Our last white paper on blockchain / DLT was at the end of 2015. Two years on and we wanted to get our heads around what was driving all the hype and where we sat on the infamous Gartner Hypecurve.

Since the initial exuberance of ‘blockchain’ in 2015 we’ve noticed that industry practitioners are making the distinction between generalisations (the stuff they hear all the time) and detail (clearly articulated actionable items).

We’ve also seen the Brexit effect now the referendum has taken place. Whilst Brexit gets labelled, not always justly, as a cause for all sorts of ills from reduced revenues to transport woes, the Brexit effect has taken some of the column inches away from DLT. Firms also have finite resources and these need to be allocated to address the impacts of Brexit, the ongoing wave of regulation (MiFID II et al.) and innovation.

So, there has been some tempering of the hype, but don’t be miss-led: there is still a lot going on.

Generalisation 1: BTC v DLT

Bitcoin, which uses the blockchain DLT and other crypto currencies have been designed and adopted by a new breed of ‘cyber libertarians’. These cyber libertarians are very much contradictory bedfellows to the workers in the Capital Markets who are familiar with working within the boundaries of their local regulatory regime.

DLT, the clever stuff enabling bitcoin, can be stripped out and applied as technology in its own right. This has the benefit of distancing DLT from the bad press, rightly or wrongly perceived around Bitcoin and crypto currencies in general. We’ve seen the industry reflect this decoupling between the Bitcoin blockchain and Distributed Ledger Technology (DLT). A typical example of this is itBit. They’ve realigned their business so that the Bitcoin (trading exchange, wallets, etc.) components continue to operate under the itBit banner whilst their DLT offering to the capital markets goes under the Paxos branding.

Generalisation 2: Business needs to meet technology

There are a lot of young, vibrant, innovative companies in the DLT space. Simply by the nature of their youth, these companies are not always familiar with some of the longer standing market practices of their Capital Markets target audience.

Broad scope firms have a tried and tested path to technology adoption. For example New Product Review processes where multiple disciplines confer on the merits of new technology and then sign off on the implementation of the application.

The new FinTech or ChainTech companies need to present the uniqueness of their offerings in a context that is relevant to a Capital Markets audience be it the business, operations, finance, technology, legal, principal investments or other.

Capital Markets buyers need to understand why and how ‘the new model’ meets or exceeds all the ingrained market practices of the existing business model.

Generalisation 3. Technology is an enabler

How did you get to work today? Train, car, bike? Does it really matter? (Well, yes, to you, but to an end user, not really). So too will it be with DLT. DLT is merely an enabler. Another component of your technology stack. Ultimately, the end user won’t interact directly with your chain or know they are interacting with a DLT just as you have no need to know the technology your ATM runs on.

These generalisations lead to several observations.

Observation 1: The D in DLT is for Distributed

This means your community and your supply chain: farm gate to dinner plate, issuer to investor, well head to forecourt bowser, A to Z. You name it, the context is yours (and if you have a catchy one let us know!).

What we can’t overlook is the power of the network effect. Point to point is great but it misses the point. The power of DLT is in the distribution or the network effect. The best applications distribute something across a community drawn together by a common interest – it could be a simple payment, a transfer of value or it could address nuances in the supply chain – was that hatch battened down on that grain cargo and by whom?

When you sit down in a room with the people in your distributed eco-system you need to have alignment. Sure, different members may have totally different business models, but everyone needs to be comfortable in understanding that the other people around the table benefit from the technology too. At the outset, you’ll get a lot of FOMO’s (Fear of Missing Out) but once you get to the detail you need to address FOJI (Fear of Joining In), nobody wants to be in a DLT with no network. We call this alignment.

Best applications are distributed across a value chain. Stakeholders, albeit from different parts of the value chain (e.g. producer, consumer, intermediary) need to be aligned with a common interest.

Observation 2: The L in DLT is for Ledger

Ledger is a noun. Not a verb! A ledger is something: It does not do anything (much like a book on the shelf). You will still require processes and applications (and possibly smart contracts) to do something with your data.

What a DLT does do is carry or provide access to, a lot of data. In our opinion the discussions around data and data structures are not getting enough attention.

Observation 3: The T in DLT is for Technology

There is a variety of blockchain frameworks available. The most commonly known is the Bitcoin fabric ‘blockchain’ but there are also Ethereum, Hyperledger, Corda, Nxt, Bankchain, Credits, Ripple etc.

Each of these frameworks is undergoing near constant enhancement. This is still a relatively young technology. For example Hyperledger V1.0 was only released at the end of March 2017.

When developing a proof of concept (PoC) the first question is which framework to use? There are various reasons for selecting a specific framework – ranging from cost all the way to the vibrancy of the development community. How many people are out there in a GitHub or Reddit that can lend meaningful support?

Also critical, are the data structures. What is it you are trying to achieve with your use case? What data do you want to distribute, what do you want to centralise? How do you address security? Different frameworks have different merits. Set against a background of constantly maturing technology it is a brave person who takes a stand on a particular technology. Yes, you need to make a choice, and for our PoC we went with Ethereum but we notice firms are increasingly claiming to be framework agnostic.

Technology frameworks are evolving. DLT is not a ‘one size fits all’ technology. Each framework has merits that need to be considered in the context of the use case.

These observations lead to further generalisations:

Generalisation 4. Not everything will be distributed

DLT lends itself to distributed work flows. But for security or efficiency reasons some records (think sensitive data or large files) may be better centralised. It is not implausible that at some future data the SHA256 algorithm could be hacked. Expect hybrid solutions where data and energy efficient models emerge – some aspects decentralised, some aspects centralised.

Generalisation 5. Permissioned is the way to go

Proof of work is a pain. Capital markets want full anonymity in price discovery, but they still want to know they’re dealing with ‘approved’ (regulated) persons. Your permission might be private or with a consortium but it won’t be permissionless (which is the realm of our cyber libertarian cryptocurrency peers).

So, we’re getting a feel for the state of play. We may even have a PoC or two to look at. This leads to some further observations on how we move from PoC to enterprise ready adoption.

Observation 4: Business Models

Indicators suggest that 3 types of business model are emerging:

Vendor. i.e. you bring us a business case, and we’ll charge you ‘x’ to develop / advise you on a solution. Typically this solution is technology based as opposed to addressing issues such as ownership and governance. If you ask a vendor what type of DLT framework they use, typically they’ll reply they’re chain agnostic. That is, they’ll build to any technology stack you prefer. Consortia. This is where the alignment of the users around a common use case has started to take shape. Next steps are then focussed on moving from a consortia of the willing onto adoption. If you ask a consortia what kind of DLT framework they use, they’ll have an answer, simply because they have to choose somewhere to start their prototyping. This may not be the ‘final answer’, but they’ll have an answer. Provider. This is a slightly higher risk strategy: build it and they will come. This alleviates some of the initial governance hurdles however it becomes just another technology provider but in this instance the services provided utilise DLT.

So we have some feel for the industry. Resources need to be allocated (and this is happening). Technologists need to present their wares in a context that is relevant to Capital Markets (and lots of incubators and hackathons are facilitating in this process). A nice looking PoC never hurts in getting the potential of the technology across to decision makers. However all this remains in the realm of hype. The measure of the technology will be adoption, which leads to some further observations.

Observation 5: Adoption – Governance

We are wary about Bitcoin’s governance structure. One thing capital markets demand is dispute resolution. Nobody plans for things to go wrong, and nobody likes it when they do go wrong but what is inevitable, is at some stage, something will go wrong. When this happens – we want dispute resolution. And our first place of recourse to address this is the governance structure.

If your application is distributed, then so too must be your governance. If you’re buying into DLT, via a one stop system vendor, all you’re doing is switching out one piece of your technology stack with another. Sure, it may be better, but ultimately, you’re running the same vendor concentration risk with all the attendant pitfalls.

Blockchain Security is a permanent record that can’t be corrupted. And we don’t want to erase history, but when something is corrupted, we need to recognise as much and address it. We do this through a robust Governance structure.

Optimising the network effects of distributed technology will require an ever increasing community. Be it membership or participation, we need a Governance structure that facilitates changes in the user community.

Observation 6: Adoption – Legal framework

Before you have any enterprise ready business, whatever the technology, you need a legal framework. It is all well and good to have a technology evangelist at the table, but the moment you mention blockchain someone will prick up their ears and draw an association with Bitcoin and ‘the dark web’. That translates into the need for enhanced due diligence. A clearly defined legal framework, that brings certainty and finality is a critical pillar to move from proof of concept to implementation.

Observation 7: Adoption – Regulation

Regulators are not in the business of regulating technology but they are in the business of regulating and sanctioning firms when they fail to conform with accepted industry practice.

The operational risk of running a new technology application without the comfort that it is at least in the remit of the regulators’ understanding is untenable.

At this juncture we can draw some conclusions.

Vocabulary

A new, nuanced, vocabulary is emerging. We’ll have to become familiar with blockchain, DLT, RegTech, FinTech and now ChainTech.

Eco-system

There is a multitude of vendors. Providers, consultants and solutions. Sometimes, one company or brand may apply across multiple categories. This emerging eco-system is far from static. A firm may start as a provider, become a vendor and then become something else. Business models are constantly evolving (typically in line with cash flows!).

Adoption.

Moving from great theory to an enterprise ready solution will require a strong governance model (dispute resolution), a clear legal model (certainty and finality) and regulatory comfort (operational risk). After this, technology, as ever, is the enabler.

Don’t boil the ocean

DLT can probably do everything…but don’t attempt to be all things to all people. Focus is a prerequisite.

DLT is here, now.

DLT is being actively explored across a diverse range of industries from Financial Services to Pharmaceuticals and many points in between. If the industry uses a ledger, there is a use case pending. People may be chasing publicity with press releases or operating under the radar in ‘stealth’ mode. Few are putting their heads in the sand in the belief that DLT is a passing fad. DLT is here, and here to stay.

There may still be some hype, but DLT is here, and good governance will ensure adoption.

Whilst there may be a feeling that the level of hype around DLT has somewhat dissipated, part of this will be that we’re becoming a little desensitised to it, simply by the volume of information that is out there and partly because other events, such as Brexit, also demand our attention. What we are sure of, is that DLT has arrived and now the genie is out of the bottle, it is here to stay.

We’ll continue to hear various press releases and announcements but the ones to watch out for are those that present not only a technology solution but ones that have a governance model around the application. For any PoC to move towards enterprise adoption 3 things will distil to the top of the stack: Governance, Legal Framework and Regulatory environment.

About the author

Scott Riley is the DLT specialist at Kynetix. He can be contacted at scott.riley@kynetix.com.

He was a founding Director of Chi-X Europe, now CBOE Bats. He has a long experience in the post trade arena including representation with the European Commission on the implementation of an improved Clearing and Settlement framework. Most recently Scott has been immersed in Blockchain or the application of Distributed Ledger Technology.

Scott has held various roles in both Asia and Europe. Be it with central market infrastructure (Chi-X, LCH.Clearnet) on the introduction of new markets or working within the ever evolving Sell Side community (ABN, BAML, Bank Austria), he has been both a user and provider of central market infrastructure services. He has been a member of industry consortiums and brought together industry consortiums to embrace technological change.