4. What does the DLT journey look like?
How can we practically realise the benefits of DLT today? What considerations do we need to bear in mind as we map out our deployment journey – and where do we even begin?
What is the first step?
In our 2020 research we underlined the huge amount of venture-capital activity going on amongst DLT start ups – as 57% of the market looked to take ownership stakes in fintech firms as their first step in the path towards building DLT capabilities.
Two years on the focus has shifted strongly from technology to the ecosystem. In 2022, the first step for 58% of the industry in building out a DLT business plan is to engage with other ecosystem partners; with 43% of the market also prioritising collaborative market initiatives over self-builds. Whilst inefficiencies can easily be identified by individual firms, their root causes and the solutions to those challenges can only be addressed through collective engagement and development.
And there are few limits to this ecosystem - successful DLT cases highlight the need to include regulators and downstream clients early on in engagements, alongside more obvious partners (such as direct service providers and counterparties). This way, problems can not only be properly sized but also scalable, market-wide solutions defined that will facilitate greater automation at every level.
Only when that ecosystem blueprint is ready does the technology then become relevant as a means of delivery. At this stage there is a second shift going on – which is the increasing productization of DLT applications. In 2021, 36% of respondents were electing to build DLT technologies in-house or with professional services firms (particularly in Asia), versus only 24% who were buying in DLT apps as a customer. In 2022 the focus has reversed, with 34% of respondents now looking to buy in apps as a customer rather than build. Consistent with the natural evolution of DLT as a technology, this shift highlights the increasing maturity of DLT and of the apps that deliver its benefits to the market.
From experimentation to commercialisation
Since the arrival of DLT in the capital markets, frequent media announcements have highlighted progress being made through numerous experimental use cases or pilots. Right up to 2021, the industry’s strong focus has been on discovering and experimenting with DLT, with only 22% of DLT projects intended to be used for commercial production.
2022 is set to be the year when industry focus shifts from learning to commercialising blockchains – with 53% of usage cases this year now intended for commercial deployment. DLT is now clearly having to pay its way – with asset classes such as structured products, private equity, OTC derivatives and crypto currencies all seemingly set for commercial development.
But not all asset classes are ready yet to scale – bonds, securities financing and carbon credits all stand out as cases where experimentation will continue to be the primary objective for the year ahead. Equally, 30% of all projects are expected to further evolve after their initial go-live, highlighting the significant future headroom in the range of DLT usage.
How much does DLT cost?
DLT teams seem to be settling in. After 2 years of strong headcount growth, DLT resourcing appears to have stabilised across the industry in 2022 – with an average of 26, 13 and 30 headcounts dedicated to the technology amongst exchanges, brokers and custodians respectively. Only custodians have seen a significant shift in hiring this year, driven no doubt by the growing focus on crypto-custody as a 2022 market deliverable.
And now that they’ve settled in, these teams are starting to spend the big bucks. Average expenditure on DLT projects has risen over ten-fold in the last 12 months as firms shift their spending from small-scale pilots to large-scale commercial deployments. Even on an average basis, FMIs are spending USD5m on DLT today, with custodians spending almost USD9m – numbers which are only justified through significant revenue generation. That 73% of all custodians are spending over USD1m on DLT highlights how important the commercial incentive is becoming in this new space.
Who is making DLT happen?
Many (regulated) firms have cited the huge need for internal stakeholder education in order to successfully realise projects – working intensively with legal, compliance and risk (for example) in order to get everyone to a level of comfort and understanding of how to operationalise DLT.
This work is clearly paying dividends, as this year’s survey highlights a 14% improvement in staff engagement on DLT – with the most significant improvements seen in Compliance (+18%) and Operations (+17%).
Although DLT projects continue to be led by strategy and innovation teams in most firms, there is little doubt that the delivery team is growing to encompass all enterprise functions.
Do we all need to be building our own private blockchains?
The prevailing view from the market today is that blockchains should be run privately – unless they absolutely need to be public. After a decade in which cyber-security risk has dominated banking due-diligence, it is no surprise that firms’ starting point is the solution that offers them the highest possible levels of (perceived) security – private blockchains in this case.
These security pressures are driving two clear distinctions in DLT usage today. The first is by asset class – wherein all assets that are being traded institutionally are being serviced today using private blockchains – from OTC derivatives to ETFs and bonds. Only those assets that are intended to be traded or held by the broader (retail and wealth) market are being built on the basis of public blockchains – notably structured products, private debt and of course crypto currencies.
"If you really want privacy and confidentiality you should be using a private blockchain"
Chuck Ocheret, Symbiont
The second distinction is by the type of organisation. Whilst only 25% of banks’ and FMIs’ blockchain projects are likely to use public blockchain today; a full 48% of brokers’ and investors’ projects are going down the public route. The burden of regulation is creating another dividing line in our industry.
Through 2022, the question of whether this dividing line is necessary has become increasingly central to the DLT discussion. Given the significant cost of this proliferation of blockchains, question of whether a more nuanced solution to security and privacy can be found is becoming increasingly acute – so that we can leverage the scale of public chains without compromising on our own network risk.
What about the cash leg?
Our 2020 and 2021 research clearly underlines the unique role of Central Bank Digital Currencies (CBDCs) in facilitating atomic settlement in the institutional markets – and a clear lack of willingness to entertain commercial stablecoins as an alternative mechanism of value-transfer. But what do we do in the meantime?
If near-term, practical security considerations are driving our choice of (public or private) blockchains, then the cash leg is equally being seen today through a practical, execution-centric lens. In the absence of liquid, cross-currency CBDC landscape, all profiles of market participant would prefer to use existing payment ‘rails’ than they would to add risk by further experimenting with alternative means of payment. For this reason, interfacing securities blockchains with existing, regulated (RTGS) infrastructures is the core preference of market operators in 2022 – even if it slows the overall transaction down slightly.
As the Bundesbank and other central banks have demonstrated, the use of existing payment mechanisms to fund securities movements is a practical and viable solution today – and one that carries far less risk or dependencies.
What else do we need to look out for?
DLT is getting easier.
From 2020 to 2022, the percentage of respondents facing ‘blocking’ issues in their DLT projects has reduced from 31% to 16% - as key blockages such as access to blockchain talent, DLT’s performance and challenges around the business case have morphed into less severe inconveniences.
But as our DLT ambition has grown – and with it our experience in realising DLT projects on a practical basis – other issues have become more acute. Regulatory limitations around the treatment and management of digital assets have moved to the centre of discussion, driving many to define interim operating models (mostly based on tokenising existing securities – instead of natively digital issuance) that are viable in the short term but less impactful. Equally, connectivity to legacy infrastructures is also a growing concern as we try to integrate blockchains with batch-based accounting systems, for example.
One question that will continue to remain pressing is “why DLT?” As we continue our industry-wide DLT journey at pace, our appreciation of the nuances and unique values of the technology will inevitably grow – helping us to distinguish compelling needs for DLT from areas where other technologies may be more effective.
