| Notes |
Building the
trust engine
How the blockchain could transform finance (and the world)
A UBS Group Technology White Paper
Authors
Alex Batlin
Senior Innovation Manager,
UBS Group Technology
Hyder Jaffrey
Strategic Investment & Fintech Innovation,
UBS Investment Bank
Christopher Murphy
Global Co-Head of FX, Rates and Credit,
UBS Investment Bank
Andreas Przewloka
Group Managing Director,
UBS Wealth Management Europe
Shane Williams
Wealth Management Transformation and Blockchain,
UBS Wealth Management
Building
the trust
engine
Anyone following recent developments in banking has almost certainly come
across discussion of the blockchain. Touted as the next great thing in financial
technology (and beyond), the blockchain has been the subject of countless
articles in the mainstream and financial press. It has also become a focus for
major players in and around the financial system – from central banks to
regulators to fintech startups to global banks like UBS.
This will strike some as curious. Many (rightly) associate the blockchain with
Bitcoin, and wonder why a legitimate financial institution would want anything
to do with a cryptocurrency of dubious reputation. Others will note that the
blockchain was designed as a way to carry out financial transactions without
using the traditional financial system. Why would a bank want to be involved
with a technology ostensibly created to bypass a major part of its services?
There are many reasons. While the blockchain was indeed invented to enable
Bitcoin, it can do much else besides. We and our peers are not so much
interested in cryptocurrencies as we are in these other possibilities. We are also
fully aware of the blockchain’s potential to disrupt many of our existing business
models. On the other hand, it is no secret that the banking industry is facing a
number of very difficult challenges. It would be irresponsible of us to ignore a
technology that, on the face of it, offers the chance for such significant cost
reductions and efficiency gains. That this technology is likely to enable
significantly improved and potentially radically changed business models makes
it all the more interesting for us.
It goes deeper than that, however. Like many of our peers, we at UBS believe
the blockchain is a potentially transformative technology that will leave as deep
a mark on our world over the next twenty years as the Internet has over the last
twenty. For this reason we have been very active not only in understanding it,
but in collaborating with the wider community in helping to shape a blockchainenabled future financial industry.
Because of its potential impact, we consider it part of our duty to explain to our
clients and the world at large as best we can what these transformations might
mean. That is what we are attempting here. While there has been no shortage
of blockchain white papers recently, most focus on the technology and are
written for an industry audience – those likely to use blockchain to retool the
financial system. Here instead we try to paint a picture of what blockchain can
do in a way that is, hopefully, clear and accessible for the average user of that
system. To our knowledge, this is the first attempt by a major bank to do so.
We have no crystal ball, of course, and cannot know how much if any of what
we present here will ultimately come to pass. We think however we can outline
with some confidence the most likely paths of transformation the blockchain
could take us down. We offer this paper in the spirit of a thought experiment as
a way to help readers understand where these paths might lead.
However things turn out, we think it will be a fascinating journey.
Axel Lehmann
UBS Group Chief Operating Officer
Foreword
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Building the trust engine
The trust protocol:
The genesis of the blockchain
– Keepers of the trust: Banking before the blockchain
– Trust in the darkness: The birth of Bitcoin
– Trust in the light: Blockchain emerges from the shadows
Foreword: Building the trust engine
Executive summary
The trust elements:
Building blocks of a blockchain-enabled financial system
– The distributed ledger: Records on the chain
– Digital value: Money on the chain
– Digital identity: People on the chain
– Digital provenance: Things on the chain
– Smart contracts: Agreements on the chain
The trust foundations:
Blockchain and the financial infrastructure
– Settling down: Real-time settlement models
– Amicably parted: Split data and service level models
– Sharing the burden: Decentralized computing models
– Let the sun shine in: Regulatory inclusive models
– Look ma, no hands: Autonomous financial instruments
P. 12
P. 17
P. 22
Table of contents
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A UBS Group Technology White Paper
The trust app:
Blockchain and banking for individuals
– Better than leather: Introducing your smart wallet
– The trading chain: Portfolio management on blockchain
– Chains of beings: You and your digital identity
– Chains of things: You and your “digital” possessions
– Gold chain: You and your own private currency
The trust platform:
Blockchain and banking for business
– Show me the money: The real-time payment paradigm
– No issues with issuance: The direct capital paradigm
– Happy in a crowd: The direct funding paradigm
– Keeping track: The self-administration paradigm
– Keeping in touch: Managing B2B and B2C relationships on the chain
The trust collaboration:
Enabling blockchain in financial services
– The long and winding road: Hurdles to a blockchain future
– A coat of many colors: The need for an open source fabric layer
– Chain gangs: Industry collaboration in the blockchain space
– Come in to the lab: Blockchain innovation at UBS
Afterword: The future of trust
Appendix: An (important) note on terminology
Appendix: For further reading
Appendix: How the Bitcoin blockchain works
P. 27
P. 30
P. 34
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Building the trust engine
The history of technology – like history in general – is full of ironies.
When Satoshi Nakamoto introduced Bitcoin to the world in 2008, the
new cryptocurrency was meant to enable electronic cash payments
directly between individuals without the use of banks. Eight years later
and the blockchain – the groundbreaking technology Nakamoto
invented to power Bitcoin – is being championed by banks as a way to
radically improve the financial system. Instead of making them
superfluous, the blockchain may very well make banks better at what
they do.
Like many of our peers, we at UBS have become very interested in the
blockchain and its potential. Over the past year we have been studying it
intensely and, in collaboration with others in the banking and fintech
industries, have begun experimenting with its possibilities. Over that
time we have learned a lot: enough to feel confident that the blockchain
could indeed catalyze significant transformation for our industry. We
have begun also to see a clear outline of what a blockchain-enabled
financial system might look like. This white paper is an attempt to share
that picture – in a non-technical and hopefully vivid way – with our
clients and the general public.
Executive summary
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A UBS Group Technology White Paper
1. The trust protocol:
The genesis of the blockchain
Imagine a world where everyone was
perfectly honest and trustworthy when it
came to money…
Banks arose from the need for trusted intermediaries to
help people protect and transact with their money. From
the early Renaissance bankers with their paper ledgers to
today’s highly complex financial system with its millions
upon millions of databases, banks have fulfilled this role
among other things by being reliable and discreet keepers
of lists. Considering the complexity of our modern society,
we think it fair to say that the financial system we have
built handles this task remarkably well. But no one would
deny that the current system is also frighteningly complex,
highly redundant, and very expensive.
Bitcoin was developed as an electronic cash system that
would allow people to make direct payments between
themselves without the need for a third-party intermediary
to keep things honest. The protocol relies heavily on
existing technologies and methods – in particular peer-topeer networking and digital cryptography. But it also adds
one key new element to the mix: the blockchain. This is an
ingenious technology that uses sophisticated cryptographic
techniques and clever incentives to ensure an autonomous
but absolutely reliable accounting of Bitcoin transactions.
With it, everyone using Bitcoin can be sure of one tamperproof version of the truth, and so can trust the currency.
No one had figured out how to do this before in an open
source, intermediary free system. As a result, Bitcoin
succeeded where other attempts had failed. While its
spectacular rises and falls garnered Bitcoin a high degree of
notoriety among the public, the underlying technology
quietly began to capture the attention of the financial
industry (and others). The object of interest wasn’t
cryptocurrencies, it was shared list-making. The blockchain
revolution had begun.
2. The trust elements:
Building blocks of a blockchain-enabled
financial system
Imagine a world with a single, universal,
absolutely trustworthy and completely
indestructible financial ledger…
The blockchain can be used to provide the basic services
that are essential to any financial system, and can do so in
ways that are often better and more efficient than the tools
we use now. For one, blockchain technology creates a
viable, decentralized record of transactions – the distributed
ledger – which allows the substitution of a single, inviolable
master database for large numbers of proprietary ones.
That could lead to radical simplification and cost reduction
for large parts of our financial system, while making it
more secure and reliable. Blockchain technology also allows
for the creation of digital currency with the attributes of
non-counterfeitable cash, providing a mechanism for direct
and unambiguous transfer of value while keeping the
advantages of digital networks.
The blockchain also offers a far better means of
establishing and using identity than the one we have now.
By providing unique, non-forgeable, cryptographically
sealed pseudonyms, which could then be associated with
any number of verified credentials, individuals in a
blockchain network can simultaneously authenticate their
identities while protecting their privacy. By providing
unique, non-forgeable identities for things as well, along
with an inviolable record of their ownership, the blockchain
can greatly simplify the direct transfer of physical assets
and increase confidence in their provenance. Finally, by
adding full programming capability to blockchains, we can
create “smart contracts.” These will allow us to not only
better record our financial agreements, but to make these
agreements autonomous and self-enforcing.
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Building the trust engine
3. The trust foundations:
Blockchain and the financial infrastructure
Imagine a global financial infrastructure
that is slim, trim, safe and secure…
Using the elements described above, we can potentially
retool the existing financial infrastructure and employ new
business models to radically improve some of its core
functions. The blockchain for example could enable near
real-time settlement models for most types of financial
transactions, which could eliminate counterparty risk, free
up capital and radically reduce transaction cost. It also
allows for split data and service level models in which
individuals in effect become the keepers of their own
accounts. This could give them not only more security, but
much more freedom in choosing financial service providers.
The blockchain relies on decentralized computing models,
which by their nature are more robust and secure than the
proprietary, centralized models we now use. This could
help create a safer, more reliable system at a far cheaper
cost.
By giving regulators a real-time view of what is happening
in the system, the blockchain can allow for regulatoryinclusive models too. That means regulators could act to
stop crises before they happen instead of regulating after
the fact in an attempt to avoid the next crisis. It could also
allow for regulatory rules to be “baked in” to financial
products and services, making the system more compliant
and harder to abuse for criminal ends. Finally, smart
contract technology could allow us to create new,
autonomous financial instruments. Smart securities for
example could issue and administer themselves, vastly
reducing the cost of accessing capital markets as well as of
asset custody, servicing, and reporting.
4. The trust app:
Blockchain and banking for individuals
Imagine a world where you can download
your own personal bank onto your phone…
A blockchain-enabled financial system would likely look
very different for individuals than the system we use now.
Tomorrow’s “smart wallets” – the apps people will use to
connect to the blockchain-enabled financial system – could
for example be configured as personal, freely
programmable portfolio managers. These apps would be
able to trade on their users’ behalf, and even read the
news and make their own trading decisions based on
market developments.
A blockchain-enabled financial system could also give
people far more control over their identities. With
credentialed pseudonyms based on public-key
cryptography, verified identities could easily be used to
open accounts at multiple institutions or prove suitability
for certain financial products. They could also allow people
to share different parts of their identities in different
contexts. Similar approaches could allow for far more
secure and reliable means of identifying assets, giving
people more confidence in the provenance and authenticity
of the items they purchase and opening up possibilities for
direct markets in high-value assets. The blockchain also
allows for the easy creation of private currencies,
something which was common in the past and may now
see a renaissance – with interesting implications both for
high-net worth individuals and retail clients.
5. The trust platform:
Banking and blockchain for businesses
Imagine a future where all sales involve
immediate transfer of funds and
businesses have instant access to cash…
The blockchain could also bring great benefits to
businesses. By enabling direct transactions the blockchain
could make most business payments cash-like, reducing or
eliminating late payments and so freeing up capital. By
reducing transaction costs to near zero, it could allow for
extremely small micropayments and with them new
business models. Smart securities could make it easier for
corporations to access capital markets, and cheaper for
them to service and report on the securities they issue.
The blockchain could potentially provide new impetus to
crowdfunding by increasing trust in those seeking
financing, no matter where they might be. It also has the
potential to radically reduce business administration costs
by automating such things as payroll, accounting, VAT
payments and regulatory compliance.
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A UBS Group Technology White Paper
The new identity paradigm associated with the use of
credentialed pseudonyms may also change the way
businesses gather and use customer data. Instead of relying
on the flood of unstructured and unreliable information
available to businesses today, they may instead increasingly
use the data their customers choose to share. This would
be far more reliable and easier for businesses to process.
As it is freely given, it should help strengthen customer
loyalty. In a blockchain-enabled world, businesses may
develop new and improved ways to interact with their
customers and, through the Internet of Things, to keep
track of and service the items their customers have
purchased.
6. The trust collaboration:
Enabling blockchain in financial services
Imagine a technological revolution that
was the result not of competition but of
collaboration…
While most of this paper is dedicated to optimistic future
scenarios for blockchain, we are well aware of the many
hurdles the technology must overcome if it is to achieve its
potential. There are technical issues, issues involved with
whether the technology is developed in a coordinated or
fragmented way, and issues of governance of the new
platform. At UBS, we believe strongly that the industry
must develop a common underlying blockchain-based
market fabric upon which all parties can build their valueadded services. This will mean solving a number of
particular challenges outside blockchain proper, including
how the industry will handle the identity of people and
entities, how it will bring legal tender onto the chain, and
how it will handle the many governance and legal issues
associated with the various parts of the new platform.
The good news is that much of this work has already
begun in earnest. Over the past year, the blockchain has
garnered an intense amount of interest and investment,
and this trend is set to explode. Nor is this interest to be
seen only among banks and fintech companies. Central
banks and regulators around the world, as well as
organizations involved in providing shared financial services
infrastructure, have also begun working on possible
blockchain applications. With industry-wide collaboration
platforms like the R3 consortium, which brings together
more than 40 global banks in an effort to set common
standards, the stage has been set for the cooperation
necessary to bring out blockchain’s full potential as quickly
as possible. At the same time, experiments by individual
institutions, including by us at UBS in our innovation lab,
are adding to the growing corpus of knowledge about this
exciting new technology.
Afterword: The future of trust
While we are very optimistic about the blockchain, we are
not naïve about its potential to disrupt our business. Quite
the contrary, the more we learn about this technology, the
clearer its transformative nature becomes. With the
disintermediation of trust may come new paradigms which
could put large, centralized organizations at a
disadvantage. We are sanguine about this change, and
indeed are embracing it. There is more to banking than
just transactions. Since its early days it has also been about
personal relationships, expertise and advice. These
functions will not disappear. Current industry players
servicing different parts of the system will have to adapt,
but their know-how will also still be needed to build the
new trust engine. If this engine is as powerful as we think
it might be, it could take us very far.
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Building the trust engine
Imagine a world where everyone was perfectly honest and trustworthy
when it came to money. Where no one could cheat. Where financial
transactions were always immediate and final. Where ownership of assets
was always crystal clear. Where money could be neither laundered nor
embezzled. Where agreements to pay, once entered into, were always kept.
This is a utopia most would welcome – and one we may never see. But the
advent of the blockchain has spurred a movement which may take us a long
way down such a road by revolutionizing how we handle financial
transactions. Like our society, our financial system has grown extremely
complex. The blockchain is a technology that could make money simple
again. That’s big news.
Keepers of the trust:
Banking before the blockchain
Trust is one of the main prerequisites for a functioning
society. We routinely put our lives in the hands of total
strangers because we trust them to do the right thing: the
doctors who keep us healthy, the pilots who land us safely,
the other drivers on the road who stop at the red light. In
these and other areas of our lives, trust works remarkably
well. But there are limits, and so we have also had to
develop trust-enforcing institutions. The police, for
instance, exist because people cannot always be trusted
not to harm each other.
In a similar way, banks exist because people cannot always
be trusted to deal honestly with money. As large and
complex as our modern financial system is, its primary
function is to cope with this simple fact. (If we humans
were all absolutely honest souls and perfectly scrupulous
record keepers, then bankers would be largely
superfluous.) Among other things, banks keep our money
safe, provide us with confidential and accurate records of
how much money we have, make available secure and
reliable means for us to send and receive money, and
ensure that people don’t cheat us or the system.
They do this, in essence, by keeping lots and lots of lists.
The immense size, complexity and expense of our current
financial system can be seen as a simple function of the
unfathomable number of money-related lists required in
our modern world, as well as the incomprehensible
complexity of ensuring that these lists are accurate, secure
and in agreement with each other.
Despite its complexity, the financial system we have built
serves us rather well. Today we have truly global financial
markets, routinely process billions of transactions a day,
and keep track of trillions of dollars’ worth of value.
Without such mechanisms, our society would not be able
to function. Yet our current regime is by no means perfect.
It relies on large numbers of private and public entities each
with their own organizations and proprietary IT systems.
That makes it expensive and, as information is replicated
through the system, often needlessly redundant. Many of
the key parts of the system are centralized, creating
potential single points of failure. By their nature opaque
(they were built to ensure privacy), financial infrastructure
systems are also hard to monitor.
With the blockchain, we have perhaps found an alternative
method of keeping extremely large and dynamic lists that
may very well address many if not all of these issues. Hence
the excitement.
The trust protocol:
The genesis of the blockchain
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A UBS Group Technology White Paper
Trust in the darkness:
The birth of Bitcoin
On Halloween of 2008, as the financial crisis raged, a
person or group using the name Satoshi Nakamoto, and
whose true identity as of this writing remains unknown,
published a short white paper on a cryptography mailing
list. The paper proposed the creation of a peer-to-peer
electronic cash system based on a currency it dubbed
Bitcoin.
At the heart of the project was the desire to “allow online
payments to be sent directly from one party to another
without going through a financial institution.”¹ Bitcoin was
therefore clearly designed to bypass key elements of the
traditional financial services infrastructure. While it was not
the first digital currency to be proposed for this purpose, it
was the first to succeed on a large scale. That’s because
the solution Nakamoto devised solved the key problem that
had bedeviled all previous digital currencies: the problem of
trust.
The solution is rather simple in theory, if harder to
understand in practice. The Bitcoin protocol uses a
combination of extremely sophisticated cryptographic
techniques (hence it is also known as a cryptocurrency),
and subtle social engineering to create an autonomous,
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Building the trust engine
trustworthy decentralized network for the exchange of
bitcoin between anyone who cares to join. The protocol
allows for the creation of new bitcoins in the network at
regular intervals, and it provides financial incentives for
special users – known as miners – to take on the work of
carrying out and validating transactions.
Much of the Bitcoin protocol, as Nakamoto readily admits
in his, her or their paper, is built on already existing
technologies and methods. It relies on peer-to-peer
networking to create the Bitcoin network. It uses public-key
cryptography² to uniquely and definitively identify all
members of the network while hiding their true identities;
as well as to – in effect – uniquely identify each unit of
bitcoin. All of this was possible before. But Nakamoto
added one key new element to the mix which made Bitcoin
different and more powerful than any previous attempt at
creating an autonomous digital currency. This was the
blockchain.
The blockchain is a record of all the transactions ever made
with all the bitcoin in existence, back to the first-ever
transaction. What makes the blockchain special is that this
record is not kept by any central authority. Instead it is
maintained by the collective efforts of anyone who cares to
join the network and become a miner.
Miners are incentivized by earning bitcoin as well as
transaction fees in exchange for their work. They are
prevented from cheating by the ingenious process they are
obliged to use to carry that work out. This process – the
details of which are not in the scope of this paper, but
which are a fascinating study in themselves³ – makes it
impossible for anyone to introduce bogus transactions, for
example to double spend coin. Only valid transactions can
make it through the process, and each valid transaction is
cryptographically linked to the previous one, forming a
chain of transactions. The chain is then updated in blocks
of 500 valid transactions each (hence the name).
The most current version of the chain, which by its very
nature cannot be altered or counterfeited⁴, is constantly
updated on all the computers on the network, creating a
viable “distributed ledger.” This ledger can be inspected
and verified at any time by anyone. The system, which is
fully autonomous, therefore provides its own trust.
Bitcoin’s real innovation has not been in building a robust,
open and secure platform for transferring value directly
between individuals. Rather it has been in building a
functioning trustless system for that purpose: one that
works even though the people who use and run the
system do not know and therefore, by definition, cannot
trust each other.
A work of genius, we may also note that at heart Bitcoin is
nothing more than a very clever means of automatically
creating, updating and storing absolutely trustworthy and
indestructible lists.
1 See: bitcoin.org/bitcoin.pdf
2 Also known as asymmetric cryptography.
3 See the appendix for a short explanation of how the Bitcoin blockchain
works as well as a blockchain reading list.
4 The ledger is sealed with a cryptographic hash, a unique, practically
unguessable number (even with the most powerful computers available
today, you have a better chance of being hit by an asteroid than
guessing this number). If even one bit of information in the ledger is
altered, the hash changes, revealing the misdeed.
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Trust in the light:
Blockchain emerges from the shadows
Although not without its teething pains, Nakamoto’s
system worked, and Bitcoin soon became the world’s most
popular and valuable digital currency. For a variety of
reasons, including early adoption by criminal elements
(drawn by Bitcoin’s ability to transfer funds anonymously
out of the reach of governments) and some well publicized
thefts, it was also soon its most notorious.
While the rise of Bitcoin brought public and media
attention to the sometimes shady world of
cryptocurrencies, it also sparked interest in understanding
how its underlying technology worked. It wasn’t long
before people realized just how ingenious and powerful
this new technology was – not for its cryptocurrency
aspects, but for its list-making ones.
This was particularly interesting for the financial industry.
If the blockchain made it possible to build a bullet-proof
and fully-automated system for maintaining a ledger
of bitcoin transactions, what other kinds of financial
transactions could it potentially keep track of? And if the
blockchain enabled automatic bitcoin transactions that
were immediate and final, what other kinds of transactions
could it theoretically automate? The potential was
intriguing, and seemingly limitless.
What followed is the blockchain revolution we are living
through today. Like all technological revolutions it is
characterized by a certain degree of hype, but also by a lot
of hard work and creative thinking. A large and growing
number of people both within and outside the industry –
including ourselves at UBS – have been looking at ways of
improving or expanding on the blockchain idea, for
example by adding new functionality to the Bitcoin
blockchain, or applying it to novel use cases, or even,
inspired by the Bitcoin blockchain, designing alternate
blockchain-like systems that do the same thing in different
ways.
In this sense, the blockchain is as much a mindset as it is a
technology. Once it was possible to see a workable
decentralized list-keeping platform in action – a tool and a
methodology for building digital trust engines that could
be used for a wide range of purposes – the cat was out of
the bag. People began to see things in new ways, and to
get excited by what they saw. Out of such moments are
true technological transformations born.
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Imagine a financial system with a single, universal, absolutely trustworthy and
completely indestructible ledger. One master list to record everything having to
do with money, all over the world. A ledger freely accessible to all yet
completely secure, reliable and tamper proof. One in which our privacy is
securely protected while our identities are definitively authenticated. Where
transactions involving money and things can immediately be recorded with
absolute confidence and no ambiguity. A ledger which can automatically carry
out our transactions, and on which we can sign contracts that autonomously
execute and enforce themselves. A ledger at the heart of an “Internet of
Value”, as some have called it⁵, as powerful and easy-to-use as the Internet
of communications we know today.
While a single, universal ledger of everything is more of a rhetorical device
than an actual future scenario, blockchain technology can move us in that
direction – along the way radically improving the means we have to handle
money. In this chapter we take a look at some of the basic building blocks of
the financial system and the new paradigms the blockchain represents for each
of them.
The trust elements: Building
blocks of a blockchain-enabled
financial system
5 See https://www.bitconnect.co/bitcoin_news/bitcoinfront/details/78 for
a discussion on who coined the term.
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Building the trust engine
The distributed ledger:
Records on the chain
As mentioned, one key function of banks is to provide a
reliable and secure accounting of assets and transactions.
In the current paradigm, each bank keeps its own records.
The result is an impenetrable jungle of lists: all the bank
accounts in the world, all the credit card, mortgage and
securities accounts, all the names of people, organizations,
and other assets associated with these accounts, the
records of the trillions of transactions that are made
between the accounts, and the copies of all of these
records that are created as transactions wind their way
through the system.
In the blockchain world, this paradigm is turned upside
down. Instead of each member of the network having its
own list in its own proprietary system, there is one list – the
distributed ledger – which everyone shares. Since the list
runs on an open platform that contains verifiable consensus
mechanisms, all parties can be sure of its validity. As it is
open to all to inspect, it can also constantly be monitored
and checked for accuracy. Before blockchain, none of this
was technically viable.
Shared list-keeping is highly desirable for a number of
reasons. For one, blockchain-based systems are radically
simple – it is much easier to deal with one list than one
thousand. They are also, at least in theory, radically less
expensive to build and maintain. Sharing one list also
means that everyone must agree up front on how data
should be structured and stored (hardly the case in today’s
proprietary model), so these systems have the advantage of
built-in standardization and interoperability too.
Because it is distributed over a vast number of computers,
a blockchain-based system is for all intents and purposes
indestructible. Unless every single computer in the network
is destroyed, there will always be a valid version of the
ledger available somewhere to keep the system going.
Because blockchain ledgers are cryptographically sealed,
they are extremely secure as well.
Digital value:
Money on the chain
Since the move to fiat-based currency 40 years ago⁶, the
vast majority of money in the world has become nothing
more than an entry on a ledger. It is made by central banks
when they create reserves or, far more frequently, by
commercial banks when they extend credit, and it lives in
electronic databases spread out through our financial
system. Fiat money is therefore not really a thing – it is a
promise to pay. Making financial transactions today simply
means adjusting our many ledgers to reflect changes in
these promises.
Money in blockchain is also just an entry on a ledger.
Unlike fiat money, however, the “coins” in a cryptocurrency
are uniquely identifiable – represented by cryptographically
generated keys so complex they are impossible to guess or
forge, even for the most powerful computers⁷. As with
today’s money, transferring a cryptocoin from one person
to another involves assigning it to a different account on
the ledger. Because the reference is to a uniquely
identifiable “piece” of money, as long as the ledger is
correct, this transfer is as definite and irrevocable as a
physical exchange of notes or coins.
Money in the blockchain world is therefore like cash, but
with significant improvements. Thanks to cryptography,
blockchain-based currencies cannot be counterfeited. Being
digital, they can’t be picked out of your pocket. Like
banknotes with serial numbers, blockchain coins can also
be easily traced. Blockchains function in fact by being
records of the movements of each coin from the moment it
is created. Since the record is public, it is easy to ensure
that each coin is only assigned to one account.
No double spending, no counterfeiting, “tangible”
currency which can be directly exchanged instantly via
digital networks. Here too, the blockchain offers means for
handling money that could greatly improve upon those we
have now.
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Building the trust engine
Digital identity:
People on the chain
A financial system can only function if someone,
somewhere, knows who the parties to a transaction really
are. Without this, there can be no correct accounting. On
the other hand, we do not want our financial transactions
to be public, nor the records of what we are worth. Here
too we rely on banks as intermediaries. They verify our
identities when we open our accounts, keep our records
safe from scrutiny, and transact on our behalf in nonpublic, secure ways.
The system is far from perfect. Banks rely on various forms
of documentation to verify our identities, and these can be
forged. Modern technology has unfortunately made
identity theft much easier, making it easier in turn for
criminals to impersonate us to banks and steal our money.
Because banks on purpose do not share identities, we need
to prove who we are each time we open an account at a
new one. Multiple copies of our identity are therefore
spread all over the system, inviting error and making it hard
to update should something about us change.
Blockchain has a better way. It uses public-key cryptography
to in effect assign a unique ID, in the form of a
cryptographic key, to each user on the network⁸. This key
has two parts: a public key, which is the network identifier,
and a private key, which is like a password that gives the
holder control of what goes on in the name of the public
key. The combination of private and public key is unique,
and cannot be guessed at or forged. As long as no one else
has your private key, you in effect have a secure
pseudonym that allows you to carry out completely
anonymous transactions.
Such anonymity, of course, can be abused. That is why in
mainstream blockchain applications we will still have need
for outside authorities to vouch for our identities. This
could take the form of a central registry, perhaps held by
the government, or – more interestingly – be the result of a
system of attested identities. Your consulate for instance
could attest that the person associated with your key is the
holder of a valid passport. The motor vehicles department
that that person holds a valid driver’s license. The birth
registry that that person is of a certain age and gender.
A bank that that person is the holder of an account.
And so on.
You could then use these attestations – which are bona
fide yet not publically traceable to your real name – as
needed. By attaching such credentials to their anonymous
public keys, honest people can build trust in their identities
while maintaining privacy. Criminals would have a much
harder time. Later in this paper we will explore some
interesting ramifications of this approach.
Digital provenance:
Things on the chain
As with people, so with objects. Today, ownership of assets
is recorded by a network of intermediaries. Your bank has
the record of your financial assets, the county clerk the
record of title to your house. For the vast majority of things
in your possession, proof of ownership is contained in your
receipt, and disappears if you lose it.
In the blockchain world physical assets – a house, a car, a
TV or a diamond ring – can have unique identifiers the
same way people do. That means they can be accounted
for, and transacted with, on the ledger. In current parlance
this is done using so-called colored coins: blockchain coins
which, instead of representing money, are tokens of things.
Just as with currency, the ownership of things on the
blockchain is clear and irrevocable – a token of an asset can
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not be counterfeited and can only be associated with one
account. Also as with the currency, transfer of assets is
easy, immediate and final, with a traceable, auditable
record of ownership going back to when the asset was first
added to the chain. Digital tokens can also accumulate
attestations, and so gain bona fide credentials. If experts
can verify the authenticity of a painting, for instance, and
that attribute is attached to the painting’s token, all
interested parties can be confident that it is not a forgery.
Smart contracts:
Agreements on the chain
Finally, a very important function of the financial system is
to keep records of our agreements with regard to money.
While payments are a simple form of this – an agreement
to move funds from A to B – most financial agreements are
more complex. Escrow arrangements, for example, where
funds are only transferred when goods are delivered. Or
derivative financial instruments that only pay out if certain
things happen in a market. Whatever the conditions are, it
is the job of banks and other intermediaries to record these
agreements and execute their stipulations.
In the blockchain world these tasks can be handled by
adding programming capabilities to the ledger. This was
already possible in the original Bitcoin blockchain, which
features a simple programming language allowing users to
attach basic conditions to transactions. Today a lot of work
is being done to add more powerful programming
capabilities to blockchains that would allow them to
understand and execute any kind of business logic. This
enables the creation of what have come to be called
“smart contracts.”
Smart contracts have some interesting attributes. Since like
everything else on the blockchain ledger they have unique
identifiers, they can send and receive information. Among
other things, that means they can hold money and so be
programmed to make autonomous decisions about buying
and selling things.
Smart contracts are probably the most exciting and
powerful extension to the original blockchain idea yet
developed. As we will see in later sections, they open up a
number of very intriguing possibilities, from automated
escrow agents to self-servicing digital securities. Like any
powerful new technology, they will also likely open the
door to new ideas and possibilities beyond our current
imagining.
6 See "Identity is the New Money", Birch, Loc. 156 in the Kindle edition.
(Full citation in appendix.)
7 This is admittedly simplifying for the sake of clarity. In Bitcoin, only
transactions have IDs, not currency. But since the transactions are the
currency, the end effect is the same. Some have worried that the advent
of quantum computing-based decipherment could end cryptocurrencies.
While this is possible, it is equally likely that quantum computing will
result in quantum cryptographic techniques capable of creating
quantum cryptocurrencies strong enough to baffle future quantum
code-breakers.
8 Here too we are simplifying somewhat. In Bitcoin, for instance, the ID is
not assigned to a person but to a wallet. People can have as many IDs
as wallets. As long as they have the corresponding private key to the
wallet, the wallet’s ID is in effect their ID.
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Building the trust engine
Settling down:
Real-time settlement models
It has never been easier for consumers to make payments.
Whether by credit card, computer or phone, it can seem
like we are able to use our money instantly whenever we
want anywhere in the world. This impression is misleading.
When you buy a coffee on vacation with your card the
record of your purchase is immediate. The actual transfer of
money from your account to that of the merchant takes
days. In the meantime information about your latte has
travelled through a dizzying maze of systems. The same
can be said for the settlement of almost any type of
financial transaction today, from simple payments to
complex trades.
The truth is, our current settlement regime, while admirable
in many ways, is far from ideal. It is full of redundancies. It
requires information to be passed along a chain of
proprietary systems where glitches can result in
discrepancies. When discrepancies occur they must be
manually reconciled, which costs money. The lag between
when a transaction is agreed and when it is settled invites
risk – one of the parties could conceivably go broke during
the settlement period. Insuring against such counterparty
risk costs money too. It also ties up capital, as the funds
earmarked for a transaction are not available until that
transaction settles.
There’s little or no waiting in the blockchain world.
That’s because blockchain enables direct and irrevocable
transactions between counterparties, with almost
immediate transfer of funds. This could theoretically
enable near real-time settlement for almost any financial
transaction, a long-time industry dream.
Near real-time settlement has many advantages. For banks
it means a simpler, cheaper and more robust settlement
Imagine a global financial infrastructure that is slim, trim, safe and secure. A
system that combines the ease and finality of cash payments with the speed
and reach of global communications. Where transaction fees are reduced to
the minimum, because the effort to carry out transactions is minimal as well.
A system so robust that it could easily survive the collapse of even the largest
institution, making too-big-to-fail a thing of the past. A world where stocks
and bonds administer themselves: automatically paying dividends and
coupons, registering their new owners, and reporting on their prices.
Imagine a financial system where money laundering and terrorist financing
are impossible, while at the same time personal privacy is strengthened. A
financial system that could be far more effectively regulated, because
regulators can view developments in real time – giving them the tools to
prevent financial crises before they happen. In this chapter we look at how
the blockchain might transform some core financial services business models
and so help us turn such imaginings into reality.
The trust foundations:
Blockchain and the financial
infrastructure
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infrastructure that could drastically reduce transaction costs
and hence fees. It could also mean drastic reductions in
counterparty risk and the need to post expensive collateral
at central banks to insure against it. That capital would
then be free to use for other ends. Trades that settle
immediately and irrevocably can also by definition contain
no errors, eliminating the need for expensive manual
follow-up.
Near real-time settlement would free up capital for
corporations and investors too. Today when a trade is
made, money is tied up until it settles. In the blockchain
world, funds are ready to be put to use again almost
immediately. In this world there can also be little or no
disagreement as to what was actually transacted. The
blockchain by its nature provides an unambiguous and
incontestable version of the truth available for all to
consult.
Amicably parted:
Split data and service level models
Most of us, if asked where our money was, would probably
say “in the bank.” And it would be a fair representation of
the truth. Today our money, or at least the records of it,
resides in the databases run by our financial institutions.
If we want to do something with that money, we first have
to send instructions to the institution.
In the blockchain world our money is an entry in a single
ledger, copies of which exist on countless computers
connected in a vast network. In other words it is
everywhere and nowhere at the same time. That may
sound eerie. But since our records are secured by a
cryptographic key only we know, we could just as easily say
that our money resides with us – a much more comforting
thought. Taken to its logical conclusion, this means we
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Building the trust engine
wouldn’t really need banks to keep our accounts for us
anymore. We could keep them ourselves.
This of course would hold true for any kind of information
stored on the blockchain. In this new world, we will
therefore likely see a split between data and service – that
is, between our information and the systems and
organizations we choose to process it. This will give us all
much more freedom. If you no longer have an account at a
specific bank, then you are no longer obliged to use that
bank for your transactions. You can pick and choose. As
we examine in more detail in the next section, this is also a
safer approach. If a bank’s systems go down or become
corrupted you have nothing to worry about. Your data is
always safe in your own hands.
Sharing the burden:
Decentralized computing models
At some point in your life you have probably experienced
the nuisance of data loss. A corrupted hard disk, a bad USB
stick, losing the password to a backup. When our personal
systems fail, it can be irritating and painful. Sometimes it
can be costly. If a bank’s systems fail, it is nothing short of
a disaster. That’s because each bank is individually
responsible for caring for its customer’s data.
There is another way – decentralized, peer-to-peer
networking of the kind employed in blockchain. In this
model, instead of one central server holding and processing
the data, all computers on the network share the
information and the workload. This model offers several
key advantages over the centralized one we use now.
For one, it is cheaper to build and maintain. In place of a
host of proprietary systems that have to learn to talk to
each other, there is one network and one protocol. In the
blockchain world there is also one data set, the distributed
ledger. This could drastically reduce development and
maintenance costs. This model is also more robust. In the
event of a catastrophe, unless every single computer on the
network is destroyed, there will always be at least one
node with the latest copy of the data that will be able to
carry on the processing. That means reduced costs for
business continuity management. Since the blockchain uses
sophisticated cryptographic methods to ensure the viability
of the ledger, it is also highly resilient to cyber attack. That
reduces the cost for cyber security.
Decentralized computing does not just reduce operational
costs. The blockchain could also potentially reduce the
requirements for resolution planning, for example to meet
too-big-to-fail regulations. When Lehman Brothers
collapsed, it took years to untangle all the open trades and
figure out where the assets were – a costly and nervewracking process for all involved. On a blockchain-enabled
system such a failure would not lead to catastrophic
uncertainty because there would be no open trades. With
a distributed ledger, everyone knows the exact location of
all assets at all times.
Let the sun shine in:
Regulatory inclusive models
Banking is one of the most highly regulated industries in
the world. The rules governing banks are meant to protect
consumers, ensure fair competition, and avoid banking
crises. As we saw in the crisis of 2008, this is not always
easy to do. One big problem regulators face is that they
can often only act after the fact. They can look at what
happened in a crisis and write rules to ensure the same
mistakes are not repeated; yet the causes of future crises
are rarely the same as those of previous ones.
In a blockchain-based system, where transactions are
immediate and the ledger public, regulators could have a
real-time view of what is transpiring in the system at all
times. This would give them a host of powerful new tools.
They would be able to spot anomalies as they arise, and
calculate systemic risk on-the-fly. This would allow them to
install “circuit breakers” to “cool off” the system before
catastrophe hits. They would be able to do the same with
individual institutions in danger of failing, quickly cordoning
them off from the rest of the system to avoid contagion.
Such capabilities would allow regulators to move from a
cure-based approach to one of prevention, making for a
much safer financial system.
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A UBS Group Technology White Paper
Regulators could also theoretically code compliance rules
directly into the blockchain. The system could automatically
check transactions against sanctions lists, for instance,
and block infringing ones before they happen. This would
make terrorist and criminal financing much more difficult.
With people’s (anonymized) identities and attested
characteristics on the chain, regulators could add suitability
checks directly to financial instruments, reducing the risk of
mis-selling. They could also in theory inspect and sign off
on smart-contract based financial instruments before they
are released for sale, so that consumers could trust that the
financial products they are purchasing do what they say.
Such regulatory inclusive models would be a boon to banks
as well. Right now, it is the banks’ responsibility to comply
with the rules, and a great deal of time and money is
expended doing so. With compliance “baked in” to the
system, compliance efforts could be greatly simplified and
streamlined. The savings on compliance costs could be
tremendous.
Look ma, no hands:
Autonomous financial instruments
The above examples illustrate the ways the blockchain
could improve the financial system we already have. But
the blockchain really is a technology of the future. The
combination of the distributed ledger, smart contracts,
near real-time settlement, decentralized processes,
regulatory inclusiveness and other capabilities will allow us
to move to fully digital financial markets, and so do
completely new things.
One early area of experimentation along these lines is with
digital securities: “smart” bonds, equities and other
instruments that live entirely on the chain, and so exhibit
some interesting properties.
For one, they are self-administering. A smart equity, for
instance, can automatically register ownership when it is
purchased, pay its own dividend, carry out its own stock
splits, and perform any other task associated with its
lifecycle. This means no asset servicing fees for the issuer.
Residing on the ledger, smart securities also require no
custodian.
This of course is only the beginning. Fully digital financial
markets would represent a completely new environment.
It is possible – indeed highly likely – that as we get used to
this environment we will come up with completely new
types of financial instruments, perhaps even completely
new ways of thinking about financial markets. If the past is
any guide, this should result in completely new products
and services the like of which we cannot even conceive of
at the moment.
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A UBS Group Technology White Paper
Imagine a world where you can download your own bank onto your phone –
not an app that connects you to your bank, but one that connects you directly
to the global financial system. An app that not only holds your money, but
manages it for you – more quickly, and likely more effectively, than you could
do yourself.
Imagine an online world where you had complete control over your own
identity, sharing only as much as you want or is necessary with different
people and organizations. An online world where you could anonymously
meet and directly transact with like-minded individuals whose true identities
you don’t know, but in whom you can still place your complete trust. Or a
world where you could share private currencies with others, or even issue
your own, to meet a variety of special needs. In this chapter we sketch out
some of the new possibilities for individuals that could result from the
blockchain-enabled financial system.
The trust app:
Blockchain and banking
for individuals
Better than leather:
Introducing your smart wallet
Today when we say we are “banking” we mean we are
using the services of a bank or other financial intermediary:
We are opening an account, visiting our financial advisor to
help us decide how to manage our portfolios, making
investments via our broker, or carrying out transactions via
our bank’s systems.
In the blockchain-enabled financial system, individuals may
be able to perform a large number of these tasks on their
own. They would do so with their “smart wallets” – the
apps that they will download to connect them directly to
the blockchain infrastructure.
Having a smart wallet will be a lot like having your own
bank in your pocket. It will be the tool you use to manage
your accounts, to configure and carry out your
transactions, to manage your preferences and identity, to
communicate with the institutions and individuals you
choose to work with, and to purchase any new tools,
information or other capabilities that might become
available. This may seem like current e-banking, but in
reality it will be much more. E-banking connects you with
your bank. Your smart wallet will connect you directly with
the financial system.
Not all smart wallets will be of the same quality. We
therefore expect banks and other providers to compete in
this space in the future, vying to develop better wallets and
more useful value-added services on top of the blockchainenabled infrastructure. Banks with the most skill and
expertise in research, advice, customer relationships, and of
course app development will be at an advantage.
The fact that smart wallets are direct connections to the
financial system is a double-edged sword: it puts vast new
capability in your hands, but also added responsibility. In a
network with no central authority, for example, no one can
restore your private key; if you lose it, you’ve lost all your
money. In a world where transactions are immediate and
final, they cannot be reversed; if you send 1,000 dollars
when you meant to send 100, there is little anyone can do.
We may therefore find that in the blockchain world people
will prefer to keep the services of an intermediary as a kind
of buffer. This too may be an area where banks compete,
providing open platforms for their clients to interact with
the financial system, while also providing a level of security
(key protection and recovery, plausibility monitoring for
transactions) and with it peace of mind.
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Building the trust engine
The trading chain:
Portfolio management on blockchain
Because of its ability to hold money, directly interact with
markets and, via a set of rules baked into a smart contract,
make its own decisions about buying and selling, a
blockchain-enabled smart wallet is a natural portfolio
manager.
We already see blockchain applications in the market that
behave very much like Exchange Traded Funds, executing
simple and easy to understand investment strategies using
money sent to them by investors. These are generally
available for a limited number of strategies and asset
classes, and for predefined risk profiles.
The next step in smart portfolio management will be the
ability to trade in multi-asset portfolios, basically handling
all the asset classes a client deals with, whether currencies,
securities or funds or even physical assets like real estate or
art (provided, of course, that ways are found to put such
objects onto the chain).
As the systems get more sophisticated, and as artificial
intelligence and related technologies become more readily
available, smart wallets will get smarter. Not only will you
be able to tailor them to your exact needs; once
configured, they will be able to automatically digest and
implement investment advice and other information sent
to them in your portfolio in ways that conform to your
particular investment preferences. In the future, then, you
may shop around for asset allocation or investment
suggestions from various providers, which will then be
delivered directly to your wallet, perhaps through a
subscription service, for the wallet to use.
It is conceivable that your wallet could become smarter
still, not just responding autonomously to trading
suggestions, but actively scanning markets and other
sources of information – in effect doing its own research –
and then making its own investment decisions. Such
artificial intelligence-enabled wallets could also, in theory,
react quickly on their own to market-relevant events like
catastrophes.
These are capabilities that are already being developed for
institutions and sophisticated investors like hedge funds.
In the future, thanks to blockchain, individual investors may
reap the same benefits. This is part of blockchain’s
potential to democratize finance, providing ever more
sophisticated solutions at affordable prices to all.
Chains of beings:
You and your digital identity
We saw above that in the blockchain world people are
identified through their pseudonymous public key, and that
in theory this key can be associated with any number of
verified attributes – allowing you to both authenticate your
identity and maintain your privacy.
Such capability could make using identity in the financial
system (and elsewhere) much easier. Once you have gained
the right credentials, you will not need to prove your
identity every time you open an account, and banks won’t
need to carry out the expensive business of checking up on
you. It will also be much easier for you to demonstrate that
you are suitable for certain financial products or are
domiciled in an area where a product is allowed to be sold.
Because you are free to only reveal the credentialled
attributes necessary for a given transaction, you will be
able to split your identity into a multitude of different
profiles. You may for example want to share a great deal of
your personal information with your financial advisor, and
less with your broker.
You may also choose to use your public identity to
broadcast certain things about yourself, like “I am a verified
collector and in the market for an antique car,” without
revealing who you are. With credentialed pseudonyms you
can conversely “meet” people online and, without
knowing their names, still learn something reliable about
them. This can be useful for instance when searching for
potential partners in an enterprise. It should also help
enable the growth of direct markets, for example for art,
antiquities, houses, or boats (see next section).
Here too, banks could serve a role as providers of
credentials. As we saw above, in the blockchain world your
private key becomes extremely valuable. If it is stolen, a
malicious person could do you great damage. Banks could
thus also provide an important function as safe guarders of
private keys, and hence identities.
Chains of things:
You and your “digital” possessions
As we also saw above, the blockchain can be used to
transact physical assets by using tokens that uniquely
identify them on the chain. This would allow you to trade
real world objects with the same levels of trust and finality
that the blockchain offers for financial transactions.
In such a world, the certification of assets – providing bona
fide credentials that can be attached to the object’s token
– would become increasingly important. We already see
businesses arising to provide authentication of things like
diamonds, art, or luxury watches, and this trend will
continue. As the system matures, trustworthy records of
the provenance of assets should become increasingly
available on various distributed ledgers, which would go a
long way to reducing fraud and counterfeiting. It would
also help ethically minded buyers avoid the purchase of
such things as blood diamonds or stolen antiquities.
The use of credentialed pseudonyms for people and things
should also facilitate the development of direct markets for
transactions in large value assets like real estate, art, yachts
or planes. As a result, specialist businesses may arise –
perhaps through banks – to provide credentialing services
specific to these markets, as with the antique car collector
mentioned above. Banks may also continue to have a role
in bringing buyers and sellers together by developing such
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direct market platforms themselves and vetting participants.
This phenomenon need not be exclusive to the wealthy.
With the rise of eBay and similar services, we already have
online markets for all sorts of goods. The blockchain could
give these new impetus by providing both a means of
verifying creditworthiness and making direct payments –
all without a middleman.
Gold chain:
You and your own private currency
Ever fancy issuing your own money? Minting your own
coin, printing your own banknotes, and seeing them
circulated in the wide world as an accepted medium of
exchange? While this may seem like a fantasy today, in the
past private currencies were rather common. Thanks to the
blockchain, they may soon experience a renaissance.
One reason is that the blockchain is, by design, well suited
to the task of making currencies. It provides a simple
technical platform for issuing them, bringing them into
circulation, and using them for transactions. And it
provides a strong decentralized trust mechanism to help
back them up. No wonder that there are already over 600
blockchain-based currencies in circulation, the so-called
altcoins⁹.
Does this mean we will eventually see – as some have
speculated – seven or eight billion currencies, one for each
of us? Probably not. But an increase in the use of private
money to meet specific needs is likely.
We may for example see specialized currencies offered by
recognized institutions like banks, for example to mitigate
currency risk when transacting high value assets. With the
current volatility in currency markets, buyers and sellers of
big-ticket items like planes, yachts or houses – where it can
take a long time between when a sale is arranged and title
transferred – are highly exposed to negative currency
movements. A private currency, provided by a bank and
kept stable, perhaps by linking it to gold, would solve this
problem.
Specialty currencies need not be only for the rich, however.
Most of us already use them in our daily lives without
realizing it, in the form of loyalty points. Frequent flyer
miles, for instance, are in essence an agreed medium of
exchange, the same as money. So too are online gift
certificates. In the blockchain world it will become easier
for vendors to create such loyalty programs, and to make
them more interchangeable. You can already use your air
miles to buy non-travel related items provided by your
airline. In the future, you may be able to trade them for
anything you like.
In theory we could also use the blockchain to make our
own loyalty programs, which would be like having a private
currency. We could use these with our friends and
acquaintances in exchange for services in informal local
economies, for instance. Or as enticements for our children
to behave.
9 See http://coinmarketcap.com/currencies/views/all/ for a list of
cryptocurrencies with market capitalizations.
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Show me the money:
The real-time payment paradigm
If you own your own business, then you know the routine.
You provide your product or service. You send your bill.
You typically wait 30 days for it to be paid. A certain
percentage of your invoices will be paid late, requiring you
to send reminders. Some won’t be paid at all, requiring
legal action of some sort. Even under ideal circumstances,
a great deal of your time and effort is expended dealing
with accounts receivable. From a business’s perspective,
this is hardly an ideal state of affairs.
The blockchain may offer some relief. If a company’s
customers are on the chain, then the company woud easily
be able to check their creditworthiness (without
compromising their privacy). That should cut down on
deadbeats. It would also be easier to arrange for direct
payments via the chain, which would mean immediate
use of funds and less costs for intermediaries like credit
card companies.
But the blockchain can do more. As natural escrow agents,
smart contracts could greatly simplify delivery versus
payment, particularly when connected to the Internet of
Things. We can imagine for example a shipping container
fitted out with a radio sender and a smart contract. When
it arrives at port, the recipient opens the container and
verifies the contents. If satisfied, he or she could use the
sender to verify receipt – and automatically unlock funds
which had previously been sent to the contract and held
pending delivery.
By radically reducing the cost of transactions, the
blockchain will also make micropayments more feasible.
Today we can subscribe to a newspaper on a day-to-day
basis. In future it will be much easier for media outlets to
arrange for pay-per-article or even pay-per-paragraph
Imagine a future where all sales involve immediate transfer of funds and
businesses have instant access to cash. Where late or non-payment is a thing
of the past and collections unnecessary. A future where capital markets are
much more direct than they are today, and in which corporate financial
instruments do their own asset servicing and accounting. A future where
direct lending and crowdfunding become viable for far greater numbers of
people around the world thanks to blockchain-enabled trust mechanisms.
Imagine a world where you could always be sure of the creditworthiness of
your customers, without violating their privacy. Where, reassured by
blockchain’s privacy mechanisms, your customers more willingly share their
relevant personal information with you, information you can rely on. Imagine
a world where cash registers automatically send sales tax to the state,
products act as their own accountants, and timesheets autonomously pay
contractors. In this chapter we look at some exciting new prospects that the
blockchain-enabled world holds for business.
The trust platform:
Blockchain and banking
for business
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A UBS Group Technology White Paper
schemes (in case you get bored in the middle of the piece).
This capability will no doubt suggest whole new business
models.
No issues with issuance:
The direct capital paradigm
One of the great successes of the capitalist system has
been securitization. By allowing corporations to raise
funds through the issuance of stocks, bonds and similar
instruments, we have found a powerful means of
allocating capital from savers to useful areas of investment,
benefitting all involved.
While it works well, the business of issuing and servicing
securities is not without its complexity or cost. Issuers need
the services of specialists to structure, price and bring the
securities to market. That involves various fees, for example
accounting and legal fees, registration costs and
underwriting fees. Once issued, securities need to be
serviced, which involves fees as well – for custody, for
example, or reporting. Companies must also have systems
in place, or pay a third party, to ensure that dividends and
coupons are paid on time and to the right people. There is
also a great deal of reporting that needs to be done for tax
and accounting purposes. The owners of a company’s
equity or debt must also be informed of important
corporate actions, like stock splits or changes to company
statutes. This too costs time and money.
We saw in a previous chapter that smart contract
technology is enabling the development of smart securities.
31
With them, companies would be able to benefit from a
much more streamlined, efficient and cost-effective
securities issuing and servicing process. These
programmable stocks, bonds and other instruments live on
the chain. As autonomous agents, they can pay their own
coupons and dividends, self-register their owners, carry out
their own reporting, and so on. This would bring down the
cost of securities issuance and servicing.
It would also offer new possibilities. Since they are easily
programmable, it should be possible to create far more
customized securities, perhaps tailored to individual
investors. It would also make it easier for smaller entities to
issue their own equity and debt. Issuers will still likely need
the services of experts to help with pricing and market
placement. But the automated nature of smart contracts
should facilitate the creation of platforms to disseminate
this expertise more cost-effectively, for example by
providing template smart contracts which can be
downloaded and customized.
Happy in a crowd:
The direct funding paradigm
One of the most interesting developments in markets over
the past few years has been the advent of crowdfunding
platforms that allow people to directly lend money to
enterprises or individuals with ideas they believe in. This has
opened up new avenues for raising capital, particularly for
smaller businesses and startups.
Crowdfunding arose before the blockchain, and is not
dependent on it. The blockchain, however, may provide a
means to greatly expand the model. By providing verified
identities and other trusted information, the blockchain
could simplify due diligence on public platforms, which
would be a great benefit. If two women in a garage in
Nairobi or Kabul have an excellent idea for a product, they
may still struggle to convince people in London, New York
or San Francisco that they are legitimate. If they can
attach credentials to their identities, perhaps through a
non-governmental organization or some other entity
specializing in such a service, they could provide more
reassurance. That would help level the playing field, and
could help increase investment in parts of the world that
sorely need it.
The blockchain may also be a catalyst for banks to
move to public crowdlending platforms, as many hedge
funds have already done. After underwriting corporate
issues they could use such public platforms to syndicate
the loans. Because public platforms are less expensive
than proprietary ones, this would reduce costs, and these
reductions would likely be passed on to the issuers. These
and other developments could drive significant efficiencies
in the cost and complexity of financing.
32 Building the trust engine
A UBS Group Technology White Paper
Keeping track:
The self-administration paradigm
No business owner has ever complained of having too little
administrative work. Between accounting, reporting,
accounts receivable, accounts payable, taxes, payroll and
compliance, just handling a company’s finances involves a
dizzying array of tasks, and keeping track of a vast amount
of information.
The blockchain can help here as well by contributing to
the further automation of many of these processes. In a
blockchain-based system smart contracts could be written
to automatically pay VAT directly to the state when
products are sold, and report sales directly into business
accounting systems. Smart contracts could conceivably be
written to automatically prepare business and corporate
tax returns. More fully automated systems could also
handle reporting, including the possibility of automatically
generated financial statements and annual reports. Such a
system could also automatically send those reports to all
registered shareholders. With verified entities, businesses
may also be able to automate a great deal of the auditing
functions behind financial statements and greatly reduce
the risk of accounting errors.
Businesses could also use the blockchain to further
automate payroll, for example by devising timesheets that
automatically pay hourly or freelance staff. Blockchainbased systems may make it easier to work with freelancers
by making it easier to vet their credentials. The same
micropayment possibilities for products and services we
saw above could also be applied to contractors, so that
companies only pay for the actual number of minutes
worked, or lines of code written. This would make it easier
for companies to manage distributed workforces, while
giving contractors and freelancers more tools for
interacting with – and also proving their worth – to their
clients.
Keeping in touch:
Managing B2B and B2C relationships on the chain
Modern technology has made it possible for companies to
collect an incredible amount of data about each and every
one of us, sparking one of the great debates of our age.
On the one hand, many people are becoming increasingly
uncomfortable with the amount of information that is
being accumulated about them. Not only do they feel their
privacy is being invaded. They also have no control over
how this data is collected or any means to verify that it is
correct. On the other side, businesses want to understand
their customers better so they can better serve them. Yet
today’s disorderly flood of customer data, much of which
may be irrelevant or erroneous, does not necessarily help
them in this endeavor.
The blockchain offers the possibility of creating a middle
ground suitable to all. Using credentialed pseudonymous
identities, consumers will be able to share only those parts
of their identities that are relevant for the product or
service they are interested in, and do so as easily as they
today grant access to location information or contacts on
their phones. Pseudonymity may very well make them
more inclined to do so, as there are many instances where
this is desirable. I want my bank and my newspaper
company to know my address, for instance. I don’t want to
share this information with the site I use to send electronic
birthday cards. Similarly, I want all businesses on the
Internet to know that my son is under 18 years of age, but
not his name or where he goes to school.
Businesses could profit from such a new identity paradigm.
It could radically improve the reliability of their customer
data. It would also relieve them from having to collect and
sift through reams of irrelevant information. And it could
strengthen customer loyalty, as people who choose to
share information about themselves with an organization
will likely feel more well-disposed to it than to
organizations which gather data without their permission.
Connected with the Internet of Things, the blockchain
could also revolutionize how companies sell and service
their products. A car leasing company, for instance, could
see to it that a car only starts if payments have been made.
In a similar way, appliances connected to the Internet of
Things could report back information about themselves: if
they need service, for example, or if they have been illegally
tampered with.
All of these possibilities apply equally to business to
business relationships, where the blockchain could greatly
simplify and make more efficient the way businesses work
together. Once again we are dealing with a whole new
paradigm, one that opens up a whole new world of
possibilities.
33
Imagine a technological revolution that was the result not of competition but
of collaboration. Technical breakthroughs create excitement, and when they
first appear people are naturally motivated to experiment with their
possibilities. This is good, as it fosters innovation. But it can quickly lead to
mass fragmentation of the new platform, as people create their own versions
of the technology, and jockey to have their implementations become the
standard. It can take years and even decades to find common ground.
And yet it is generally only when common ground is found – when standard
protocols and fabrics develop – that new technologies can flourish. When it
comes to the blockchain, instead of repeating the mistakes of history we think
it makes sense to learn from them, developing the blockchain’s common
standards now, when it is easiest to do so, and together, so that we all may
benefit from them.
The trust collaboration:
Enabling blockchain in
financial services
The long and winding road:
Hurdles to a blockchain future
So far in this paper we have looked at what this exciting
new technology called blockchain can do, and extrapolated
as to what benefits this could bring to our financial system
and those who use it. This is not the same as saying it will
be so. We are well aware of the hurdles that stand in the
way, the questions that are yet to be answered, and the
great amount of work that will need to be done.
The first set of hurdles are technical. Blockchain proper has
issues of speed which need to be overcome, though much
has been accomplished in this area already. There are also
questions around scalability: a distributed ledger recording
every transaction in a securities market would get very big
very quickly, potentially overwhelming systems. There are
also serious questions about security that will need to be
answered in order to make an open source financial system
viable.
The second set of hurdles revolve around the issue of mass
fragmentation mentioned in the introduction to this
chapter. This technology is very exciting and it is right and
proper that people try to build viable businesses around it.
That provides the incentives to unlock its potential. We
strongly believe however that it makes sense for all involved
to collaborate on the basic foundations of this new world,
so that we can all build our own solid houses on top of it.
The third set of hurdles are in the area of governance. To
build a large, open source system which can be shared by
all will require common rules. The existing financial
infrastructure has these to a great extent, but in the
blockchain world, which works differently, these rules will
have to be written anew. Blockchain also raises a host of
34 Building the trust engine
legal questions. As new types of contracts and products
arise, they will need new legal frameworks.
A coat of many colors:
The need for an open source fabric layer
We think one of the most important tasks in enabling the
blockchain future will be to establish a common market
fabric: the common underlying layer upon which everyone
will build their own service offering. If we can do this, we
can truly unlock blockchain’s potential to the benefit both
of ourselves in the industry and our clients.
Where should we start? As part of our experimentation
with the blockchain we have asked ourselves this question
often. What essential capabilities at a systems level, outside
of the development of blockchain technology proper,
would the market most likely need in five years time in
order to reap the full benefits of the blockchain? Among
the many possible answers, we feel the following are
particularly important.
Who is who: Baking identity into the chain.
While public-key cryptography in theory offers all of the
advantages of credentialed pseudonymity we outlined
above, the devil will be in the details. The truth is that
identity is an issue the financial industry has long been
struggling with, and not just with people. Our system
connects an unfathomable number of entities, individuals,
assets, and instruments together, and is composed of a
complex web of internal systems, vendor systems, market
wide systems, and so on. As a result, it is awash in
identifiers.
While we are able to deal with these today, it is an
enormous challenge, and a costly one. To bake identity into
A UBS Group Technology White Paper 35
Building the trust engine
the blockchain ledger and make it part of the new market
fabric, we will need to tackle this problem at its root,
through standardization. That would allow us not only to
provide the credentialing for individuals that could be so
beneficial, but also for all the parts of the system that will
still need to talk to each other. If successful, such
standardization of identifiers could drive massive
efficiencies.
How much: Putting value on the chain.
We have talked throughout this paper of blockchain’s
ability to easily and securely transfer value. While this is
true, a blockchain-based financial system will not reach its
full potential until we can use it to transact in national
currencies. At the moment, those using Bitcoin and other
altcoins are dependent on exchanges to turn these
currencies into legal tender in the real world. We will need
to find a way to get legal tender onto the chain. Central
banks are beginning to talk about the possibility of creating
reserves directly on chain, potentially heralding the advent
of cryptodollars and cryptopounds. Through blockchain
reserve accounts at central banks, commercial banks may
be able to do the same. Much however remains open.
Who’s the boss: Settling issues of governance on
the chain.
A financial system – like any large system – needs rules.
As a blockchain-enabled financial system would be
fundamentally different than what we have now, the rules
which govern our existing system will likely not translate
neatly. We will need a new rulebook.
At a technical level, this means developing a single or at
least a very reduced set of protocols. The Internet, with its
TCP/IP, HTML, SMTP and other base protocols, can serve as
an example. In the blockchain-enabled financial system we
will see something similar. But who will ultimately decide
what kind of blockchain we will build? And how and when
to update it?
The same will hold true for specialized protocols that will
likely develop on top of the basic blockchain. Common
utilities like JavaScript or PDFs have made our experience of
the Internet much better. In the blockchain financial system
such specialized protocols will likely be asset-class based:
an equity protocol, a fixed income protocol, and so on.
Here too, who will devise and manage it? Such issues of
36
protocol governance have not always been easy to settle in
the Internet world. The recent schism in the Bitcoin world is
a poignant reminder of how difficult such questions can
be10.
There will of course be a host of legal questions to tackle
too. To what extent are smart contracts (or certain aspects
of them) recognized as binding legal contracts? Additional
legal principles may need to be created to govern them. In
theory, smart contracts are self-enforceable, to help make
them "airtight." In practice, they are only as good as the
underlying code. Who adjudicates if a smart contract turns
out to contain ambiguous conditions? Or if it has a bug?
Chain gangs:
Industry collaboration in the blockchain space
These are still early days for the mainstream adoption of
blockchain – but they are already heady ones. Last year
interest in the technology exploded, with over one billion
US dollars having been invested in blockchain enterprises11.
That number is set to increase dramatically in 2016.
This interest can be gauged in other ways as well. Central
banks, including those of England, Europe, Japan, Holland,
Russia and China, to name a few, have announced plans to
experiment with the technology, or have published papers
on its possible uses. Regulators, for example those of
Singapore and the UK, have also expressed great interest in
blockchain. Organizations that make up the common
financial infrastructure, like DTCC, Euroclear and SWIFT,
have endorsed the potential of the blockchain as well. And
we have seen exchanges begin to embrace the technology
too, for instance Nasdaq, whose Linq platform uses
blockchain to provide a market for private securities
issuance.
The fintech community has of course been very active in
blockchain. New ventures like Digital Asset Holdings,
Ripple, Clearmatics and Ethereum have been developing
blockchain-based applications to meet a wide variety of use
cases, and industry stalwarts like Microsoft and IBM are
also offering blockchain-based services. At the same time
we are seeing important open source projects in the
blockchain space, for example Hyperledger.
A great many of our bank peers have also stated that they
are investing in and working with blockchain. Companies
like Santander, Goldman Sachs, Citicorp, and many others
have begun investigating and/or experimenting with
blockchain use cases. The good news is that there seems to
be a clear desire among banks to collaborate. This can best
be seen in the R3 CEV consortium, which consists of over
40 global banks including UBS. A concerted effort to help
build the base layer blockchain technology that may
underpin a blockchain-enabled financial system, and to do
so with bank input, it is perhaps the most far-reaching
blockchain collaboration platform in existence at the
moment in our industry.
Come in to the lab:
Blockchain innovation at UBS
How does blockchain innovation take place? Like any other
kind: through a bit of inspiration and lots of perspiration.
This is certainly the case at UBS where, like many of our
peers, we have been busy exploring blockchain and
experimenting with its possibilities.
In 2015 we launched our own in-house blockchain
program called “Crypto 2.0 Pathfinder”. As part of this we
opened our own innovation lab, making a conscious
decision not to place the lab within the bank but rather in
an external fintech startup environment. We found the
perfect location when we joined the Level39 fintech
incubator in London, the first and only global bank to do
so. At Level39 our experts can easily exchange ideas and
insights with the wider fintech community, and so
collaborate on pushing this technology forward.
The lab has provided a platform for us to carry out a
number of experiments that serve as proof of concept for
various blockchain use cases. In one, we created a “smart
bond” to validate the feasibility of the overall blockchain
approach as well as our initial smart contracts hypothesis.
Our application was able to recreate a bond’s issuance,
interest calculation, coupon payments and maturation
processes without pre- or post-trade intermediaries. To
achieve this we created our own virtual coin, which we
dubbed the BondCoin, and which functioned as a token
intended to be linked to real-world currencies via a central
bank account. We have also conducted an experiment with
a ‘utility settlement coin’ which is intended as a token of
value linked to a real fiat currency on blockchain and used
to settle transactions in multiple asset classes.
These kinds of experiments help us to both test hypotheses
and gain experience in this new world. Small steps at the
moment, we hope they will be the basis for large strides in
the future.
10 For more see: http://www.theverge.com/2016/2/9/10946072/bitcoincore-classic-software-block-size-debate.
11 See: http://money.cnn.com/2015/11/02/technology/bitcoin-1-billioninvested/
A UBS Group Technology White Paper 37
The
future
of trust
We have just taken a long trip down the potential path of
the upcoming blockchain transformation. As we hope has
come through in these pages, we are very optimistic about
the possibilities of this new technology. We are however
not naïve about its potential to disrupt our business.
Quite the contrary, the more we learn about blockchain,
the more we understand how transformative it may be. It
will force us as banks, as it will force many other types of
institutions in our industry, to re-evaluate what we do,
sometimes radically. To close then, we provide a thought
on what might be the most important blockchain-driven
paradigm shift for our business in the future – the
disintermediation of trust.
In the pre-blockchain world, being a large financial
institution was good for many things. Large banks like
ourselves could take advantage of economies of scale to
provide more cost-effective transaction services. Having
large brick and mortar operations also helped foster trust:
it showed that we were serious and successful, competent
and solid. Banks of course are required to hold a lot of
capital as a sign of their trustworthiness as well.
In a blockchain-enabled future, all of this may be turned on
its head. If trust is moved from private institutions to a
public chain, then large, expensive, highly capitalized
entities will not be necessary to enforce it. Since centralized
systems are more expensive and less agile then public ones,
they will be at a disadvantage. These developments will
also significantly lower the barrier for entry for new players.
Without expensive legacy platforms to deal with, these will
be free to concentrate on innovation.
Does this mean the end of banks? We don’t think so. The
developments we have been describing mostly affect the
world of financial transactions. Long before the blockchain
arrived, the tendency had been for these services to be
commoditized and become common utilities. Bank
revenues from transactions have been steadily falling for
years. The blockchain simply offers us a way to bring this
trend to its logical conclusion. As we said in the foreword,
it would be irresponsible of us to ignore such a significant
development. Instead, working with fintech, we will
transform ourselves, continuing to innovate and to change
into the new paradigm.
Banks however do more than just carry out transactions.
Since the dawn of our industry, we have also offered advice
and a host of other value added services to help clients
manage and protect their money. This will not change.
Indeed, in an ever more complex, technologically driven
world, the need for knowledge and experienced-based
services may well increase. Banking has also always been a
business based on relationships. We think bank clients will
continue to value the human touch.
Other organizations in the financial system will go through
similar transformations. While the blockchain may replace a
great deal of our clearance and settlement infrastructure,
for instance, the functions themselves will not disappear.
They will simply be handled in a different way. There will
always be a need for those with knowledge of these
functions to help set standards, build the new
infrastructure and maintain it.
Finally, while we have concentrated on the financial use
cases for the blockchain, there are a great many other areas
where blockchain technologies could – and likely will –
cause great transformation. From government records to
art markets to intellectual property to consumer protection
to real estate registries and on and on. Wherever we have
need of lists – and that means almost everywhere in our
complex world – that is where the blockchain can be
profitably employed.
We are happy to be a part of the effort to build the new
trust engine because it is the right thing to do. If this
engine is as powerful as we think it can be, it should drive
us all a very long way.
Afterword: The future of trust
A UBS Group Technology White Paper 39
Appendix
A UBS Group Technology White Paper
It is not uncommon when a new technology gets introduced for there to be
confusion as to correct terminology. This is certainly the case in the world of
blockchain as it evolves. Here is a short glossary:
– The blockchain proper is the distributed ledger used to record Bitcoin
transactions. The methodology behind it has since been employed to record
many other things, so it has become common to use the term blockchain to
refer by extension to the technology, as we do in this paper.
– A distributed ledger is a ledger – a list, spreadsheet or database – that is
shared among nodes in a decentralized network. It is not uncommon these
days for people to use the term interchangeably with blockchain. Correctly
speaking, the blockchain is a type of distributed ledger.
– A digital currency is a currency that relies on digital technologies.
A cryptocurrency is a type of digital currency that employs digital
cryptographic techniques. Bitcoin was the world’s first decentralized
cryptocurrency.
– The word Bitcoin is capitalized when referring to the concept or the overall
network; it is written in lowercase when referring to the actual currency, as in
the sentence "A friend of mine explained Bitcoin to me, and then showed me
how she used her wallet to transfer one bitcoin."
See https://bitcoin.org/en/vocabulary.
A final note: In this paper we refer almost exclusively to banks when talking
about trusted financial intermediaries. We are of course aware that there are
many other types of organizations, like clearing houses or exchanges, which
are vital to the financial system and provide similar intermediary roles. For the
sake of simplicity, we have at times used the term bank to refer to these as well.
An (important) note
on terminology
41
Building the trust engine
Books and papers:
Bitcoin: A Peer-to-Peer Electronic Cash System
Satoshi Nakamoto, 2008
Available for download at https://bitcoin.org/bitcoin.pdf. This is the paper that
started it all, and is now a classic. Short and very well written, it is surprisingly
accessible despite being a technical paper.
The Age of Cryptocurrency - How Bitcoin and the Blockchain Are
Challenging the Global Economic Order
Paul Vigna and Michael J. Casey, 2016 edition
An excellent recap of the rise of Bitcoin and blockchain as well as possible
blockchain use cases.
Mastering Bitcoin: Unlocking Digital Currencies
Andreas M. Antonopolous, 2015
While written for programmers, the initial chapters of this book provide an
excellent introduction to how Bitcoin and the blockchain work in a way that can
be understood by non-specialists. Highly recommended.
Identity is the New Money (Perspectives)
David Birch, 2014
Not about blockchain per se, this book provides an excellent discussion of the
changing identity paradigm in our digital world, a paradigm which a blockchainenabled financial system will likely make use of.
Websites:
https://bitcoin.org/en/ - the original Bitcoin site.
https://bitcoinmagazine.com - a leading source of information on Bitcoin,
the blockchain and the digital currency industry.
http://r3cev.com - website of the R3 consortium.
https://www.hyperledger.org - website of the Hyperledger Project.
For further reading
42
A UBS Group Technology White Paper 43
Building the trust engine
How the Bitcoin
blockchain works
While there are now many different methods for creating blockchains, to
understand the basic blockchain concept it makes sense to look at the original
Bitcoin blockchain. The details are rather complex, and involve sophisticated
cryptographic techniques. Here is a somewhat simplified overview of the
process.
1
2
3
Signed Transaction
Transaction Chain
Network
Selena wants to send 1 bitcoin to her friend Martin. She uses her
Bitcoin wallet app to create an instruction to send 1 bitcoin from
her public key address to Martin’s public key address, which she
happens to know. The wallet signs the transaction with the
signatures authorizing the spending of the funds referenced by the
transaction. Although the transaction is now public, only Selena
and Martin know they are the parties involved. Everyone else only
sees that bitcoin has been transferred between two public key
addresses.
The transaction is then broadcast on the blockchain P2P network,
which propagates the transaction across nearly every node. Each
node validates the transaction for correctness before relaying it to
its peers. For example, it is easy to check if the public key address
Selena used actually has 1 bitcoin to spend by consulting the
existing blockchain, which is a record of all previous transactions.
This makes it impossible for Selena (or anyone else) to double
spend bitcoin.
Special nodes known as Miners aggregate the valid transactions
they receive and...
44
A UBS Group Technology White Paper
+ =
>
4
5
6
Block
Proof of Work
Blockchain
Header Nonce
Difficulty
Hash
... generate transaction blocks of 500 transactions each through
solving a difficult cryptographic puzzle.
The solution to the puzzle, which is called Proof of Work, is
included in the new block to prove its validity. The solution involves
incrementing a number known as a nonce in the block header and
seeing if the resultant hash of the header satisfies the block
difficulty target. The Bitcoin protocol constantly adjusts this target
so that it takes on average 10 minutes for a computer to guess the
right answer. This is a failsafe: it makes it expensive in terms of
computing power (electricity) to carry out mining, and therefore
prohibitively expensive for anyone to gain enough computing
power to overrun the system.
Miners receive two types of reward for mining, new funds (UTXO)
created with each block and transaction fees from all the
transactions included in a block. As of this writing, the reward for
solving a single block was worth around USD 11,000.00.
Once a miner has created a valid block it will broadcast it on the
blockchain network where it will propagate to every node. Each
node performs some checks to validate it before forwarding to its
peers. If valid the node will then attempt to add the block to its
existing copy of the blockchain. Each block carries a reference to its
previous block (block hash) to facilitate this. Once a transaction is
included in the blockchain it is said to be confirmed and the fund
transfer has completed. After six confirmations (additional blocks)
the transaction is effectively immutable.
45
Building the trust engine
Disclaimer
This document has been prepared by Alex Batlin, Hyder Jaffrey, Christopher
Murphy, Andreas Przewloka and Shane Williams at UBS AG.
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A UBS Group Technology White Paper 47
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