The Observer

ARTICLES OF INTEREST

Blockchain: A New Era of Transparency, Efficiency and Security

by Hugh McKee, BMO Global Asset Management

While the current volatility of virtual currencies like Bitcoin may prevent them from playing a significant role for asset allocators today, blockchain – the technology behind the cryptocurrency – should be on the radar for institutional investors. By simplifying and streamlining many business processes, blockchain is an important underlying technology that has the potential to transform the financial industry.
 
Though blockchain is still in the early days of exploration and implementation, and far from widescale adoption, Hugh McKee, Head of BMO Partners, shares his insights on the potential benefits of the revolutionary technology, prospective investment opportunities, and ways to participate in a growing trend that’s gaining collective momentum.

More to Blockchain than Bitcoin
 
While most in the financial sector have a grasp of Bitcoin and other virtual currencies, what they may not understand – or even distinguish between – is blockchain. Blockchain is more than a buzzword. Known by many simply as the technology that underpins Bitcoin, in fact, blockchain has significant potential to drive lower costs, faster processing, higher efficiency and increased transparency across industries from banks to governments, to pension funds.

As a digital, and cryptographically secure ledger, transactions are distributed across a network, with data recorded and validated through a consistent and verifiable peer-to-peer mechanism. Every member of the network has an identical copy of the ledger stored on their computer, and can review previous entries and record new ones. Transactions are grouped in “blocks,” and seamlessly recorded in a chain, with the links between these blocks and their content protected cryptographically. Previous transactions cannot be destroyed or forged, enabling a self-managed, decentralized network that operates without any coordination from an intermediary. Essentially, the ledger is immutable because it’s virtually impossible to change the ledger without effectively rewriting the entire chain. In the case of Bitcoin, the ledger is legitimized through a process called “mining,” which is used to incentivize members to validate the ledger and drive consensus on the book of record.

Compare this to a traditional centralized environment, where there is one trusted authority (e.g., bank, government, credit card company) who maintains and is accountable for accurately updating the ledger, and as a result, is theoretically more vulnerable.

Blockchain technology is also flexible. You can have both public (such as Bitcoin, Ethereum, Ripple, etc.) and private blockchains depending on the use case. Private blockchains have all the advantages  of  public  networks,  but  only  provide  access  to  a smaller, more familiar subset of members.
 
The Blockchain Benefit:
 
  • Lower costs
  • Enhanced efficiencies
  • Increased transparency
  • Greater security and assurance
  • Wide-reaching scope across industries
  • Operates within a public or private network
 
A Disruptive Technology with Vast Possibilities
 
Blockchain is a potentially transformative technology that could have broad application beyond virtual currencies across many industries and use cases, from monitoring the providence of diamonds or fine art, to simplifying cross-border payments and enabling smart contracts for financial transactions.

In fact, the decentralized model could potentially have a significant impact on the financial services industry, and asset management in particular, both as a new way of doing business and by creating a new asset class. For example, APG and PGGM (Stichting Pensioenfonds Zorg en Welzijn), managers of the two largest Dutch pension funds, announced late last year that they are testing a blockchain-based model to help administer pensions that would be shared by all stakeholders, including employers, pension funds and regulators.1 Meanwhile, JPMorgan Chase & Co recently launched a new payment processing network that will be powered by a proprietary blockchain technology called Quorum, which will allow payments to reach beneficiaries faster, with fewer steps and improved security.2

5 Illustrative Use Cases for Financial Services:

 
  1. Cross-border payments or international money transfers – simplifying and hastening the transfer of value, which would also reduce costs significantly
  2. Securities settlement/loan trading – allowing for greater trade accuracy and a shorter settlement process (can be applied to any exchange of physical or digital assets on a platform)
  3. Smart contracts – executing commercial transactions and agreements automatically, while enforcing the obligations of all parties, without the added expense of a central authority, preventing fraud and enhancing efficiencies (e.g., insurance claims, trade finance)
  4. Identity management – streamlining identification through a digital register for multiple services (e.g., voting, healthcare, banking)
  5. Loyalty and rewards – increasing transparency and traceability of transactions will allow banks and insurers to create improved and more targeted loyalty programs

Both public and private blockchain applications provide a variety of new investment opportunities, from mining hardware, to exchanges, to virtual vaults and distributed applications. As a growing awareness builds around the technology, and regulators become increasingly involved to crystallize their position, we should expect to see the use of blockchain become more prevalent and mainstream – across industries, asset types and countries.
 
The Time is Now: Keep Blockchain on Your Radar
 
While blockchain has the potential to be completely transformative, it should be approached from the mindset that it will likely  not be one solution that solves everything – similar to many technologies that came before it, including cloud computing and the Internet. While many financial institutions have invested millions in the technology in the hopes of adapting simplified, lower-cost processes, there are still some uncertainties around scalability, the underlying technology and regulatory stance that remain to be solved, and in many cases blockchain may not be the right solution.

The best way to think about adapting blockchain is to understand the drivers behind each potential use case, and to evaluate  them against three essential criteria: value, friction and the importance of trust. First, is there material value in solving the problem, or is it simply an interesting science experiment? Second, is there an element of friction  involved  in  the  existing process including time, cost and complexity? Third, are there trust issues that need to be addressed? For example, the world of trade finance is fairly archaic, with long timelines, high costs, manual processes and potentially unknown counterparties that make it well suited to a blockchain solution.

Though the extent of how blockchain will alter the financial services industry remains to be seen, the fact is that its capabilities have allowed us to rethink how critical information can be sourced and exchanged, especially between  global  financial institutions.

This is an important time for institutional investors to evaluate how blockchain technology may impact their own business. Exploring opportunities through network participation, experimentation, or even early implementation can help drive a better understanding of industry benefits and potential investment opportunities. Whether it is through active work with start-ups, peers, regulators or industry experts, it is vital to navigate the potential challenges – and benefits –to our sector, levering essential learnings as blockchain continues to mature, in an effort to shape the future of asset management.

As a global banking enterprise and a leader in innovation, BMO Financial Group joined the
R3 consortium in 2015, a group of more than 100 banks, financial institutions, regulators, trade associations, professional service firms and technology companies collaborating to develop a robust blockchain platform designed specifically for financial services. We have also been involved in testing the technology for trade finance and digital verification purposes, but more broadly, our ongoing goal is to proactively assess emerging opportunities as the ecosystem evolves – fostering blockchain education, awareness and industry leadership through collaboration.
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 Hugh McKee
 Head, BMO Partners
 
BMO Global Asset Management





Hugh McKee is Head of BMO Partners, BMO’s Enterprise partnership team accountable for using strategic partnerships and investments to help accelerate innovation and growth across BMO.  He is accountable for developing partnerships with Fintechs, Bigtechs, financial services consortia and innovation accelerators.  Prior to his current role, Hugh was the Vice President of Enterprise Strategy in the Office of Strategic Management where he led Enterprise strategic initiatives.

Hugh has also held a number of operating roles within BMO including President and CEO of BMO Mutual Funds and Vice President of Customer Segment Management.  Before joining BMO in 2007, he was a Global Account Manager for Monitor Group, a management consulting firm, where he was a leader in the financial services practice.  Hugh holds an Honours BA in Economics from Queen's University and an MBA from the Richard Ivey School of Business, University of Western Ontario.

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