NEW PRINCIPLES TO EXPLORE BANKING BLOCKCHAIN USE CASES EFFECTIVELY

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1 NEW PRINCIPLES TO EXPLORE BANKING BLOCKCHAIN USE CASES EFFECTIVELY

2 Summary A new breed of blockchains are being developed to become identifiable, controllable and asset-agnostic. This evolving architecture demands new rules to explore use cases in the financial industry. Here we outline three usecase principles for bank CIOs that can potentially guide their blockchain investments in Bitcoin, since its inception in 2009, has seized the imagination and attention of the world. However, 2014 onwards, the underlying protocol enabling Bitcoins, blockchain technology, is capturing the center stage. Governments and industries alike are looking to exploit the blockchain to lower costs and bring in operational efficiencies while at the same time increasing security. Blockchain has the potential to fundamentally change the business and process governance. The power of the technology cannot be denied and hence, the world is willing to reengineer age old processes to implement blockchain. Blockchain is fast coming of age in the banking and financial services industry and its potential can be fully leveraged by selecting the right use. This sentiment is echoed across industries, with many large banks looking to exploit it for multiple use cases. However, blockchain in its true avatar may not be entirely suitable for highly regulated financial institutions. Hence, a new breed of blockchains is cropping up to meet financial institutions requirements. 2 I External Document 2017 EdgeVerve Systems Limited

3 The New Era of Blockchain - Innovation made Usable Financial institution s (FIs) priority has moved from understanding blockchain s potential to what further needs to be done for a blockchain to work within the regulatory boundaries of the industry. Their aim now is to meet the key aspects that a financial institution requires in order to use it effectively. Three broad areas are emerging in the New Era blockchain architecture. Identifiable The pseudo-anonymity of the blockchain does not work for FIs, where identifiability is key To meet regulations like KYC/AML and FATCA, FIs need to be able to identify and pinpoint the identity of the nodes This is addressed by including the real world identity to the blockchain address based identity Auditability was always a strong point of traditional blockchains, but with identifiability, it gets stronger FIs can take this further and build a fool proof repository of identities on the blockchain Controllable A public blockchain gives very little control to its participants and is truly democratic in nature. This does work in many cases as FIs need to be able to exercise control on several aspects, especially in the financial regulation space. Therefore, the need and the proliferation of private networks (or consortiums) Such networks allow control to a group or an individual organization to decide who can participate, how consensus on viewing rights, membership and frequency of validations can be arrived at Such a permissioned environment brings in certainty, predictability, and accountability into the blockchain based system Asset Agnostic The concept of creating value on the blockchain has been a point of controversy from the time of its inception. Regulators have mostly taken a negative stance on the value aspect while being open to the blockchain itself Thus, a blockchain which is not tied to one asset (that is created on the chain or otherwise) is an ideal way forward Such chains allow FIs to transfer legal tender/instruments/documents or any other asset which can be digitized These adaptations of the blockchain make it extremely attractive to the financial industry. The FIs can now focus on the use cases that interest them most, rather than worry about the suitability of the underlying technology. Key considerations for FIs to look at for developing use cases would be regulatory constraints, the readiness of the ecosystem and of course the nature of the process/area that is under consideration. External Document 2017 EdgeVerve Systems Limited I 3

4 Three Principles to Explore Use Cases FIs are cautious by nature. Blockchain technology has the potential to revolutionize financial transactions but several challenges have to be overcome one of the fundamental question from FIs is where to start for proofs of concept of blockchain use cases. In 2016, Moody s published a whitepaper that identified 25 important use cases from over 100 use case candidates, most of which are still valid in 2017 but a collection of 25 use cases is still far more than sufficient to give a clear view of exactly which use case fits most to a bank s business. The new blockchain architecture identifiable, controllable, and assetagnostic demands FIs to explore further what are the right use cases. In this chapter, we introduce three fundamental principles to help identify best-fit blockchain use cases, so that FIs can move forward to operationalize the technology and integrate it into current processes and systems. Principle 1: Non-Monetary In an era of cybercrime and stringent regulatory requirements, blockchain regulation is a gray area in the financial industry, creating some uncertainty around its implementation. Regulators are keeping an eye on blockchain technology, especially in the area of: The basic tenets of a KYC/AML compliance program (for instance FINRA 3310) require the customer identifies (who, where, and which organization) must be traced by blockchain payment system The general ledger integrity must be assured - all distributed ledgers that reflect account changes must be reconciled to bank s enterprise GL In such a context a blockchain, when tied to fiat or virtual currency, creates extra complications with compliance and legacy integration. Instead, documents, records, financial instruments and even private equities carried by blockchain could be an ideal way forward to avoid the compliance hurdles and regulation uncertainties. However, central banks are catching up quickly. In countries where regulation supports blockchain innovation for instance, the Monetary Authority of Singapore is testing blockchain for a new payment transfer project FIs could adopt an aggressive approach to try blockchain payments in sandbox environments. Principle 2: Contained R3 CEV, as one of the largest blockchain consortium, stated early on, that the initiative will, seek to establish consistent standards and protocols for this emerging technology across the financial industry. However, the question for financial firms is whether they should work together on a standardized consensus model that everyone agrees on or work independently on different versions and let the market decide. The other side of the coin is it takes time for a consortium to reach an agreement, and extra efforts to implement any initiative of this scope to harness a standard in a fast pace environment is definitely not easy, and sometimes a road block not a catalyst to innovation. What happened to R3 in recent year has shown the difficulties of building an ambitious consensus among a large group of key stakeholders. Therefore, FIs could first look at use cases that could be implemented inside the organization, or within a much smaller scale of consortium it enables them to test the technology in a time-to-market manner, and start small with niche-market use cases. Most FIs are interested in blockchain but have not participated in major consortiums for instance, regional and small-medium-size banks. Such FIs can go ahead with this light-weight approach, and even global multinational banks could run a bi-model strategy to try both contained and consortium relevant use cases. Having said that, a bank should consider all these factors in a local context to determine the best-fit approach. There are exceptions where agreement can still be efficiently made among a group of banks. It could be achieved by a powerful centralized organization, for instance, a financial holding company that includes a family of banks, or a strong state-owned banking association that represents a group of local credit unions. 4 I External Document 2017 EdgeVerve Systems Limited

5 Principle 3: Distributed It is essential to understand that from a business perspective, blockchain doesn t fundamentally change how payment or money market works. However, blockchain as a technology platform can be adapted to a business context and potentially transform the whole process and operations. The dispute of the pros and cons between a centralized database and decentralized database has been continued for decades. Centralized system has approved its efficiency in many business scenarios to handle mass volume transactions, for instance, core banking. On the other hand, although no formal benchmark released to indicate any serious capacity issues for blockchain, efficiency (for instance network scaling problems) is a general concern to not just blockchain but many other types of distributed databases - where significant overhead or replication associated with these protocols exists. However, blockchain, by its nature as a distributed record-keeping database, could demonstrate its true value, especially in a collaborative, distributed business environment. Typical scenarios include trade finance, international remittance, and syndicated loan. For these use cases, and with careful planning, FIs should have the confidence to deploy a scalable blockchain solution not only in a sandbox environment but also in a production environment. External Document 2017 EdgeVerve Systems Limited I 5

6 The Segmentation Model Though there is no one-size-fits-all rule, these three non-exclusive principles form a segmentation model. It is designed to help FIs further filter and identify suitable blockchain use cases. See figure 1. Segment 1: Ready Classic It is a segment where the use cases can fulfil all three principals. These use cases, though with a limited number, can leverage the full advantage of distributed ledger, and be easily integrated into a legacy environment without a compliance breach. Example use cases include trade finance document transfer, digitizing paperwork for both inter and intra organizations. Segment 2: Innovation Showcase A distributed platform like blockchain could potentially lead to cost optimization and operational efficacy. Although this business value is yet to be justified in a real production environment, FIs that have a strategy to appeal tech-savvy consumers can explore the use cases to replace a centralized legacy system to deliver a clear marketing message in innovation and digitalization. Example use cases include digital vaults and collateral management. Segment 3: Monopolistic Collaboration Due to the complexity of building a standardized protocol within a consortium, a monopolistic power in collaboration - implying a holding group, a monopoly banking association or a mega-bank leading trade finance partners is a prerequisite to applying a business scenario within a group of different business entities quickly. By implementing blockchain, it should be able to improve time-to-market and gain competitive advantage. Example use cases include syndicated loan, and multi-bank KYC if regulator as a catalyst to push for national KYC standard. Segment 4: Open Regulation Uncertain regulations keep bankers away from using blockchain for payments in a format of digital money including fiat currency and loyalty points in a real world. However, an open regulation framework or sandbox approach (in both advanced markets such as Australia, Singapore and emerging region such as Eastern Africa) opens up new opportunities to re-design payment ecosystems using blockchain. Example use cases include same-bank international remittance. Contained Innovation Showcase Open Regulation Ready Classic Non- Monetary Monopolistic Collaboration Distributed Figure 1: Segmentation model to identify suitable blockchain use cases 6 I External Document 2017 EdgeVerve Systems Limited

7 Conclusion Many FIs select blockchain use cases due to the hype surrounding this technology and not based on the local business and regulatory context. The three principles and the segmentation model is designed to help these organizations to review its blockchain investments and pipelines. FIs are suggested to look into a multitier approach adopting multiple segmentation approaches to participate blockchain development with a list of prioritized use cases. Several proofs of concept of blockchain use cases have been put forward by financial institutions. The battle for distributed-ledger pilots and business cases will define success for many innovation players in the financial services and payment sectors. However a clear understanding of where next generation blockchain is moving and how to explore most suitable blockchain use cases will be key to deliver successful outcomes in this space In spite of the challenges facing the blockchain, as technology becomes more robust, blockchain will eventually demonstrate its true value to reinvent banking and payment processes. Authors: Ethan Wang, Product Manager, Infosys Finacle Shweta Shivaraja Product Manager, Infosys Finacle External Document 2017 EdgeVerve Systems Limited I 7

8 About Infosys Finacle Finacle is the industry-leading universal banking solution from EdgeVerve Systems, a wholly owned product subsidiary of Infosys. The solution helps financial institutions develop deeper connections with stakeholders, power continuous innovation, and accelerate growth in the digital world. Today, Finacle is the choice of banks across 94 countries, and serves over 848 million consumers estimated to be nearly 16.5 percent of the world s adult banked population. Over a billion bank accounts are powered by Finacle globally. Finacle solutions address core banking, online banking, mobile banking, payments, treasury, origination, liquidity management, Islamic banking, wealth management, and analytics needs of financial institutions worldwide. Assessment of the top 1000 banks in the world reveals that institutions powered by Finacle enjoy 50 % higher returns on assets, 30 % higher returns on capital, and 8.1 % points lesser costs to income than others. For more information, contact finacle@edgeverve.com EdgeVerve Systems Limited, a wholly owned subsidiary of Infosys, Bangalore, India. All Rights Reserved. This documentation is the sole property of EdgeVerve Systems Limited ( EdgeVerve ). EdgeVerve believes the information in this document or page is accurate as of its publication date; such information is subject to change without notice. EdgeVerve acknowledges the proprietary rights of other companies to the trademarks, product names and such other intellectual property rights mentioned in this document. This document is not for general distribution and is meant for use solely by the person or entity that it has been specifically issued to and can be used for the sole purpose it is intended to be used for as communicated by EdgeVerve in writing. Except as expressly permitted by EdgeVerve in writing, neither this documentation nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, printing, photocopying, recording or otherwise, without the prior written permission of EdgeVerve and/ or any named intellectual property rights holders under this document.