Deutsche Bank: What DLT research taught us in 2016

David Watson is Head of Product at Deutsche Bank’s Global Trading Business (GTB). Edward Budd is Head of Digital Business Model Strategy at Deutsche Bank.

In this article, Watson and Budd share their research progress and experience in distributed ledger technology in 2016, and predict the prospects of this technology in 2017.

The invention of the electric light had nothing to do with the continuous improvement of the candle. —Oren Harari

There is no doubt that 2016 is the year of distributed ledger technology (DLT). This year, DLT reached the peak of the hype curve, and its wide range of application areas also brought a lot of inspiration to people.

As 2017 quietly approaches, the market will continue to view DLT as an important reform force in the financial services field, which is enough to influence the business models of market participants.

Therefore, it is important to understand the real needs of the market. Whether it involves the financial services sector or not, we must look at what the impact of DLT will mean in terms of business model reform. More importantly, what DLT will mean for our customers and their businesses.

To truly understand the implications of this technology, we need to do more than just “hard-and-fast technical testing” and explore real-world use cases. In addition, the legal and regulatory implications of DLT deployment cannot be ignored.

Achieving this goal requires active collaboration and close connections among industry participants, the fintech sector, customers and regulators.

Some people believe that the popularization of DLT is a big problem. Take the first generation of iPhone as an example. Before the official release of the iPhone, Apple and telecom operators also had a months-long legal battle.

When the first iPhone was released in 2007, there were no apps available. Six months later, the second-generation iPhone had 500 apps available. By 2011, the number of apps in the Apple App Store had exceeded 500,000. At that time, the number of iPhone users had soared from 3 million to 35 million.

Apple then began working with the fintech industry to further improve the functionality and security of iOS, focusing on data security and testing products in a sandbox environment to seek customer feedback. Although their evolution was not fast, it was fruitful.

Just like the current DLT, the research and development of related apps and products has just begun.

Here are some of the things we learned from our DLT research this year:

1. “It’s a journey”

DLT will (must!) evolve as new opportunities emerge.

Did 2016 see a transformational journey for the financial services sector? Yes. Have we reached the end? No. Is there an end? Probably not.

We have learned a lot from this colorful journey of DLT activities, but it is clear that each participant has different research priorities and progress.

Our DLT research focus continues to be on the digitization of securities markets and smart contracts.

We recently completed the second phase of commercial testing of DLT securities, a system based on smart contract corporate bond value verification that was successfully established as early as 2015.

This year we are mainly focusing on solving the actual deployment of some functions, including SWIFT message matching, dispatch, funds verification, net settlement, interest payment, perfection and trading.

In the second half of this year, we will mainly conduct in-depth research on DLT through cooperation with the Settlement Coin (USC) Alliance. Our focus is on relatively new digital concepts, such as "digital cash".

We mainly use this concept for securities settlement and possible cross-currency transactions in the future.

Apparently, this concept is a hot topic right now. Even the German central bank and Deutsche Börse have said they will develop DLT prototypes and conduct research in this area.

2. “Learn to walk before you run”

Complying with rules and legal frameworks is not a choice but a necessity.

Therefore, research and exploration of DLT should not be limited to the technology itself or business model reform, but should pay more attention to the construction of market architecture and the legal significance therein.

Due to legal requirements, our use case this year is mainly a private ledger architecture (with full compliance with KYC and data protection policies), because this approach has real-world application potential.

Especially in large-scale post-trade settlement and clearing markets, this architecture is more compliant with laws set by regulators. When DLT is used for financial products and services, this architecture focuses on security and stability challenges and governance issues.

This architecture will not limit the application scope of DLT to the financial services sector, but it will be able to make great progress in the financial sector in the short term. The development of other fields under the leadership of this architecture may take longer.

3. “Technology that solves problems”

Reforms outside the banking sector can determine the future development of financial services products.

The risk of technical research lies in the researcher himself. You cannot conduct research purely from a technical perspective, but should set a specific goal.

In 2016, most people were focusing on the business challenges brought about by the key attributes of blockchain and DLT applications. This also triggered more constructive thinking: Which part of the value chain or process should we solve?

We have been studying back-end system solutions for a long time. DLT has made this possible and triggered a deeper investigation of end-to-end systems.

This change is actually a good thing. In any case, the focus is still on existing financial products, aiming to reduce costs, improve efficiency and simplify processes.

It is important to address the challenges that exist today, but for DLT to be fully successful, we must also be prepared to meet the challenges of the future. As Oren Harari said:

The invention of the electric light had nothing to do with the continued improvement of the candle.

Another aspect that is often overlooked is that DLT research is not a standalone financial services debate. If financial firms’ customers choose to embrace this technology in the future, the way they operate will change, giving rise to new market demands.

The fields of art and music, and even the diamond industry, are using DLT technology as the only source of truth. This trend will only become more and more obvious in the future.

In order to be well prepared in this regard, we attach great importance to regular communication with our customers. We achieve this goal through regular discussions and customer consultations held throughout the year. Direct contact with customers helps us provide effective solutions and accurately make relevant predictions for the future.

4. “You have to rely on yourself to learn”

Unity and collaboration are the most reasonable and practical way to promote the development of DLT.

It has become a trend for the banking industry to collaborate with each other to explore DLT.

"Openness" has always been the focus of DLT, an open source technology (R3's open source Corda platform is one example). Industry participants have long reached a consensus: only cooperation can promote the success of DLT.

Internal research does not prove that the results produced are worthless.

Because we first need to understand what business model problems the technology is used to solve, and then assess the capabilities of the companies deploying DLT.

Network effects are important for DLTs, but the exact mode of operation of the network will change depending on how it is deployed, and consensus is not necessarily required to enable the network.

5. “Blockchain is not a panacea”

While DLT is an important trend in digitalization, it may not be the most radical or fastest reform we have seen.

Another major misunderstanding in the current DLT exploration is that the research of various institutions is carried out independently and is not integrated with today's digital industries.

The different research progress and initiating institutions you follow lead to diverse insights into digital trends. Whether it is artificial intelligence (AI), IoT APIs or cloud, they all seem to be independent revolutions. In fact, it is not clear which technology will eventually take the lead in the reform.

In fact, only open banking systems that adopt all the above technologies - especially IoT interfaces, cloud and FinTech - can participate in this transformation.

The structural impact of these technologies may even be earlier than DLT, because some of these technologies have already "forced" regulators to make changes, such as the EU's Payment Services Directive 2 (PSD2).

Outlook for 2017

So, what awaits us in 2017?

We have begun to attach importance to communication with customers, and this trend will continue. While we are launching the digital agenda, our customers have already taken the lead. Many customers have contacted us and asked us how to participate in digital transformation, explore digital trends, and reshape their own companies.

Onboarding customers is an important part of the digital journey, while expanding projects and developing more products are secondary.

Digitalization is not a hype. We want to make progress in this area and improve our own business model together with our customers and their customers.