The wider adoption of blockchain technology by financial incumbents is likely to take place over four stages according to a new report by business management consultant firm McKinsey & Company.

Entitled “Beyond the Hype: Blockchains in Capital Markets”, the report states that blockchain technology will “dramatically reshape the capital markets industry”, impacting business models, cost savings and capital requirements in the sector.

McKinsey contends the adoption of blockchain technology will have significant near-term benefits, bringing faster clearing and settlement to the capital markets, while reducing the number of ledgers needed to be maintained by financial institutions and ensuring audit trails are more precise.

However, McKinsey’s chief finding is that the financial industry needs to move in unison to unlock the benefits of the blockchain, a conclusion that supports recent efforts by major banks to back efforts like distributed ledger consortium R3.

The report states:

“The full potential of blockchain technology will only be realized through cooperation among market participants, regulators and technologists and this may take some time.”

Roadblocks to deployment, the report suggested, include the irreversible nature of blockchain databases, which would require that those who participate in running such a network agree on mechanisms to resolve conflicts.

However, the McKinsey report does provide a detailed roadmap for how it expects this transition to play out, despite challenges, providing financial institutions with a window into how they might be able to prepare for the transition to distributed financial technologies.

Four stages

Armed with these benefits, McKinsey argues the rollout of the technology will occur in four steps, with a distributed ledger first uniting all of a financial institution’s legal entities.

In this scenario, each of a company’s legal entities would act as a “node and bookkeeper” on the distributed ledger, a development that would provide the organization the chance to “rewire” its existing platforms.

“Design issues could be internally resolved and modified with experience over time. This first step could also solve for moving assets into and out of a closed blockchain network,” it says.

From this point, blockchain technology can scale up by replacing the manual processes at a subset of banks, providing what McKinsey called a “solid testing ground” for the tech.

“Small networks of market participants could convene to agree on standards and protocols for booking and transfer with relatively little investment and with the potential to improve current operations,” the report reads.

This stage would be followed by the conversion of inter-dealer-dominated markets and finally the large-scale adoption by buyers and sellers in public markets.

Early observations

Today, McKinsey found blockchain adoption is happening most rapidly in over-the-counter markets, where “volumes are lower and operations are more manual”.

Other areas where blockchain solutions are likely to proliferate, the report said, are in asset-backed securities, precious metals, repurchase agreements, syndicated bank debt, title insurance and unregistered securities.

Many of the use cases targeted by early entrants into the bitcoin space, the report suggested, will need longer to develop.

Notably, this includes the application of the technology in the payments sector:

“Over time, developments in currency trading based on experience in bitcoin markets may seep into foreign exchange (FX) businesses, as bitcoin exchanges obtain the licenses to accept cash deposits. And application of blockchain technology in the payments space may move beyond the current retail focus.”

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