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Blockchain’s ‘Administration 3.0’ will turn the financial sector upside down. But for banks, insurers and asset management companies this will not cause total disruption. Patrick Lemmens and Jeroen van Oerle look into the potential impact of blockchain and explain how investors can take advantage of this trend.
In our summer reading series, here’s a chance to catch up with some of our top picks so far in 2016. The following story was originally published earlier this year.
‘Let’s all calm down a bit’ – sound advice when it comes to blockchain. “It is a very promising technology that could really shake up the financial sector. But Blockchain is more likely to be evolutionary than revolutionary and to have an innovative impact rather than a destructive one“, according to Patrick Lemmens, portfolio manager of Robeco New World Financial Equities, a fund that invests in trends in the financial sector.
Currently, significant sums of private-equity funding and venture capital is being poured into blockchain and the technology is receiving considerable media attention. Jeroen van Oerle, trend analyst for the investment fund: “I think it’s a hype. The short-term impact of the technology is being over exaggerated. Nevertheless, I do think that blockchain is here to stay and that we should not underestimate its long-term impact.”
Lemmens and Van Oerle wrote a paper titled Distributed ledger technology for the financial industry. Blockchain administration 3.0. In it, they research the role blockchain could play at banks, insurers and asset-management companies. In the current unceasing publicity surrounding fintech in general and specifically blockchain, the report puts the phenomenon in perspective.
Blockchain is the technology behind the digital, virtual currency Bitcoin, but it also has other applications. The collective name is ‘distributed ledger technology’ and blockchain is one example of this. Distributed ledger technology can best be compared to a register in which transaction and ownership records are kept. In general, a digital ledger is a central, closed database with restricted access.
Blockchain, however, is a decentralized, open database in which transaction records can be updated and which is accessible to all. It is an online register which users can access directly without a bank as intermediary. Data is no longer saved in one central location, it is scattered across the internet. Another characteristic of blockchain is that only new information can be added, nothing can be removed.
Van Oerle also refers to distributed ledger technology as ‘administration 3.0’. ‘Administration 1.0’ represents the paper ledger administration, the shift to digital ledgers (‘administration 2.0’) came next, and now we are making the move towards a decentralized and distributed ledger. “The decentralized aspect is extremely important and will result in a surge in efficiency and innovation”, he thinks.
According to Lemmens and Van Oerle it is still too early to pick out which companies will be the winners and losers, when it comes to this trend. Lemmens: “A huge number of companies are involved in blockchain and fintech at the moment. We’ll just have to wait and see which survive and which don’t.”
According to Van Oerle, blockchain will put pressure on certain processes and business models at banks, insurers and asset-management companies. “Financial institutions with expensive, labor intensive and time consuming administrative processes where a quick win can be achieved are at risk if they ignore blockchain. Corporate processes or intermediaries that offer no added value in the chain will be eliminated.”
One of these quick wins for banks is in the area of international transfers, according to Van Oerle. “International payments are not yet very efficient. Blockchain can simplify and speed up the transfer of instructions and money.” He expects to see competition in the asset-management chain between stock exchanges and custodians vying to become the validator-hub for blockchain transactions. This is the party that requires everyone’s trust; the party that confirms that the underlying assets in the transaction exist, whether they are shares, real estate or diamonds, and verifies ownership.
Lemmens feels that easy implementation and quick wins with blockchain are somewhat further off in the insurance world. He thinks primarily that insurance products with programmable and clear cut payout structures such as insurance for delayed flights or the effects of the weather are the most obvious example. “As an investor, I am cautious about insurers that only offer straightforward products that are easy to digitize.”
Lemmens points out that blockchain does not work everywhere in the financial sector. ”Blockchain is not suitable for a transaction that must happen instantaneously, like a payment. Visa and MasterCard’s networks and processes are much faster than blockchain for this.”
As an investor, Lemmens looks not only at which financial institutions may be threatened by blockchain, but also at which banks, insurers and asset managers are already getting to grips with these changes. R3CEV is a good example. This is a consortium of – currently – 42 banks that are researching blockchain applications. “Banks in the Robeco New World Financial Equities portfolio such as ING, BBVA and Nordea must all be members of this group, as that means they are among the frontrunners.”
Lemmens also invests in digital technology developers for the financial sector for his fund. In this segment too, there are distinctions between those being threatened and those taking advantage of the opportunities. It’s not clear whether the services of ‘old’ IT companies like IBM, Accenture and Cognizant will still be necessary in a ‘blockchain world’, or whether they will be able to adjust their business models in time and compete with ‘new’ tech companies that are working on their own blockchain applications.”
As a fund manager it isn’t currently that easy to invest in blockchain, because those involved are mostly small and – as yet – unlisted companies. Having said that, Lemmens is not really eagerly awaiting the listing of a blockchain developer either. “I am hoping for a ‘sensible’ IPO – a company that has proved its worth, has gone through an economic cycle and is making a profit. However, I fear that any IPO that comes will be surrounded by still greater hype. That it will be a company that is not yet making a profit and its stock price will be too high for a venture that has yet to prove itself.
All the publicity about blockchain implies that distributed ledger technology is ready to be used. In fact, the opposite is true, says Van Oerle. Blockchain is not yet fully developed and many elements still require testing. He thinks that there are two important aspects you should not lose sight of when following blockchain’s progress – laws and regulation and technical issues.
“The financial sector is already used to plenty of laws and regulations. It will be a number of years before the regulators fully trust this new technology. And the parties using it will have to agree on certain standards. Banks are already further on than asset managers in this area. I am in no doubt that the technical problems will be solved, it’s just a question of time. Investing in blockchain is a logical next step for financial institutions.”