New bids on the block

Banks ponder blockchain's first-mover disadvantage

Banks have a first-mover dilemma when it comes to blockchain technology. The ideas that underpin cryptocurrency bitcoin could allow banks to take an axe to their huge back offices. What's less obvious is whether to splash precious cash on investment now, or hang back.

For embattled chief executives trying to work out how to meet return-on-equity targets, blockchain could be a gift. The sector-wide savings could amount to $20 billion in annual sector costs by 2022, according to consultant Oliver Wyman's estimates.

Bitcoin solves the problem of lack of trust between anonymous counterparties by getting decentralised participants to clear each transaction between buyers and sellers. Banks can adapt this by doing the same thing, but in a private network. The result: no need for thousands of staff in each bank to check and clear the trading and lending that takes place in their customer-facing front offices.

The $20-billion savings are a genuine draw: they would increase the top 1000 banks' pre-tax profit in 2015 by two per cent, according to data from The Banker. What's less obvious is the extent of the first-mover advantage individual banks could get from financing the necessary research. Currently, there are two models: 30 lenders have joined a bank-funded consortium called R3, which has amassed expertise to address the issue. Others are joining smaller groups working with individual fintech firms on bespoke ways to use bitcoin technology.

The upshot is a situation similar to the early days of the internet in the 1990s, when several technologies competed with each other. That presents an opportunity for those who would rather be free riders. If and when R3 devises a workable and scalable model, it intends to share the basic ledger details. Regulators might insist on it anyway, to stop large banks from using their private networks to disadvantage new entrants and entrench their oligopoly.

The cynical view might be that blockchain will happen regardless, and the best plan is to hang back, save capital and reap the rewards generated by others. As it is, groups like UBS are pressing on anyway. That might be because innovators will still get kudos if the technology comes good. And if it works there will be enough financial gain to go around.