Blockchain technology will bring forth the next generation of the Internet in the years to come. A change from a network for information exchange to a network for the exchange of values. In the field of asset management, proven models are also facing a disruption through blockchain implementations. Cryptocurrencies are the first real use case, and their rise over the past decade has sparked a heated debate over how Bitcoin & Co. As a new asset class, this could change society’s current financial and economic structures.
Blockchain is important to asset managers because of two capabilities. First, it can act as a digital wrapper around each object. And second, it allows them to be exchanged across remote networks. There are also two reasons why the decentralized exchange of digital assets is crucial for asset management.
First, because these exchanges are distributed. They have the potential to undermine many centralized business processes within the financial services industry. Second, cryptocurrencies have introduced a new asset class and Initial Coin Offerings (ICOs) have enabled investors to invest in this new asset class past the classic banking system. Investors can thus participate in a global exchange of assets outside conventional structures.
Today, the wealth management industry is based on business models and processes based on decades of technology. These legacy systems and processes often lead to costly data maintenance and pose a serious threat to client sensitive data, transaction data, and the institution’s reputation with customers and regulators. Leaking these data can result in heavy fines and loss of customer confidence. In addition, many legacy systems are not flexible enough to implement new workflows according to market needs.
The basic components of blockchain technology, such as decentralization, consensus, immutability, and faster or cheaper transactions. It can also transform existing business models to make transactions smoother than ever before. Blockchain technology can improve service quality across a range of processes, including customer on-boarding, asset transactions and portfolio management. It offers a range of real-time settlement model use cases, money and value exchanges, know your customer (KYC) processes, automated investments and re-balancing of portfolios based on smart contracts. Customers are curious about the new asset class based on this technology, and supervisors are keen to capitalize on this technology for broader purposes, from improving inter bank financial transactions to regulatory reporting.
What technological leaps has Blockchain made over current technology such as Web 2.0?
The current Web 2.0 developed primarily on the classic OSI model, in which network and data layer are separated. From an OSI perspective, Blockchain essentially combines the data layer, the transport of information, and cryptographic elements into a single concept known as Distributed Ledger Technology (DLT).
In a Web 2.0 network, central instances maintain data journals and distribute them to participants. In a blockchain network, the data is distributed to different nodes and consumed according to the rules defined in the protocol. In its simplest form, the Blockchain is a secure transaction ledger database that is shared by all parties participating in an established, distributed network of computers. It captures and stores every transaction that takes place in the nodes, thus eliminating the need for trusted intermediaries.
Transferred to the asset management systems, the implementation of the technology enables a golden copy of the reference data to be stored remotely on an approved blockchain. In that case, only the approved list of systems has the authority to make changes. A company can then run on two different chains, one interacting with external entities such as consortia and another working internally within the organization.
Building a customer journal is a critical aspect of asset management business. It enables consultants to understand customer needs, make new suggestions, and improve relationships with existing customers. Consider an example of using blockchains and smart contracts to re-balance the portfolio of customer journal development.
Once customers are involved and their portfolios are set up, smart contracts can actively monitor the customer’s journal in a blockchain network. A smart contract is triggered when asset allocation within a portfolio changes or when the cluster risk for a single asset class rises above a threshold, resulting in customers and their financial advisors being notified in real time.
The customer portfolio is realigned based on the response of the client or consultant through the available channels. In Smart Contracts, several other rules can also be implemented to verify the suitability of the customer. The following diagrams show two more asset management cases for Blockchain:
- KYC and Customer On-boarding
- Trading bookings and settlements
Short-term challenges and response options
On a technical level, Blockchain still faces salability challenges due to its nascent experimental state, and few organizations and conglomerates are testing blockchain-based implementations in incubation environments. In addition, businesses are now unsure if they should bet on Blockchain technology or operate their legacy infrastructure in parallel until the blockchain is mature enough to minimize operational risk. The majority of banks are satisfied with the current technology for day-to-day business.
At the regulatory level, few development initiatives have been taken by central banks and governments to establish the basic protocol and infrastructure to implement blockchain. However, this should not affect growth. Institutions should investigate more use cases for low-risk internal applications such as credit card loyalty points or internal file transfers to test the original blockchain infrastructure and then access more critical applications. In this way, they can identify potential benefits and opportunities according to their strategic and long-term vision.
In addition, banks can collaborate with growing open source community platforms such as Hyperledger and R3, where they can pool their resources to achieve the desired results.
Another path is inorganic growth. Over $ 1 billion has been invested in blockchain startups since the technology was introduced in 2009. The platforms of fintech players are close to production readiness, which have the opportunity to integrate into existing business, without having to go through expensive and costly implementations.
Finally, and most importantly, due to the decentralized nature of Blockchain, all stakeholders including internal and external stakeholders should agree to implement the solution.
So the only way to tackle these challenges is to take the initiative to lead the change. Which means innovating in collaborative environments at the same exponential pace as with brisk startups.
The experimentation with disruptive blockchain solutions should not be ignored by any asset manager.