The pot of gold? Higher efficiencies

It's early days, but industry heavyweights are sponsoring a wide range of blockchain use cases supported by industry consortiums. As NIM fades and capital builds, global bank managements press harder for a step down in costs. Cost mutualisation through blockchain architected financial system utilities could provide some earnings boost after the related multi-year investment spend plateaus.

But blockchains could be a double-edged sword and disrupt financials

Blockchains won't just change the Financial Services' IT architecture. They could also change accessible profit pools. A lot will depend on the governance and how quickly incumbents move. The firms holding the keys to the data and the IT architecture could drive more profit pool towards themselves. So it's no wonder that the custodians like JPM, BK and STT are among the lead sponsors of Linux Hyperledger and are members of R3 as they seek to drive the standard and retain their ground.

The market underestimates the advantages banks and custodians have already, given not a single policymaker we met with for this note would allow an "unpermissioned" distributed ledger

Nor would the banks, given concerns on AML and KYC. As a result, we think industry supported consortia rather than VC sponsored start-ups will have the edge.

10 roadblocks for blockchains to become a reality in banking:
1) is the use case cost/benefit compelling?,
2) cost mutualisation/who funds the overhaul old systems?,
3) misaligned incentives,
4) evolving to the right standard,
5) scaleability/performance,
6) governance,
7) regulatory issues,
8) legal risks,
9) cryptology/security, and
10) simplicity/interoperability.

What's the best use case?

The majority of ideas hinge on reducing inefficiencies in capital markets infrastructure. Several industry leaders including Blythe Masters (CEO of Digital Asset Holdings – see conversation later in this note) put post-trade settlement for a variety of asset classes at the top of the list. Domestic payments is already efficient, especially with real-time pay in much of EU/UK and coming to the US, but some believe international payments could benefit from a blockchain-type communication protocol.

While the long-term opportunity is clear, the blue sky is still too far to the right to affect 2017/18 EPS, we think, so our stock positioning generally reflects medium-term earnings issues for our banks.

Download below this Morgan Stanley report.

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