A fringe topic as early as last year, blockchain was one of the buzz areas of discussion at the World Economic Forum in Davos, Switzerland, last week, as policymakers considered the implications of removing "trusted third parties" from the financial system and replacing them with a network of computers.

Digital Asset was not the only start-up announcing significant progress in testing blockchain systems last week. On Thursday, R3 CEV said 11 global banks – including Commonwealth Bank of Australia – had successfully tested a private, peer-to-peer distributed ledger to exchange value using "tokenised" assets without the need for a centralised third party.

ASX takes equity stake

Then on Friday, ASX announced to its own market that it had taken a 5 per cent equity stake in Digital Asset. The two will build a blockchain to allow the ASX to move its equities settlement and clearing systems to near real-time. In the process, ASX says it will remove risk by eliminating the T+3 settlement system, and allow the ASX's clients to strip hundreds of millions of dollars from costs by slashing back office reconciliation processes.

JPMorgan and ABN Amro were among the global banks that joined ASX in investing in Digital Asset, as banks around the world ramp up investigations of the blockchain's potential.

In an interview from New York on Friday, Masters told The Australian Financial Review that banks' growing interest in blockchain reflected their operating challenges, including soft revenue growth and tougher capital requirements, and recent developments in the technology that have enhanced security.

"Our investors, some of whom are large investment and commercial banks, are making a major investment in Digital Asset to help us develop solutions that will address reducing risk, reducing cost, improving transparency and offering new sources of revenue," Masters said.

"Banks are under tremendous pressure to adjust their business models to improve their returns on equity. They are facing this challenge because their costs have increased, capital has risen, and revenues have declined compared to prior years."


"Banks recognise that this technology offers tremendous potential as it represents a genuine opportunity to mutualise infrastructure that didn't exist before. They understand that it will allow them to operate a more sustainable business model and better serve their existing customers."

To realise the potential, banks and the start-ups building blockchains must convince global regulators that the technology will not increase risks in the financial system. Early indications suggest key regulators in Australia have open minds.

ASIC embraces blockchain

Australian Securities and Investments Commission chairman Greg Medcraft said in December that ASIC had "embraced" blockchain, and he encouraged regulators to move quickly to "harvest the opportunity and mitigate the risk".

Reserve Bank of Australia governor Glenn Stevens said in his regular year-end interview with the Financial Review in December that banks should be examining how blockchain technology could create efficiencies in the financial system. He said the work was "fascinating, and I think, important".

This year, teams from the RBA and ASIC, along with federal Treasury and the government's new Digital Transformation Office will be investigating blockchain to determine whether they should sign off for the systems to go live.

As she did at the early days of credit derivatives, Masters is set to play a key role in the education of regulators as they get their heads around the latest innovation. She says that "while regulators were understandably initially concerned about the potential for blockchain applications to bypass certain controls, their thinking has evolved".

"They are learning that distributed-ledger technology brings many benefits and efficiencies to wholesale financial markets, including reduced cost, reduced counter-party risk, reduced latency, enhanced security, increased transparency, ease of reporting, and reduced errors. These are all important to regulators."


The blockchain underpinning bitcoin is open, designed to bypass the financial system; but Digital Asset and R3 CEV are developing "permissioned", or private, blockchain solutions. Masters says this should be attractive to regulators, given the added transparency by being a link in the chain.

"It is now well understood that this technology represents a major step forward in database technology, offering the combination of vastly improved security as well as the ability to share infrastructure safely in a way that couldn't be done before," Masters says.

"This technology is offering regulators a bird's-eye view into activity in certain markets that they never had before. As such, distributed-ledger technology is actually an enhancement to transparency, rather than a mechanism for bypassing it."

Regulators 'well-informed'

Alongside Masters, ASX chief executive Elmer Funke Kupper will also play a key role educating regulators, along with the other 150 participants in the equity market's infrastructure, about the blockchain's potential.

Regulators are already well up the curve, he says. "Our regulators are incredibly well informed on where the world is at. Both the RBA and ASIC are showing a deep interest in this right from the highest levels, because they recognise some of these technologies can lead to a better-regulated environment."

But so quick is the pace of change that regulators themselves need to adapt. "The world is at the beginning of this. From a regulatory perspective this is so different and it might move so quickly that we need a more iterative way of developing the regulatory frameworks around it."

For ASX, timing of the arrival of blockchain is fortuitous: only last year, the exchange made a once-in-a generation decision to repurpose all of its tech platforms.But at the time it was made, ASX didn't know what a blockchain was. Despite the steep learning curve, Funke Kupper says Australia is in a position to be an early adopter of blockchain because the equity market has a single piece of infrastructure to which all participants are connected.


By moving to blockchain-generated real-time settlement, ASX may give up around $90 million in annual revenue from clearing and settlement services under the status quo, but that doesn't worry Funke Kupper: "If you believe that you can hang on to everything forever in a world that is developing this quickly, I think you are likely to be disappointed.

"Our mission is not to end up at the end of any process with fewer revenues than we started, but we recognise that being a leader in innovation should mean what will come the other way over time should be better than what we give up. This is the way Apple, Amazon and others are thinking. And in this particular part of our business, that is the choice we have made."

The real advantages will be seen when market participants start eliminating some of the $4 billion to $5 billion in total expenditure each year on everything to do with the market, as distributed ledgers eliminate back offices and duplicated platforms, Funke Kupper says. "Every now and then, something comes along that might just change everything. And this is one of those moments."

Masters says: "This is the first large-scale, real-world deployment of such technology, which could have great significance for the Australian economy. This technology is not experimental: it has a real-world application for solving business problems and improving performance."