Ask a U.S. banker about the prospects for Bitcoin, a digital currency with no trusted central authority or mechanism to reverse transactions, and you're likely to get a lukewarm answer.
But financial institutions are increasingly taking an interest in Bitcoin's recordkeeping system, known as the blockchain, a so-called distributed ledger that can be used to track much more than stateless electronic tokens.
Bank of New York Mellon, for example, has created its own digital currency, BK Coins, and built an employee recognition application that rewards IT staff with the tokens, which can be redeemed for gift cards and vouchers. CBW Bank, an innovative community bank in Weir, Kansas, is building a risk management system incorporating cryptocurrency technology. USAA has a team of researchers looking into the potential of the blockchain.
These institutions see possibilities for efficiency and security improvements in areas like payments and securities handling through the use of the blockchain.
The concept of a distributed ledger would seem to be the antithesis of banking. Banks have always kept all manner of data and records of payments, transactions, loans, what have you in their own systems. You could argue that that's what banking is, the business of storing money and information about money.
But when financial institutions talk about the possibilities of the blockchain and distributed ledgers, they usually don't really mean an open, public database that will sustain copies all over the world, like the Bitcoin blockchain. They're usually talking about using a variant of blockchain technology that would live in their own data center or private cloud, or be run by a central authority. (A notable exception is the Nasdaq's experiment with the Bitcoin network as a means to track security ownership.)
"The blockchain can fundamentally reduce costs and provide real-time service," said Chris Skinner, chairman of the Financial Services Club networking group in the U.K. and author of "Digital Bank." "But on the other hand [bankers] want to make it centralized, which runs counter to the concept of blockchain."
Like an accounting ledger in which entries can't be edited once they've been written, the original blockchain's distributed ledger is an indelible record of Bitcoin transactions. Maintenance of the blockchain is performed by a network of computers around the world running Bitcoin software. About six times per hour, a new group of accepted transactions, a block, is created, added to the block chain, and quickly published to all nodes. This allows Bitcoin software to determine when a particular bitcoin amount has been spent, which is necessary to prevent double-spending in an environment without central oversight.
Kept entirely within a bank, a blockchain is "nothing more than an application within multiple nodes," said Suresh Ramamurthi, the chairman and chief technology officer of CBW Bank. "It's a just a great way to have failover systems."
His $12 million-asset bank is working with Ripple Labs, developer of the Ripple protocol, an open-source distributed transaction infrastructure which has its own native digital currency, but can be used to transfer ownership of all sorts of assets.
"We are integrating our existing risk-scoring analytics system to support crypto-currency protocols," Ramamurthi explained. "In most of the existing channels such as check, [automated clearing house] or even debit card, there is a gap between funds availability and funds settlement that helps provide banks some time to manage the risk," but like wire transfers, cryptocurrency allows "instantaneous availability and settlement," removing that helpful cushion of time and reintroducing risks.
"As a bank, you can't enter into any area unless you understand it," Ramamurthi said. "We're using some of these protocols and delving into details on how to understand the gaps and risks of that and integrate them into our risk management system. Once we do that, then we'll start to create applications around it."
Anything that can be defined with a number could be stored in a blockchain-like facility, Ramamurthi said a payment, a piece of property, a security. "Anything that can be tagged, which is pretty much anything in the world, can be linked and tracked."
Experimenting at BNY Mellon
BNY Mellon's developers downloaded open source code from Bitcoin.org, modified it to run on the bank's internal network, and created BK Coins.
"It's a way for own employees to understand what it is so they can think about the implications for their own work and for our clients," said Suresh Kumar, the $385 billion-asset bank's chief information officer. "It's not that we were interested in Bitcoin, we're more interested in blockchain" a common refrain among bankers.
It's one of the first projects for the bank's relatively new innovation centers, set up to help employees learn about technology initiatives. "It's not like going to a classroom training or a seminar, but something that people can try themselves and play with it," Kumar said.
Kumar is most interested in using a distributed ledger to track securities and corporate actions.
Corporate actions are events, such as a merger or the death of a CEO, that affect the stock or debt of a company. Tracking them is a source of frustration for most financial institutions, he said, and mistakes can be expensive. "There's no reason why you couldn't use [the blockchain] as a mechanism to disseminate information that's of interest to all the participants," he said. "That's a perfect example of what is possible, that all the participants work off the same facts."
Although initially the bank is experimenting with the blockchain on its own, Kumar also sees a need for partners.
"By nature, you're talking about a distributed ledger, so no one company can benefit from it by itself without a network effect, so it's important to keep an eye on the vendors that are bringing in a broad number of participants and get everyone to use something," Kumar said.
As it vets vendors in this space, the bank seeks out those that understand its technology, that have sufficient credibility with enough participants, and are able to meet bank-specific needs such as anti-money-laundering and know-your-customer compliance and security, Kumar said.
"We clearly think this is a meaningful innovation and we all need to figure out how to do it," Kumar said. "At the same time, we cannot put the firm and our clients at risk. It's a balancing act, but as with any industry, there's a sufficient amount of inefficiency in the financial industry and I can only imagine how something like this will help."
Efficiency is the primary goal.
"Can we use this to speed up cross-border payments?" he said. "Are there things we don't even do today because they haven't been practical?"
Like some Bitcoin proponents, Kumar compares these early days of cryptocurrency to the beginnings of the Internet itself.
"As Internet technology was becoming mainstream, we tried to figure out, 'how do we use this for our businesses'?" he said. BNY Mellon used it to build an online brokerage.
"It's our responsibility to make sure we understand anything new that comes up on the horizon that has a reasonable chance of success and think about how we can leverage that for our clients and our businesses," Kumar said.
Similar to BNY Mellon, the Swiss giant UBS has opened a technology lab in London inside the fintech accelerator Level39 at the Canary Wharf office tower -- to explore how the blockchain can be used to verify financial transactions such as securities purchases and cross-border payments.
USAA Deploys Researchers
In San Antonio, USAA has a large team of researchers looking into ways the financial services firm might use blockchain technology.
Like BNY Mellon, USAA sees the decentralized nature of the blockchain as a key to efficiency.
"What's been talked about is around creating efficiencies in a process," said Alex Marquez, managing director of corporate development at USAA.
"That's what's intrigued us from the start. Because it's an immutable contract, there's an element that is a proof of record of a transaction that's very deep in security, using cryptography," Marquez said. "There's an element of that that invokes trust."
The auditability of the blockchain is appealing to USAA.
"Any edits to that record that are embedded in the blockchain are forever embedded in that component," he said. Such an electronic audit trail could replace paper trails and manual audits.
USAA is in the learning phase of understanding the technology and the vendors that have begun offering their versions of it, Marquez said.
"We're excited by the broad array of companies that are pursuing it, from the large traditional technology companies to the other financial institutions that are kicking the tires on it," he said. The company has spoken with several vendors, including Factom, a startup based in nearby Austin, Texas.
A good use for blockchain would be any process that requires extensive recordkeeping, Marquez suggested. Property records, title transfers are possible examples. When someone buys a house, if the title to that house were embedded in the blockchain, it could theoretically be transferred to another person without the need for title insurance.
"If you can make that more efficient, auditable and traceable, with 100% accuracy, that's something that's of interest," he said. "But we're very far away still from doing any deployments. We're still learning."