Blockchain and digital assets could remake the financial services industry, and that affects everyone who uses money. Deloitte’s Linda Pawczuk and Richard Walker share the insights gleaned from a survey of global industry leaders.
“They can move those assets between legal entities, cross-border, 24 by seven by 365, at no cost to meet capital liquidity requirements. Where does the bank come in? A lot of these things the banks do for corporate treasury today can be done by treasurers themselves.” — Richard Walker, principal, Deloitte Consulting LLP
Tanya Ott: There is a seismic shift happening in the financial services industry and my guests today on the Press Room say it’s going to affect each and every one of us — from multi-national corporations to the more than one billion adults in the world who don’t have a bank account. 1
Linda Pawczuk is Deloitte Consulting LLP’s leader of global and US blockchain and digital assets and Richard Walker is a principle in banking and capital markets. Their team recently surveyed more than 1,200 senior executives and practitioners in financial services around the world to get of sense of what they expect to come down the pike.
Linda Pawczuk: Let's be clear, in the last year a lot has changed—not just in US markets but all over the globe—with the virtualisation of business and commerce and regular day-to-day things for consumers. Imagine, even a year ago, how health care has shifted to telemedicine. We have accelerated into this weird period of what we like to call “digital everything.”
[We looked at] what that's doing in terms of the financial services industry’s new business models, and one of the things that surprised me is that 80% of our respondents say that digital assets will be very, or somewhat important, to their respective industries in the next 24 months. 80% of all respondents; that's globally. [Blockchain had] been something that had some decent pace a year ago, [but] it was still being explored. Now, 80% [of all respondents] view this will change their industries in 24 months. What's a bit curious is that 75% agree strongly or somewhat that the organisation will lose an opportunity for competitive advantage if they fail to adopt digital assets and blockchain. Now, remember, we were highly centered in the financial services industry, but these are two very profound findings. So here we are in the era of blockchain and the era of digital assets moving at hyper speed. We call it a seismic shift. It's taken a wee bit of time, but it's dramatically and profoundly changing what we know today to be the financial ecosystem market.
Tanya: And, Richard, there've been a lot of disruptions that are making this shift happen. One of the first of them, of course, has to do with the move to digital currency. I know most of our listeners are probably familiar with the concept of fiat currency; but, in case we use that term, I want to define it for people who aren't familiar with it. If you've got a US$5 bill, you've got Lincoln in your wallet. That is fiat money. It's government issued currency that's not backed by a physical commodity like gold or silver. Essentially, one of the disruptions we're seeing, Richard, is the end of fiat currency—maybe somewhere in the future—and then the move to digital currency.
Richard: Yeah, Tanya, it's really, really interesting to unpack, Why now? Why is that happening? Global trends over the last couple of years, largely catalysed by COVID, have led to increased digital payments, increased reliance on networks and network-based transactions for local country as well as global commerce, [and] the rise of digital payment companies, which are shadow banking systems. If you look at China, for instance, the largest payment companies are private companies using their version of information-based, but not digital, information-based money to affect transactions outside the banking system, which ultimately do get settled in the banking system. It led to China, in particular, introducing and being the first major economy to introduce a central bank digital currency, thus catalysing central banks around the world to look at the future of money. These trends had been building for a while but really came together and are now in focus.
When we step back and think about the seismic shift, you might ask me: What does it mean? What is that and what's changing? What's changing is the surety and the cycle time of a transaction, the basis of trust in that transaction, transparency, speed enabled by simplification, standardisation, just general good design. Well, where does that good design come from? Bitcoin and blockchain introduced a design for a distributed ledger to capture a transaction in a block and then layer those blocks securely, to do them with a distributed network to drive trust through solving the Byzantine generals' problem of distributing a piece of information to multiple parties and then identifying exceptions — bad actors trying to change a transaction. It's a perfect data model, but before general acceptance there needed to be a maturation, a growth. There needed to be advancements in the scalability of the network.
A few years ago, people talked about the blockchain network not being scalable. If we look at our survey results, among a cohort called FSI pioneers, 96% of those respondents said they view blockchain as broadly scalable. That is a significant change because of advancements in the global network, in layer two protocolsw and other things that are going on. While there's been growth beneath the surface in the maturity of the network, the distribution, the reliability of the network, the performance of the network, coming from the top down, there have been these other macro drivers: the pandemic driving digital payments and central banks getting on board with exploring what will be a very different money. Those two data points vector into where we are now. The survey data shows that the respondents also believe there's a compelling business case now for blockchain, digital assets and cryptocurrencies within their organisation because of these factors. It's seismic in the thinking. It will be seismic in the impact, but we're not yet into the full impact phase.
Tanya: I wanted to follow up on something that you said, because you were talking, particularly at the beginning, about the speed at which some of these transactions are conducted now and how that's really exponentially increasing the velocity of what happens in terms of global payments. It happens almost instantaneously, but with little or no cost, which also has some significant implications for financial services institutions.
Richard: It certainly does, because arguably the industry is built up around the inefficiencies and the friction that exist in the global model because of the evolution of a disparate set of point solutions that [have been] brought together against different temporal or time-based models to ultimately deliver an outcome for a client. The industry is built around specialised roles, around a batch asymmetric model that moves from one stage to the next stage to the next stage. In each of those is a transformation and there's rent seeking as a payment moves through a network, through different clearing agencies or transfer agencies, through different banking systems and different currencies. There is a margin taken at each of those steps and the banking industry benefits from that. It's not as though they designed that from scratch. That's not a clean sheet design that banks set out in some diabolical way to create so they could make money. They make money by providing a service to deliver an outcome in an imperfect network, in a legacy morass against different standards, different systems across different rails.
The potential for near real time, very straightforward forward movement of digital assets across borders is going to be disruptive. It's going to be disruptive to revenue [and] complementary products. Also, it's going to be disruptive insofar as [it enables] the potential for self-service. Corporate treasurers can have their own direct custody that they can set up and they could hold their assets in custody themselves outside of a bank. They can move those assets between legal entities, cross-borders, 24 by 7 by 365, at no cost, to meet capital liquidity requirements. Where does the bank come in? A lot of these things the banks do for corporate treasury today can be done by treasurers themselves.
Tanya: Let me just interrupt for a second here, because essentially what you're talking about, Richard, is self-banking. Corporations basically serving as their own banks?
Richard: To a large extent, yes. Many of the banking services that they rely on for payments — for remittance and disbursements, for receivables — they can do direct settlement with counter parties for those payments. Banks still have a proposition, it will be disrupted as well, in different ways for credit, for capital formation, for debt placements. You can use digital assets for doing direct placement, too — tokenised bonds [is] something that exists today and that more and more organisations are doing. They haven't completely disintermediated the banking network from that because banks are needed for the distribution [and to be] the marketplace for those assets. But those will come along as well. It's some self-banking, but it's also new ways of meeting the financial needs of an organisation.
Tanya: There's a phrase in your study that really stood out to me and that was "major existential threat."
Richard: One of the largest banks in the world shared their view that they believe that digital assets and the ability of large corporations to do self-banking is one of the largest existential threats they face. Their words. And it's because of the ease, the speed, the transparency, the lack of friction and therefore the lower cost. As a result, banks will have to find other ways to intermediate and add value through surveillance or information-based products or sources of capital liquidity. This is a big existential threat to the status quo for banks globally.
Linda: It's the underlying condition of redefining what we see today as the financial services ecosystem and gateways. Every organisation, every industry across geographies, the 10 [organisations] we focussed on have a stake in financial services and how we conduct trade, how we conduct settlement and how we conduct cross-border payments. The interest in this and the sovereignty of nations is why not only an enterprise cares, which in some cases could be transactional in nature, but a government cares. Consumers certainly care and, really in a very exciting manner, the unbanked care. The disruption to the marketplace is really about a much broader question: What is the future of money? What will that financial ecosystem look like as we transform globally and as we reconsider old paradigms of banking systems and processes and transactions that were governed by a set of rules that, for the period of time, worked well? We've all become the owners of smartphones. We have the ubiquity of access to lots of information and the simplification of transactions associated with that because of the advanced technology.
Tanya: The landscape is changing very quickly, sort of underneath their feet. But there are a lot of factors that influence how that sorts out for the financial services industry, including things like regulation and technology. What would you put sort of at the top of the list in terms of the factors that might be most likely to affect the direction of this?
Richard: I would put at the top regulation. Many view US, European and Asian regulators stepping in to potentially stop innovation and stop activity and use of digital assets. Another view is that, the regulatory framework and the backing of the digital assets within a regulated system, is going to catalyse and provide the support needed for adoption. Regulators today are busy at work to provide guidance, not to stop use. As greater clarity is provided, acceleration can continue. It's a bit of a pause globally because of some of the recent regulatory activity around different exchanges, different digital assets instruments, [and the] use of stable coins, because the amount of liquidity in those assets and the challenges to the traditional rails and system are causing regulators to pay attention. So that's one factor.
It has been mentioned by a number of regulators of the systemic risk of asset-backed digital assets like stable coins. That's primarily because they're outside of the regulatory system. If you say it's a dollar for dollar or a euro for euro match, where is that euro or dollar sitting? What's the governance framework to make sure that there's actually currency behind that asset, so that if there's a redemption, that asset is able to be produced? That's caused a lot of stable coin providers to provide disclosure on reserves and proof of solvency of their assets. This regulatory inspection is providing an opportunity for companies to show the veracity of some of the systems they've put in place, like proof of reserves.
Linda: To elaborate a little bit further and vectoring a different way, this is not about the US, this is a global complication. Whether it's regulators or the governments involved that are driving towards a set of safe standards and plugging in the right types of regulations, [they’re doing it] to support innovation, but at the same time, to keep assets safe. What we talk about here is the digital movement of digital money. There are concerns around data security and privacy and industry-specific regulations. When we talk about treasurers being able to act on behalf of their own enterprise, that doesn't mean just the banking institutions. That means all types of institutions. There could be specific regulations for each of those that are industry specific.
When we think about everything from cross-border and the challenges that regulators face, the framework in which they would traditionally look at a security and how that would plug into the existing regulations and the existing framework, [all of] those things are changing themselves, including how to account for a digital asset which may be considered property, not necessarily fiat. So accounting rules, the actual taxation process associated with the movement of the physical asset, are also changing. The challenge that regulators are focussed on is not just trying to figure out the rules, but it's changing the entirety of the framework in which they think about things like the future of money.
Tanya: We've talked about what the regulators are confronted with. We've talked about managing systemic risk. We've talked about taxation. You brought that up, Linda. When we get into the area of security, cybersecurity, data security, illegal activity, there are a lot of considerations there as well.
Linda: Well, let's be clear. Our survey points out that if there is one area that is tempering the caution, it is around security: That fear of cybersecurity and the obstacle of how do you address that in the context of digital assets? The reality is we shouldn't isolate that to just digital assets. I think collectively the world is concerned about cybersecurity, period. Whether it's an information asset, digital asset, some form of commerce, some way of banking, there are a number of incidents which have occurred that give rise to securing information, whether it's financial or otherwise. To that end, I think part of the opportunity that is going to continue to elaborate in the area of digital assets using blockchain technology and DLT Digital, a distributed ledger technology, is specifically the benefits that are created through security. As a result of that, there is no single answer today for any of the categories I just mentioned in terms of concerns for information security at all.
Richard: Tanya, [it’s] interesting thing that you asked about illegal activity. It's remarkable. It's as though we think we have a great system today that, when a million dollars in cash is in a suitcase, we'll be able to define that with some surety. I'd much rather have a currency that moves on a chain that can be analysed by one of the major companies who is able to do such things. That led to the recovery of ransom in an event earlier this year.2 That is going to continue to grow and the transparency of movement of monies is going to offer much greater recovery, much greater security and reduction of illicit illegal activity. It's remarkable to say, “wow, this is happening.” What about that? Well, the current system is terrible. There's a high percentage of activity that is outside the banking system. All the stuff that we do in banking around the Bank Secrecy Act (BSA), around know your client, it catches single-digit illicit activity. So, it's not great today and it's very expensive. The spend-to-result yield is very low. I think that what we see from the survey results that 85% of pioneers think that it's going to reduce risk and they think that having a digital asset in a CBDC [central bank digital currency] will have a net positive impact. I'm encouraged by that.
Tanya: Let's talk about the scenarios, the future scenarios. What are the broad considerations when we're looking at what the future could hold here?
Richard: The possible scenarios, Tanya, are that financial markets infrastructure is going to be transformed and replatformed onto a blockchain architecture to allow same day clearing and settlement in one transaction. The EU parliament has drafted a DLT regime to run a pilot to prove that you could do trade, clear and settle in a single transaction for securities and for bond trading. The scenario there is that markets are going to get far more efficient. The efficiency of those markets has secondary benefits as it relates to things like repo trades, a repurchase agreement, which historically has been used by treasurers to provide yield on cash overnight. It had to be overnight because of the movement of money in the commitment, the purchase, the resell or repurchase agreement and then the return of capital. Those cycle times have changed so that that's happening intraday. If I've got a million dollars on the balance sheet, I can put it into a repo trade for an hour and I could get a yield on that. It's going to make financial markets more efficient, no doubt. It's going to make payments faster. It's going to increase the velocity of money and it's going to enable enhanced commerce, full stop. It's going to improve the lending model and the risk management of credit through smart contracts, through immutable contracts that are secured. It's going to allow new assets to be brought into the financial system because of the ability to tokenise illiquid assets and post those as collateral for credit. It's going to have a big impact. These are the scenarios we're seeing play out in different ways.
A few years ago, we thought of blockchain as a disruptive technology, independent of digital assets. We found that most of the activity around that was using blockchain to recreate the processes that we know today, trapped in the paradigm of the processes that we do today. With the exploration of new processes, [we] found that digital assets really do play a strong part in the value that blockchain and digital assets together can bring. It's the combination of those things into financial services verticals like capital formation— like markets trading, like credit, like investing, like treasury management, like payments — [in] all of those verticals, we're seeing a molecularisation of the technology as it gets embedded in each one of those and transforms each one of those independently. It's not a singular topic. What we saw in the survey results is the focussed implications of these technologies in targeted areas. Once the transformation is driven across each of those areas, the ability to bring those all together with a common architecture for assets, a common set of rails, a common processing architecture, is going to be the next wave of seismic shifts and disruption.
Linda: I think those are poignant, each of the things you've raised. As we move to wrap here, I want again to reinforce why we've centered our 2021 Deloitte global blockchain survey on the financial services industry. Whether it's an enterprise, a consumer, a government, a bank, the unbanked, it affects all of us.
Tanya: That was Linda Pawczuk, global and US blockchain and digital assets leader at Deloitte Consulting LLP and Richard Walker, a principle in Deloitte Consulting’s banking and capital markets practice. Their new report on blockchain and digital assets is available at deloitteinsights.com.
We’re on Twitter at @deloitteinsight and you’ll find me at @tanyaott1. Be sure you follow the podcast on whatever podcatcher you use so you don’t miss anything. I’m Tanya Ott. Thanks for listening and have a wonderful day.
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