I gave a talk on the blockchain and such like to the Scottish Financial Services Club. It was a lot of fun, and I got a couple of really excellent questions that made me think on my feet, something I greatly appreciate.
— BT for Finance (@BT_GBFM)
I chose the example of the Old Lady of Threadneedle Street as a case study to try to illustrate just how a some sort of blockchain sort of technology might work in practice. I chose this example, because a deputy governor of the Bank of England recently gave a speech that mentioned the replicated decentralised permissionless shared ledger formerly known as the Bank of America Blockchain ™, saying that:
instead of settlement occurring across the books of a single central authority (such as a central bank, clearing house or custodian), strong cryptographic and verification algorithms allow everyone in a DLT network to have a copy of the ledger and give distributed authority for managing and updating that ledger to a much wider group of agents.[From Bank of England to Explore Distributed Ledger Tech for Settlement – CoinDesk]
But why would the Bank of England want to do this? Why would the market participants? Let’s start with a little bit of background. The deputy governor was talking in the context of the UK’s Real-Time Gross Settlement System (RTGS). This is run by the Bank of England itself. The Bank of England’s role as a settlement agent emerged in the mid-19th century with the provision of settlement accounts for the commercial banking sector. Since 1996, these accounts have been held in this RTGS, which provides for real-time posting, with finality and irrevocability, of debit and credit entries to participants accounts. This system, which is an element of vital national infrastructure, is used for several purposes.
• It is used settle in real-time for the Clearing House Automated Payment
System (CHAPS) payment system.
• It is also used to settle in real-time for the payment system embedded
within the CREST securities settlement system.
• It is used to settle several times per day on deferred,net basis for the
Faster Payments Service (FPS).
• And it is also used to settle on a deferred, net basis for a variety of other
retail payment systems (BACS, Cheque & Credit, LINK and Visa).
So, crucially, it is used by CHAPS. This is real-time final settlement to any limit in “central bank money”. If I send you a billion quid through CHAPS, then you have the billion quid and that’s that. No ifs and buts. If RTGS were to fall over, it would mean that large value payments throughout our great nation would be totally knackered and that would have an immediate and very serious impact (on, for example, people buying and selling houses). It is therefore a piece of vital national infrastructure.
The current system settles almost a third of the UK’s annual GDP – or about £500bn – every single day, covering everything “from salaries to company invoices, from car purchases to coffee sales, from pensions to investment flows”.
The current system itself dates back to 1984, so it’s not exactly the very latest in technology. But you can understand why the Bank of England should be conservative about this computer system and network of crucial national importance. They can’t afford to mess around or tinker with anything but tried, tested and utterly sound technology. This is why no expense is spared (I assume) in making sure that the system is completely reliable, safe and secure. Oh, wait…
Mark Carney, Bank of England governor, launched an independent review on Monday into the worst disruption of Britain’s banking payment system in seven years…The breakdown meant the CHAPS payment system, which last year processed £277 billion of transactions a day, was down for more than nine hours. The bank was forced to start processing the most important payments manually.
To get back to the question, then, why would a sensible, conservative and practical institution like the Bank of England be thinking about the very latest in replicated decentralised Shared Ledger Technology (SLT) in this context? They don’t need a blockchain or Bitcoin, proof of work or mining. So what do they want? Well, if you analyse the problem using Consult Hyperion’s “4×4” SLT model, you will see that there are key reasons at each SLT layer.
The Bank of England can, I imagine, see advantage at each of these layers:
- Robustness. Suppose every bank had an RTGS gateway but there was no actual RTGS system? Each gateway would have a full copy of the Bank of England ledger (the Bank of England would have a copy too!) holding the participants central bank balances. There’s no RTGS to go down now.
- Integrity. A very fast consensus protocol can be used to ensure the near-immediate integrity of the copies held by each participant so that counterparty risk would be down at the same level that it is today using the centralised system. This integrity is especially for delivery versus payment (DvP) settlement as is used for CREST. The integrity of the ledger would, in this case, represent finality of payment (and the reduction of counterparty risk) because of the legal status that the Bank of England would confer on the RGTS-SLT.
- Innovation. The member banks might decide to hold balance in new assets so that final settlement might be in something other than central bank money. This might be what the former governor of the Bank of England, Melvyn King, alludes to in his new book “The End of Alchemy” when he remarks that we may not use money in the future. I once had the great good fortune to have lunch with Otmar Issing, who was a member of the board of the Deutsche Bundesbank, then a member of the Executive Board of the European Central Bank (ECB) as and its first Chief Economist. He knows a lot about money. In a speech at the turn of the millennium, he said “it is conceivable that at some point in the future the settlement might take place without regular recourse to central bank reserves”. take this to mean that because of technological and economic change, settlement could be in corporate paper, energy, Islamic e-Dinars, water, land, gold, or London Lucre, all of them appearing as content on this kind of ledger. Using claims on future products and services, companies might net out central bank altogether, which I think it what Mr. King means. They didn’t have his book at the airport so I couldn’t check.
- Flexibility. It may well be that the RTGS-SLT members might want to add Shared Ledger Applications Programs (SLAPS), often referred to as “smart contracts”, to the ledger in order to create new kinds of financial markets. Current centralised systems (such as RTGS) are inflexible and difficult to change and SLAPs give markets tools to build customised self-enforceable agreements across the balances and new kinds of assets introduced at the content layer. In a SLAPS world, business rules could be invented and implemented with relative ease.
The Bank of England is absolutely right to be exploring this new technology and I certainly think that it has something to offer. But that does not mean that the Bank of England is going to start using Bitcoin as a settlement system or that bitcoins will replace Sterling!