Is the Forex Market Ready to Go Blockchain? Some Banks Don’t Think So | Cryptocurrency
On July 27, the foreign exchange trading market (forex) settlement powerhouse CLS reported it was in the final stages of testing its blockchain payment service for banks. However, while the service is reportedly set to be launched as soon as in August, the amount of players backing the project has halved since the initial announcement. As it turns out, large financial institutions are not quite ready to hand over their data to a blockchain-powered system.
Brief introduction to forex and CLS system
Forex is a worldwide market where convertible currencies are traded and their conversion rates are determined. Albeit being decentralized, it is the largest and most liquid market in the world: In April 2016, for instance, trading there averaged $5.1 trillion per day, according to Bank for International Settlements (BIS) data. Given the fact that forex relies on over-the-counter type deals, larger participating players — i.e., international banks — strive to mitigate the settlement risk associated with their forex transactions.
Cue in Continuous Linked Settlement (CLS), a U.K.-based financial institution that has the U.S. Federal Reserve Bank as its primary regulator and provides its customers with just the thing forex players need — risk-reducing settlement services. CLS minimizes the perils through payment versus payment (PvP) settlements — the process ensuring that a final transfer of one currency occurs only if a final transfer of the other currency also takes place.
CLS was founded in 2002 and has been rapidly growing since: In July 2012, it officially became a Systemically Important Financial Market Utility — meaning that its disruption might shatter the U.S. financial system as a whole — and by March 2017, it was handling over 50 percent of forex transactions globally. CLS’s members include more than 60 of the world’s largest financial institutions, such as JPMorgan Chase, Barclays, Goldman Sachs and Citigroup.
CLS’s relationship with blockchain, IBM and R3
CLS is by no means new to the concept of blockchain. It began researching distributed ledger technology (DLT) proofs-of-concept (PoCs) back in 2015, when the technology was in its earlier stages and the prospect of mass adoption barely existed. In September 2016, the early CLS blockchain experiments were put under CLSNet, a network that essentially played the role of a sandbox for DLT-powered attempts to streamline CLS’s internal processes at the time. Made in conjunction with IT giant IBM, it aimed to ensure intraday liquidity, enable real-time awareness of currency and reduce risk, among other goals. At the time, CLS Netting would reportedly allow participants to submit forex instructions for six products and 24 currencies.
Notably, CLS has been cautious not to put its main settlement system, long favored by the world’s largest financial institutes, on blockchain — at least until it becomes fully tamper-proof and adoptable, from their viewpoint. The 2017 joint report presented by CLS and IBM read:
“Based on the CLS-IBM collaboration, it seems most banks will need to readjust their approach to risk in terms of go/no-go decisions, especially in the early phases of a project. As we’ve learned, organizations can design their first blockchain initiative to avoid significant risks. At CLS, our first decision was not to build a bridge too far or wide. In other words, our first initiative could not be one where failure put our existing business at risk.”
Similarly, in April 2017, Tom Zschach, chief information officer at CLS, explained to the International Business Times (IBT):
“The important thing about CLSNet is it doesn’t have anything to do with settlement or funding. It doesn’t touch our central bank accounts, it doesn’t access RTGS [real time gross settlement] gateways. What we are doing here is introducing the technology as more of a foundational step than a transformational step.”
The CLS joint project with IBM relies on Hyperledger Fabric (version 1.0), an open-source business blockchain framework hosted by the Linux Foundation, that the companies have been weaving into their DLT-based ecosystem. IBM seems confident in regards to the their collaborative work, as its vice president Keith Bear told IBT:
“Volume is an important consideration, but the technology is perfectly capable of supporting the levels we are talking about in the case of CLS, also with Northern Trust and the other projects that we have going on at the moment.”
CLS and IBM’s collaboration has also resulted in the creation of a seperate PoC project called LedgerConnect, a so-called financial blockchain “app store” that showcases DLT solutions crafted by fintech and software companies to help banks navigate through the maze that is blockchain — for conventional business players, at least.
Nevertheless, CLS doesn’t limit its blockchain operations to collaborating with IBM. The forex giant also works with R3, a blockchain consortium of more than 200 financial firms globally, whose primary goal is building a DLT platform called Corda. R3 could be considered a rival to IBM, at least on the field of blockchain.
Both R3 and IBM use Hyperledger Fabric for their blockchain efforts. Notably, in a comment for IBT, Charley Cooper — the managing director at R3 — emphasized that Corda is written for Java, “the language of banks” specifically, while IBM attempts to employ a more general approach:
“The folks at IBM Fabric who donated it to Hyperledger are looking to solve a whole set of problems for a much broader set of industries — healthcare, auto financing, supply chain management, finance, etc. — whereas Corda was built specifically for financial institutions and built with the financial institutions[…] I think what CLS is doing is the right thing, meaning they are working with multiple different providers; they are involved in Hyperledger work with Fabric, they are involved with the R3 consortium and working on projects that go beyond that.”
Additionally, in late May 2018, CLS invested $5 million in R3. Under the deal, CLS also entered R3’s Board of Directors, hence it would be fair to expect other DLT-based projects to be introduced by CLS in the future.
But do banks want to rely on blockchain for settlement payments?
Apparently, many of the CLS-enlisted, large financial firms are hesitant to incorporate blockchain at this point, as Alan Marquard — chief strategy and development officer at CLS — told Financial News London. Indeed, investment banks have shared concerns regarding the use of the “largely-untested technology” in the past, citing privacy concerns and blockchain’s current “immaturity” among the primary reasons.
Having this in mind, CLS planned to offer members two ways to access CLSNet: directly and via the old, tested way — SWIFT, which is a 45-year-old interbank messaging service and a co-operative owned by about 11,000 member banks. As the company’s spokeswoman confirmed to FN London:
“It was always CLS’s intention to launch the service in phases. With the first phase, clients will rely on SWIFT connectivity for inputs submitted to and received from CLSNet. As the service continues to grow with functionality and client adoption, and the DLT matures, CLSNet will enable clients to host their own node.”
Marquard of CLS mentioned that some of the banks were reluctant to merge blockchains into their tuned IT systems, mostly due to “security implications”:
“You are not just installing a piece of software. [Banks] need to build operational knowledge and know-how.”
Originally, when the blockchain-powered settlement system was announced back in September 2016, the project was backed by 14 large institutions, including Bank of America, Bank of China – Hong Kong, HSBC and Morgan Stanley, among others. Other banks preferred the wait-and-see approach, as Ram Komarraju — head of innovation and technology at CLS — told Forbes in 2017:
“The journey has been accelerating. We were building something for the very first time, and we started selling to larger buy-side firms. Some of them are attracted to bleeding edge technology while others would rather stick with existing systems and wait and see. As we talked to banks, we found they are investing in blockchain, but they aren’t taking the risk to actually use it. They are investing in multiple blockchain vendors.”
However, now that the service is almost ready and is expected to launch by the end of the summer, about half of the 14 banks that originally signed up for the CLSNet have reportedly dropped out of the program — at this point, there are much fewer players that are expected to enlist themselves for CLSNet once it’s released. Still, CLS might convince the majority of banks to join later through efforts like the above mentioned LedgerConnect and collaborations with organizations like R3 — which, for instance, gathers different law firms to educate lawyers globally in its efforts to bring about the mass adoption of the technology — steadily pushing global banks to swap their traditional tools with new blockchain ones.