21 Jun The Impact of Blockchain on Investment Banking
As blockchain continues to march at the forefront of the fintech boom, we can clearly see the ramifications for system efficiency and simplification across the investment banking ecosystem. While the impact is likely to be huge long term, the technology is still going through the typical growing pains of a somewhat nascent player in an entrenched and complex capital markets world.
For those unfamiliar with the concept of blockchain, a quick-and-dirty explanation may be helpful. Blockchain uses blocks of data or other records in a chronological chain sequence in a shared ledger across various counterparties to a transaction. This cryptography-powered, distributed messaging system allows for authentication and verification for a number of purposes. At the event when a specific transaction ledger is approved by all the parties pursuant to the transaction, the block of legers will get added under a chain sequence.
Said differently, participants who sign in the consortium or network under the block, create a database of transactions that are shared by all parties. Because this shared database is shared and replicated simultaneously in real-time across various computer nodes in different geographic (and often country-specific) locales, the consortium can validate the authenticity of a transaction (or a change to a transaction) immediately. The chain can be also be added-to with other “nodes” as all parties in the chain can simultaneously add, validate and agree to any made changes.
By combining the chain-sequence validation with cryptography at the transaction level, fraud is all but eliminated as all transactions are authorized or “viewed” by all parties in the sequence in real-time. Blocks in the chain leave behind a digital trail that can easily be verified because all the parties in the chain will have the same record. The chain may be modified (by syncing with varying parties in the chain), but blocks cannot be deleted.
What follows discussing some of the unique ways blockchain will disrupt the current status quo in investment banking. When it comes to what we do in investment banking, there are several areas where blockchain is likely to greatly disrupt:
Trade Reconciliation for deal escrow
Know Your Customer (KYC) rules
Anti-Money Laundering (AML) laws
WORM (write-once-read-many) compliance data archival
Compliance tracking & process automation
Investment banks are required by law to perform their own “Know Your Customer” (KYC) checks according to the specific jurisdictions in which they reside. Using a shared-client database in a blockchain, investment banks will have the ability to on-board previously-KYC-validated investors from other financial institutions. Common KYC documents will be immediately accessible AND validated across the nodes on the chain. In more detail:
- Investor uploads requisite KYC documentation into the shared repository block database tied to the chain
- The customer then authorizes XYZ Investment Bank access rights to the KYC documentation
- When the investor authorizes ABC Investment Bank to access the KYC documents, they will not only include whatever the client uploaded in #1 above, but also any additions or commentary that is relevant coming from XZY.
The chain can also help alert investment banks of potential “bad actors” through AML using the same sequenced chain validation process. Any known or suspicious persons will show up across the database chain, allowing dealmakers immediate access to data relative to potential bad apples. According to Goldman Sachs, they estimate the global cost savings of AML and KYC compliance to be as high as $6 billion a year.
KYC and AML processes are not the only areas that immediately benefit from blockchain tech. Any system or process that requires significant third party intervention is likely to be disintermediated by using this type of validation. Think for a moment of the lucrative business of stock transfer agents. They use a manual process for verification of securities, including things like “gold medallion guarantee.” The blockchain will virtually destroy the traditional business of stock transfer agents. When computers can do the work, margins drastically dwindle and people get moved to other tasks. By delivering near-immediate verification combined with error reduction and process transparency, I do not doubt Goldman’s weighty prediction is not far off.
Fortunately, blockchain cryptography is much more than just bitcoin and cryptocurrency. In fact, the blockchain will be extremely beneficial as crowdfunding an other legitimate online capital formation tools march forward in the disruption of traditional investment and finance. Unfortunately, the tech is still in its infancy. As such, banks are likely to start small and work toward full implementation over a several year period. This experimental phase will also see greater developments in how the tech can apply to various situations. It is likely the most simple and mundane will be disrupted first, but as the tech improves and the operators’ familiarity with the tools increase, I would imagine implementation will encompass more complex versions of similar processes. Deal syndication opportunities among a large handful of FINRA-registered investment banks is likely to be a complex process with huge upside, but the tech isn’t quite mature enough yet to facilitate such a process with ease and efficiency–and I emphasize “yet.”