Do banks really need blockchain?

In their book Blockchain. How It Works and What Lies Ahead (Moscow, Alpina Publisher, 2018), Artem Genkin and Alexei Mikheev note:

“The banks’ interest toward the new technology is quite explicable. Potentially, blockchain technology can be employed to remove a bank as a requisite element of the entire system of economy and finance. Therefore, apart from a purely applicative exploration of blockchain’s capacities to be integrated in internal banking processes, bankers also look for ways to preserve their role of an intermediary in economic processes. After all, blockchain is merely a technology which can be employed in differing ways”.

Discussions on employing blockchain in Russia’s banking sector have been going on for a few years already. Still, until now distributed ledger technology has not found any use of a scale. Blockchain is being accepted by the financial sector at a much slower pace than it could have been expected, given the widespread excitement about it. The examples of banks’ attempts to employ the trending technology are few and have nothing to do with the practical daily life.

Savings Bank is no doubt leading the way. It has employed blockchain system for factoring transactions information exchange with M.Video, its client company. Besides, this largest Russian bank has opened a blockchain laboratory to perform respective research and create prototypes of the products. Late last year, a blockchain project launch was announced. The project concerned encrypted information exchange between Savings Bank and the Federal Antimonopoly Service.

Alfa-Bank, the largest private bank in Russia, is trying to keep up with Savings Bank. Alfa-Bank has started blockchain developments in its Innovations Research and Development Center. In summer 2017, S7 Airlines and Alfa-Bank launched an innovative Ethereum protocol-based blockchain platform and accomplished the first ever deal of buying air tickets via an open blockchain API. According to the bank, the time of settlements between the air company and its partners reduced from 14 days to 23 seconds. Megafon telecom operator transferred one million rubles from its account with Alfa-Bank to the account of its subsidiary with Savings Bank. According to the pilot project participants, money was remitted instantaneously whereas a regular bank transfer may take up to 30 hours. Last October M.Video, Sberbank Factoring and Alfa-Bank announced setting a consortium targeting a commercial use of blockchain-based solutions in the financial sector.

Vnesheconombank jointly with MISIS National University of Science and Technology in December 2017 established Blockchain Commune Center of Blockchain Competencies and Digital Transformations. Still, among the six pilot projects Blockchain Commune is promoting, none relates to the banking industry. Instead, they are all about various government services such as patents and property titles registration. As Vladimir Demin, Advisor to Vnesheconombank’s Chairman, told Invest Foresight:

“Blockchain in banking will develop more actively than in other industries. The possibilities which cryptocyrrencies and smart contracts open in FinTech can totally overhaul banking sector. That will first of all concern payments performance and new financial instruments (pledge instrument, letter of credit, bond, etc.)”.

Theoretically, FinTech Association’s Masterchain blockchain platform based on Ethereum algorithm, is most promising. Masterchain is technically ready to be employed in financial transactions. According to Alexei Chubar, Director of Digital Transformation Department at VTB Bank, Masterchain will primarily be used for developing a service of issuing bank guarantees. Chubar explained to Invest Foresight:

“VTB Bank is now developing several blockchain projects and one of those is a digital bank guarantee. The project is being implemented within the frameworks of our cooperation with FinTech Association. The project is a much needed and useful demonstration of the technology capacities since it allows to simultaneously test a number of approaches. First, it is a possibility to substitute paper documents with structured digital documents and to distribute them among all interested entities. Second, it is a possibility to use smart contracts to effect routine transactions”.

Nevertheless, nobody can explain any Masterchain’s practical application.

To sum up all of the above, it may be noted that in early 2018 banks were still experimenting with blochckain without attempting to turn it into everyday practices.

“All major credit institutions including RosEvroBank have been testing that technology. Jointly with our partners, we develop various services for B2B scenarios”, Alexander Vasiliev, Deputy Director of IT Department at RosEvroBank, told Invest Foresight.

The slow progress in the affair between blockchain and banks may be explained by the fact that any novelty is to be studied and tested. Besides, the very blockchain philosophy does not fully comply with banking. Many banking services may well be successfully effected on the basis of the existing central registries if those are supplemented by respective security and customer verification circuits.

Blockchain is in the first instance a system of exchanging nominal virtual values, digital money, for example. Due to use of some sophisticated technical solutions such a system would not allow its participant to transfer one and the same value twice. In regular systems, that is taken care of by central registries such as banks, notaries, government real estate registers, etc. Blockchain provides technological guarantee of settlements safety and accuracy, instead of legal guarantees provided by banks and government databases. On that foundation, cryptocurrencies emerge. Their circulation is made possible by direct dispatch of communications among settlements parties, without involvement of an intermediary bank. Blockchain therefore allows interaction among customers with no banks’ partaking. Yet if a bank has no intention to withdraw, would it use blockchain in dealings with its customers? Within the bank/client relationships frameworks, nearly everything blockchain can ensure, may be effected by using more traditional technology solutions.

As Alexander Bychkov, Director of IT Department at Geobank, told Invest Foresight,

“Blockchain solves two tasks. It guarantees transactions anonymity and ensures data decentralization. At the moment, banks need none of those. There is no anonymous banking in Russia, whereas decentralization is аn extremely disputable thing for lending institutions. Decentralization is first of all required for open data, but there is no such data in banks. Virtually all of their data falls within banking secrecy or commercially sensitive information. For that reason, most of financial institutions are not interested in introducing new technologies. Additional workload should not be ignored either, since developing new solutions will require hiring new specialists and employing cost intensive IT hardware. In my view, at the moment, any projects in this area are nothing but self-promotion. The current coupling of technologies and finances fully covers the needs of Russia’s banking sector. There may therefore be no significant implementations expected to be made in the near future”.

Andrei Chuiko, Director of IT Department at Novikombank, believes that one of blockchain’s major shortcomings is the time required to accomplish transactions. That does not permit using blockchain-based solutions in online transactions which nowadays mainly employ traditional systems.

“For a few years already, an efficient blockchain technology application in the banking sector has been explored. Regretfully, no meaningful results (apart from cryptocurrencies and ICOs) have been obtained so far”, Andrei Chuiko thinks.

A the same time, he does not rule out that a positive effect of employing blockchain may be obtained in systems based on smart contracts which usually require approval by many participants for a deal to take place, and only allow honoring contracts if certain conditions are met. In such cases, blockchain helps reducing aggregate time of deals performance. Therefore, a promising area of blockchain application, according to Andrei Chuiko, is factoring and LOC transactions, real estate deals and transfers of title to property assets or securities.