Blockchain And The Convergence Of Banking And DLT

In the last decade, we’ve seen a major trend in developing modular components of financial services by digitalising legacy capabilities and exposing them for partner integration. As an industry, this has been labelled Fintech, and represents the digital response to the previous centralised and siloed legacy architectures.

Further, the decomposition of the Fintech legacy backends is moving apace driven by the major trend of migration to Cloud microservices that may be deployed as part of a global DeFi Banking as a Service infrastructure.

Similarly, and in parallel, a trend to externalise the shared state of partner interactions between participants in the financial services domain, has resulted in the widespread adoption of Distributed Ledger Technology (DLT) as a common decentralised ecosystem providing business logic as a service, while maintaining data sovereignty and security for all parties.

Similarly, DLT has also arisen as a technological solution to achieving faster reconciliation to approach T+0, addressing the periodic nature of end-of-period batch processing resulting in T+1..n cycles.

In an example of synchronicity, DLT leveraging Blockchain technologies has simultaneously arisen to provide crypto assets and smart contracts as a nascent alternative to the dominant FIAT financial systems.

Over the last 3 years, we have witnessed the convergence of these trends in Fintech and DLT as a digitalized interface for traditional Core Banking functionality, with the parallel development of analogous Core functions for crypto assets and transactions. Extrapolating further, the path to the future appears to lie with the further integration of the technologies and business cases for this convergence, where FIAT currencies and Crypto assets merge to form a multicurrency DLT platform for a transactional state.

Definition of Core Banking; as a technological solution to latency and cost, as well as the scope for a set of functions common to all banks. Branch banking and reconciliation, Legacy communication networks commoditized into industry pipelines such as SWIFT, and NASDAQ. Digitalization provides a new face on the core functions yet largely leaves the backend running on T+1 reconciliation through overnight batch processing. Cloud migration to leverage PaaS economies for the global economy, but largely implemented using Lift and Shift. Turning the architecture on its head through refactoring to decouple business logic from the data it operates upon using web-based APIs supported by event-driven, microservice clouds collaborating to replicate core functions as the basis for Fintech devolution.
Defi as the lightbulb moment when the TCO of owning the transaction capability, reaches its revenue nadir, and data ownership and market analytics and insight become the target opportunity. As the core functions are common across all banks, these functions are ripe for commoditisation. But who will host these functions if there is no compelling economic incentive? The answer lies in the rebellious cousin that introduced Bitcoin, Ethereum, Proof of Stake consensus models and the PaaS which is Distributed Ledger Technology. In this model, parties to a transaction can share an external, secure, incorruptible and auditable view of each other’s state in any transaction or account-keeping function. All that is required is to submit proprietary transactional data to the smart contracts that implement core functions, and state changes. All while maintaining InfoSec around the data by not exposing it to any other party.
This, of course, is a fine opportunity for that intent on disrupting the traditional heavyweights playing catch up through FinTech and cloud migration. As anyone knows, who has worked in such a large global corporation, changing speed and direction is as easy as changing the direction of the Titanic as the iceberg is seen ahead. To maintain market dominance, these titans have been quick to support regulations to constrain alternatives for cross-border activity, the potential for money laundering, and tax avoidance. On the other hand, regulations such as Open Banking, PSD2 and soon, PSD3, are prying open the closed FinTech architectures to allow parallel development of core functions outside of these proprietary systems.

And what of the parallel crypto-asset platforms and services? Unsurprisingly, these also implement the same core functions of deposits, withdrawals, payments, lending, and investment. So the opportunity for convergence is obvious. In 2021, this convergence seemed all but impossible, based on the antipathy to everything crypto by the established ancient regime. Even the Fintech unicorns such as Wise and Paypal were reluctant to offer FIAT services to businesses dealing in crypto. At least, that is what was provided as a rationale for rejecting account opening requests. Fast forward to 2022 and we see Paypal providing crypto wallets, Wise planning to build out its own ability to provide crypto services.
Looking at a crystal ball, this trend seems to reach that watershed moment, when FIAT and crypto assets will just be seen as equivalent forms of mediums of exchange — currency and stores of value — money. The companies that manage to heal this breach to support core functions through the building blocks of finance, will be the harbingers of this devolution and commoditisation of core banking functions, by producing the new, global, ubiquitous (de)Centralized Online Realtime Environment that was given birth when the costs and latency of interbranch reconciliation were seen as a problem needing a technological solution.

Scallop’s proposed solution architecture is the Bank on Chain.

Søren Stammers — CTO at Scallop

40+ years of professional experience across Corporate and Retail Banking technology, Tier 1 consulting, Digital Transformation, Agile Methodology (SAFe + LEAN), Hi-tech, DLT, Cryptography & Cyber Security.

With deep experience in Digital Transformation strategy & methodology for Business & IT Architectures, Søren supports organisations to deliver value-driven outcomes.

He provides a logical & pragmatic methodology founded on his formative 25-year engineering background, ensuring solutions are realistic and achievable.

References:

1. https://medium.com/mimodefi-blog/defi-the-evolution-of-fintech-728ae1ec6b70

2. https://defi-planet.com/2021/09/defi-vs-fintech-defi-is-ready-to-disrupt-fintech/

3. https://www.ethichub.com/en/blog/defi-vs-fintech

4. https://tokeneconomy.co/defi-vs-fintech-d152bae2585c

5. https://medium.com/cea-says/fintech-vs-defi-whats-the-difference-a79324ce6521

6. https://fintech.vision/resource/whitepaper/decentralized-finance-defi-a-new-fintech-revolution/

7. https://metaroids.com/feature/why-defi-is-the-future-of-fintech/

8. https://bian.org/deliverables/bian-coreless-banking/

9. https://sdk.finance/what-is-core-banking/

10. https://www.thoughtmachine.net/blog/core-banking-transformed-accelerating-migrations-with-cloud-native-cores

11. https://www.mckinsey.com/capabilities/mckinsey-digital/our-insights/tech-forward/how-to-get-a-core-bankingtransformation-right-eight-mistakes-to-avoid