Bitcoin is not going to be a major disruptor in payments- but the blockchain could be, and financial institutions around the world are exploring options to leverage it in different ways.
This article provides an overview of the key attributes of blockchain technology, as well as a high-level assessment of the potential for disruption in different areas of the market. The opportunities for blockchain technology in payments are many and varied, but they are also highly dependent upon the needs and characteristics of a particular payment arena, write Jip de Lange, Senior Consultant, and Chris Dickey, Consultant, specializing in Credit Card Issuing at First Annapolis.
At this early stage we see strong potential for blockchain technology to improve areas with relatively weak infrastructure (in particular, global remittances and wholesale transfer markets), but less likelihood that it will have a significant effect on other areas such as retail payments.
Attributes of Blockchain Technology in Payments
As illustrated in Figure 1, blockchain technology primarily affects back-end infrastructure. The technology is not consumer-facing, and is unlikely to give rise to fundamentally different consumer front-ends (as Bitcoin once portended). For an overview of blockchain technology, see Blockchain 101.
Figure 1: Components of a Payments Network (Traditional vs. Blockchain)
With blockchain technology, messages are distributed differently than they are in traditional networks. Rather than employing centralized message clearing, messages are broadcast to the entire community. Ledgers are kept de-centrally, and all participants maintain a copy of the ledger that is protected through cryptography and updated periodically (typically every ten minutes).
The blockchain approach to technology offers some clear advantages relative to traditional networks, including:
+ Increased transaction speed relative to certain networks (e.g., ACH, international remittance).
+ Reduced friction and lower cost due to the absence of a central hub.
+ Increased resilience without the ‘single point of failure’ common in traditional banking networks.
+ Full transparency, with no dependency on a single network administrator for data or execution.
+ Easy scalability, with the ability to fully operate with only two nodes or incorporate thousands of nodes around the globe.
+ Robust capacity, enabling the exchange not only of transaction data but also other information (e.g., contracts, invoice data, collateral, etc.) that can be important in commercial transactions.
Blockchain technology has its limitations, however, particularly depending on the use case, and is not without risk. Potential disadvantages associated with blockchain technology include:
– Delayed transaction time. Blockchain transactions are logged in ‘blocks’ and trust is derived from having multiple participants in the network agree that a transaction has occurred. Distributing a block through the network takes several minutes, making blockchain technology less attractive for high-risk real-time transactions or as an alternative to existing real-time infrastructures.
– Professional use only. Blockchain-based networks send GBs of data between nodes at a high velocity, requiring significant computing power.
– Spotty track record. The technology is largely unproven for high-volume applications, and Bitcoin, the area where the technology is most notably applied, has been plagued by high-profile fraud cases, hacks and misuse.
– Concentration risk. A single participant controlling more than 50% of the nodes of a blockchain network can, in theory, authenticate transactions and overrule the rest of the network—this creates a significant administration burden associated with authenticating participants before they join a network.
Outlook for Blockchain in Payments
There is much activity underway in the area of blockchain technology, and substantial investments are being made by financial institutions and other industry providers. Many current initiatives are related to commodity or stock market trading, which are highly specialized markets with professional participants, high average tickets, and recognized weaknesses in the existing infrastructure. The same principle is true for insurance, where blockchain networks could allow companies to keep more precise data on the underlying assets. Current payments-related blockchain initiatives can be divided between those aiming to create networks and those aiming to develop or support nodes (or network participation) (see Figure 2).
Figure 2: Example Blockchain Initiatives
Much of the blockchain activity related to payments has been in the area of remittances and wholesale transfer markets, and that is where we see the greatest potential for disruption in the market. As outlined in Figure 3, the application of blockchain technology will most likely be limited to the wholesale payments infrastructure. It is difficult to see widespread opportunities for blockchain technology in retail payments, given that the retail payments ecosystem tends to focus primarily on front-end, consumer-facing technologies, and that the card schemes have already established a strong centralized global infrastructure. Opportunities on the wholesale side are more easily identifiable, with cross-border clearing being a prime candidate. International remittances lack a centralized-infrastructure and are hindered by a lack of trust—a situation for which blockchain technology is ideally suited.
Figure 3: Outlook for Blockchain Technology
Blockchain technology is likely to have long-term relevancy for the financial services industry in general, and the payments industry in particular—but while the potential for disruption in certain areas of the payments space is significant, we expect the evolution will be gradual.