There is an air of confidence about UBS at this time concerning the bank's exploration of distributed ledger technology and smart contracts.

Recently, UBS demonstrated how a bond could be automated on a blockchain, the shared ledger system similar in design to that used by Bitcoin. It also proposed a fiat currency-backed "settlement coin" to fit within the existing regulatory framework. The bank appears to be leading the way in distributed ledger technology at this time.

During a detailed explanation of the technology, Alex Batlin, a director in UBS's technology innovation and research team, told IBTimes the bank remains open to ideas, and this includes ideas that are essentially attached to the public Bitcoin Blockchain.

"We are not ruling it out. There has been a lot of debate about permission versus permissionless; actually it's for purely technical reasons, at least in the short term, where we think permission ledgers may well be more useful.

"One is because you don't need to do proof of work, so all of a sudden you can have a business model with much higher transaction throughput.

"The other issue is that given the current regulatory and legal view, you need to know who your payment processors are. So again having a permission chain gives you easier integration into the legal and regulatory framework.

"People talk about banks wanting to have permission chains to keep control - that's not true. The key things we need are transaction volume and we need to integrate with an existing legal and regulatory framework."

Batlin was making a point about the need for multi-asset chains. He mentioned Bitcoin in the context of the Sidechains project developed by Blockstream. Pegged sidechains can enable bitcoins and other ledger assets to be transferred between multiple blockchains.

Batlin said a proliferation of single asset chains would be less than desirable. Purely from a capitalisation point of view multi-asset chains facilitate far greater efficiencies.

"So we have seen on Bitcoin, altcoins are 500-plus; imagine if you had operating costs for 500 altcoins, let alone hundreds and hundreds of bond chains, derivative chains and so on.

"So just like with internet we are a strong believer that we need to have, if not one, but a few platforms that are multi-asset, rather than a chain per variant of particular instrument.

"We do feel strongly about that and hopefully we can articulate that there is good reason behind that. Partially it's to get the operating efficiencies and capital efficiencies we think are important in this case.

Sidechains

"But even that is changing rapidly," noted Batlin. "There are some interesting solutions like the Blockstream solution where they are looking at sidechaining.

"If folks make that work very well then we might find we take advantage of that. It's just too nascent to make hard technology decisions at this point."

This is an interesting and rapidly evolving area of computer science. In a recent interview, smart contracts expert Nick Szabo was asked if he could envisage the Bitcoin network, bitcoin the currency, Ethereum contracts and ether combining in commercial environments.

Szabo, who understands security must come before economics, agreed that this could happen especially if Sidechains can be made to work; there are some open questions about how long you can store collateral on one blockchain with the cryptocurrency of another using Sidechains, which have to be solved first.

Regarding the Sidechains project Batlin said: "I think the project is extremely interesting because they got both the transaction privacy using homomorphic encryption [a crypto system that allows computations to be performed on data without decrypting it] to make sure the amounts being transferred are not in plain text.

"And the whole ability to do sidechain pegging; they are trying to move up the chain towards Turing complete smart contracts, so we will be watching their progress with great interest."

Batlin also mentioned Enigma, the MIT initiative. This idea also guarantees greater privacy on the blockchain. Data is split between different nodes, and they compute functions together without leaking information to other nodes. Specifically, no single party ever has access.

"It's such a fascinating area right now; so many amazing, brilliant brains working on it - it's quite overwhelming," he said.

Smart Bonds

UBS quickly came to the conclusion that a cross market initiative was needed; that the UBS chain would be a very lonely place.

"So the first thing we did was we picked bonds - it's a very well understood instrument and we said, can we implement a bond on what we would call a third generation blockchain technology - let's call it Ethereum.

"If Bitcoin is first, Ripple and Steller is the second, Ethereum is a general purpose distributed app so you've got full blown smart contracts. So let's see if we can use that technology to then implement the business logic of what we call a smart bond - primary issuance only use case - and in effect we did it.

"We have managed to model a smart bond on Ethereum which gave us a lot of confidence. So one of the things that we concluded as part of that exercise and a couple of other experiments, was that for as long as all you are doing is moving tokens of value on chain, rather than moving actual items on chain, you are always going to have physical settlement risk."

According to Batlin's conversations at the bank, a lot of people still would want to buy bonds or other securities, that also could become digital only assets on blockchain, for fiat currencies rather than for virtual currencies.

"As long as we only had something that was only a token of that it can still suffer from settlement risk offchain. Then you are not going to get all the benefits of atomic escrow conditions for payment versus delivery or payment versus payment.

"You still have the risk that, just because it's on the ledger people won't come back and decide to actually give that item to you.

Settlement Coin

"That's really the simple idea behind settlement coin. What we want to do is enable this kind of settlement coin utility which really is a representation of fiat money on blockchain.

"So if you spend a pound on blockchain it is equivalent to spending a pound in cash. So it is still a native asset but it is pounds, it is dollars, it is Swiss francs - whatever.

"People have a choice, they can either continue transactions in virtual currency or they can have all the benefits of almost real time clearance and settlement, transactions through smart contracts but deal directly in fiat currencies. That virtual pound or whatever you call it, a cryptopound, would one-to-one, asset-backed with a central bank.

Batlin said the point was to remove UBS as a settlement risk, and use the central bank as a settlement risk, like cash. He added there could potentially be multiple settlement coins to represent different currencies.

"We are not looking to create a UBS blockchain - we want to use open standards and we don't want to a UBS virtual currency," he reiterated.

"This is really to enable blockchain transactions, whatever the blockchain is - could be Ethereum, could be Bitcoin - we haven't finalised the design, we have just come up with the deployment if you will."

He pointed to precedents for this which are already in operation today, such as Billon which is technology company partnered with Plus Bank in Poland. They have used the EU Directive for E-money, and basically they have issued e-cash using Bitcoin as the payment rails.

"It's not a dissimilar idea from that," said Batlin.

Clearmatics/Ethereum

UBS also announced a partnership with distributed clearing specialists Clearmatics – IBTimes asked why this choice.

"First of all they have got some brilliant business knowledge based on their background. So I think that was a very clear advantage.

"We do at this point see a lot of value in multi-asset, smart contract-enabled platforms like Ethereum.

"But there are some things about Ethereum like lack of scheduling. For instance, there is no way for us on vanilla Ethereum to create schedule jobs.

"Our experiment with the smart bonds requires also payment of coupon and we have to create an external schedular to automate the coupon payment, which effectively stimulate the smart contract. Clearmatics have a scheduling capability.

"They are working in the right kind of multi-asset general purpose computing distributed solution like Ethereum with enhancements. Very smart folks working with the technology we think is the right direction."

Batlin recently tweeted that coding up Ethereum was both nascent and fun. These days he has to spend a lot of time doing stuff like explaining technology to journalists, and as a result doesn't do as much actual coding.

"Often I find out by proxy. I talk to the guys in the lab and get their experience. It's fun because the productivity gain is quite incredible.

"It's of course an experiment, but we found that we achieved a lot with this platform in a short amount of time.

"The technology is moving extremely fast; literally you have weekly code drops and you have to redesign quite a few bits of the smart contracts or the user interface. That's fine - people are very on it, it's very nascent, the frontier really."