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Once upon a time, there were clearing houses…

The payments industry is about to go through a mammoth change, a change that forever will associate the word “Tsunami” with “Disruptive Technology” in the minds of those impacted. Jobs will be lost and jobs will be made. Decade old companies will fall and new ones will be born. This change is “blockchain” and it will be a game changer!

Banks, like people, don’t trust each other when exchanging money and the central bank trusts banks even less, and so there exists the role of the clearing house. The clearing house represents the trusted 3rd party in the exchange of money. Bank A trusts the clearing house to forward the payment to Bank B. Bank B trusts that it will receive the funds. The Central Bank trusts that the movement of funds is above board and reportable. Bank A pays the clearing house, Bank B pays the clearing house. The clearing house makes money and the movement of money now comes at a cost. Not only is it pricey, but it is also slow as it has to move through the hands of a middleman.

Blockchain technology does away with the need for clearing houses by replacing the trusted 3rd party function of the clearing house with a trusted distributed data store. Money can suddenly move directly from Bank A to Bank B without any concern that the transfer won’t be honoured. The transfer is there in the open for all to observe. It is cryptographically signed, and therefore no malicious party is able to modify any record.

The Central Bank is no longer a passive receiver and can begin to actively interrogate this central shared ledger. Reporting becomes a breeze. We are no longer dependent on entities sending reports to us to collate, we simply run our own reports. In other words banks will no longer be required to distribute produce reports for any regulatory party, rather the party can simply draw its own reports from the ledger directly.

Blockchain technology therefore promises to make payments faster and cheaper and Reserve Bank reporting much easier and much quicker. It is a significant enabler for real-time anywhere payments which is a decisive driver for payments today.

Not surprisingly the technology has been drawing huge interest from banks around the world. 22 Banks including Bank of America, Citi, Deutsche Bank, HSBC, Morgan Stanley, Barclays, Goldman Sachs and J.P. Morgan have partnered with a financial innovation firm, R3 to design and apply distributed ledger technologies to the global financial markets.

Blythe Masters, inventor of the credit default swap, has also thrown herself behind blockchain with her company Digital Asset Holdings, which promises to use blockchain technology to reduce “settlement latency and counterparty risk”. She is also known for her analogy that blockchain does to money what email did to mail. One of the enablers of this technology being the potential to “email money” anywhere.

Ripple, previously Ripple Labs, have also been making waves in the financial industry with their blockchain offerings. After months of experimentation and testing with bank partners Ripple have finally dropped the “Labs” and released an enterprise grade real-time settlement product which allows for direct bank-to-bank settlement, globally or locally.

The technology is too good, the interest too great, it is just a matter of time before clearinghouses are a thing of the past.