramp up?
RUTTER: We haven't done an outward reach to anyone since August. They've all called us. We started with the banks. We intend to be inclusive of all the major financial institutions. We started with banks and we have to be realistic given our resources. We have to make sure we are not distracted from our goals by building a super large group of financial institutions just to say we have them. But we have begun to talk to buy-side accounts. For example, if we can shorten settlement times to release capital to the dealers, the dealers could then use the capital and that would add liquidity to the market. So, we are listening to buy-side guys. But the banks have been at this for a while and their innovation labs seem to be further ahead than any of the other financial institutions we've talked to.
How are you different from the other ledger companies that are doing similar work?
RUTTER: If you're a startup and you raise venture funds, you have to promote a product that has a rather rapid adoption and creates revenue quickly. You have to sell a story. The global financial systems are very old and because they are so entrenched it is going to take a while for this technology to take hold and be adopted. The transition from the current state to the future state is quite difficult and could take a lot of time. We are different in that we don't have to sell a story. We can take our time and make informed decisions.
COOPER: The venture capital model is really quite different. There is money flying around and people pitching interesting products, but they are going to go to the banks and say, “Here is what we built. Do you like it?” That's a high-risk proposition. You're guessing what they need. You're guessing that it is going to comply with laws and regulation. David and his co-founders went to the ultimate customers first and said, “We are willing to lead this. We will hire the people. We will put in the effort, but come with us at the beginning and tell us upfront what you want us to build.” It is not guesswork for us.
Where does R3 stand on the issue of private versus public blockchain? Do you see any value or application for banks from the public ledger?
RUTTER: Banks in today's world have a tremendous amount of trust amongst themselves already. There are processes in place already where they transfer back and forth billions of dollars all the time. Very early on, we were convinced that the bitcoin blockchain, or specifically the proof of work for the transfer of value, was not fit or necessary for big bank customers. We look at the public blockchain so we can learn from it, but almost all of our work has been on a shared ledger concept. I'm personally not bullish on bitcoin, for various reasons — such as the amount of power consumed in mining it. It is not central to our plans.
What do you make of the recent developments involving financial institutions warming up to bitcoin partnerships?
RUTTER: The banks are less fearful of providing some services to customers who want to hold bitcoin. I'm not aware of banks getting behind products that use bitcoin as a currency in any meaningful way. I think it is a matter of providing customer service where they had previously been reluctant to do so. I don't make much of it.
What are the most practical applications of the blockchain for banks? Are there things they could do just as easily through a shared database?
RUTTER: Not to prejudge our label results, but much more efficient data repositories and regulatory reporting is a major one. Over time, the issuance of securities, auto titles and home titles makes practical sense, even if they are outside of our remit. Where I don't see a lot of applications is in trading itself, but I see some advantages in pre- and post-trade processes.
A shared database can solve some issues, but a shared distributed database does have some advantages as it relates to you having your own copy. It solves some security issues of not having a single, potentially vulnerable point of attack. You also don't have the third-party vendor risk of a clearinghouse or a settlement agency.
Can there be multiple shared ledgers?
RUTTER: There will be multiple shared ledgers. We want to facilitate seamless communication between them. We don't want a world like we have today with a bunch of disparate systems. We hope what we are working on can be a valuable translation layer for multiple solutions that sit higher up the stack. That's one of our goals.
You're trying to establish the standards.
RUTTER: Because of our work with trying to build this layer, it has been covered as if we are a standards body. We are not; we're a technology company and one of the main things we hope to accomplish is to build something that benefits everyone in the space.
What are the potential roadblocks? What could go awry?
RUTTER: It is a champagne problem, but we've been overwhelmed with opportunity. We've been asked to do a lot of things. The key for us is to pick our spots and remain laser-focused on execution and deliver a valued product at the end of the day.
What about external things that could hinder the company?
RUTTER: I think this is going to be an amazingly valuable technology for regulators, but you can't predict how they'll act. There is a confluence of forces that have banks focused on this right now, but there could be another global financial crisis that takes focus away. There could be lackluster results, with the savings not being as great as expected.
But I think there has been enough intellectual energy put into examining the potential of this to say that there is a high probability that these technologies will be adopted by financial services companies that see it as a way to bring efficiencies and security. Think about the failure of Lehman Brothers and the reconstruction of transaction histories. This technology is excellent for that. Theoretically, that can be done in minutes instead of six or seven years.
What is it going to cost the banks to integrate this technology?
RUTTER: It's a great question, but it is not clear what it is going to be. The savings have to be significant enough to justify the near-term spend of the integration.
Will an improvement in the earnings environment make it an easier sell to banks? In other words, once they are no longer as laser-focused on hitting earnings targets through cost control, will the savings still have to match the cost?
RUTTER: Things like Basel III capital rules are here to stay. I don't care how much earnings improve, you still have really restrictive rules about how you use your capital. So the ability to shorten up settlement times is an absolute win.
Is the consortium model a bit like herding cats?
COOPER: There are challenges in managing relationships with any set of investors. The more you add to it, the more challenging it is. One of the interesting things about the distributed ledger space is the power of the idea comes from the networking effect. If all the banks decided to run in different directions, it would largely eviscerate the positive impacts that this technology promises. There is a built-in incentive in working together.
How are you working with the other startup companies focused on blockchain, like Ripple.
RUTTER: Barring two or three, we have open dialog with most of the ones that matter. And the number that matter is a smaller number than it was a year ago. Once the fabric layer is ready, our hope is that some of the largest blockchain companies will work with us.
I've gotten to know Chris Larsen of Ripple recently, and I have a tremendous amount of respect for him. They are the most developed. It is a big challenge to go after global payments. Getting back to our advantage, we work with the biggest banks in global payments and if they get excited about something it is easier to coordinate it. Maybe R3 can help in some way.
What are the identity-based issues that you think your technology can tackle?
RUTTER: Identity is something that is very interesting to all of our members and to us, but it is an enormous topic that I'm not prepared to speculate on what we may or may not be able to solve right now. Maybe that changes. It is on our radar, but there are a lot of other things on our radar that are a lot closer at this point.
How do you make money?
RUTTER: Once our lab proves use cases that we know will work and can be commercialized, we will build the software solutions and sell it to the world. If you believe what banks like Santander say — that you can take out $20 billion to $30 billion of the system annually, there is a lot of potential out there or we wouldn't have dedicate the last two years of our lives to this. In the meantime, it is the banks that are funding our work and we are grateful.
Tanaya Macheel contributed to this article.