Kurtosys Insights: Blockchain Challenges Investment Management Culture

Share on facebook
Share on twitter
Share on linkedin

Blockchain has quickly become a hot topic of conversation in the financial industry. However, the full potential may not yet be well understood. A Google search of “blockchain” can leave you with mind numbing results that have you wondering “what the heck?” The possibilities with blockchain technology have been frequently highlighted in Andreesen Horowitz’s a16z podcast which is a favorite of tech cognoscenti in Silicon Valley.

Jim O'Donnell
Jim O’Donnell, Asset Management Entrepreneur

But will the financial industry powers-that-be, adopt and deploy this new technology? I spoke with former asset management Chief Investment Officer, Jim O’Donnell, who has spent a lot of time implementing investment strategies on operational platforms and is currently a consultant in the industry.

Isn’t blockchain, because of it’s relationship to Bitcoin, a little controversial?

“I think Bitcoin is a bit of a phenomenon and people are either very, very favorably disposed toward Bitcoin or they are violently opposed to Bitcoin. And I think that the reason why is that when you typically look at the definition of a currency, it’s a medium of exchange and a store of value.
Some people like Bitcoin because it’s supply can’t be manipulated (created out of thin air) by central banks. The thing about Bitcoin is that the price fluctuates widely and part of that is because it’s not really liquid – meaning if you have an imbalance of buyers and sellers, the price is going to whip around. So that’s where the controversy lies around Bitcoin.
But now, more and more people are setting the Bitcoin controversy aside and looking at the underlying technology that enables Bitcoin. And they’re saying ‘well wait a second, THIS is what’s cool.’ So Bitcoin may or may not survive, but blockchain, the enabling technology of Bitcoin, will survive and lend itself to other transactional applications.”

What is blockchain and why is it misunderstood?

“A lot of people can get lost in the weeds on what blockchain is, but really it’s kind of a transaction ledger that is maintained by a number of parties, and because of this it makes it virtually impossible to defraud. So, you’ve got a number of people are saying, ‘ok, transactions exist all the time – in the buying and selling of consumer goods, I can pay cash or with a debit card or a credit card, and now I can also use this crypto currency that is enabled by blockchain.’
But, the buying and selling of basic consumer goods – butter, milk, gas – is a fraction of all the transactions that exist. People buy and sell real estate, people buy and sell shares of stock, people buy forms of indebtedness like bonds, bank notes, etc. And people buy and sell mutual funds. The operational side of the mutual fund business is extremely antiquated. So the question is, who are the potential early adopters in financial transactions, and what is the potential for mass adoption across all forms of financial transactions (investments, stocks, bonds.)
When you look at the landscape, you’ve got these new start-up companies in the FinTech space. They’re doing everything from robo-advisor asset allocation to crowd funding private real estate transactions to crowd funding student loans and other forms of debt financing. These companies are smaller and nimbler and can adopt blockchain applications a lot more rapidly than a stodgy old line company that is fighting off cultural, regulatory and financial challenges.”

What do you mean by ‘cultural issues?’

“Cultural is, you’ve got a bunch of old dogs that have been working in the business for 40 years and they don’t like new stuff. They’re very used to their routine and don’t want to disrupt it – they hate being moved out of their comfort zone. Typically, they think if it works, don’t mess with it.
Another example is, 10 years ago they may have presented to their organization, a $1M spend on tech they promised would be the last they’d ever need. And so they have this reputation at risk for that legacy spend. You’ll find these cultural forces primarily at broker-dealers and large financial intermediaries. They effectively become slaves to what they spent on technology 10 – 20 years ago, to the exclusion of adopting new technologies. It’s very difficult to break through that.”

And the regulatory issues?

“Whether it’s Dodd-Frank, Sabanes-Oxley or the Consumer Protection Act, there are financial intermediaries that feel they are under siege from financial regulators. And from a budgetary perspective, its all they can do, to just to try to keep up with the new regulations. An example would be, when any new financial regulations come down, the CCO would read the law, have a conversation with the COO and the other fiduciaries that would be responsible for complying with the law.
There would be a lot of time and effort understanding what the specific mandates, rules and regulations were. Next, they would go about the task of trying to find out if anyone is offering software and/or services to help comply with the law. And how is that going to fit into the budgeting process? How are we going to pay for that? The CEO and the Board would have to be brought in to understand this from a budgeting perspective and authorize the spend.
The other thing is, if you just have to fill out a new regulatory report, that’s one thing. But in certain cases, you have to reconfigure the entire product offering to comply with the new regulations. There are incremental burdens and complexity in terms of all of that.
So, the last thing on your plate every day is ‘hey, let’s figure out how we can convert all of our operational foundation into blockchain.’ Now, if the regulators come down and say ‘hey, we want everyone on the blockchain foundation by 2020’ THEN it becomes a priority.”

What would happen if the regulators did make it a regulation to be on blockchain?

“Typically the government doesn’t embrace or endorse a technological platform, but if they did… the things is, the number of transactions it would scale to is mind boggling. It’s one thing when you’ve got a hand full of tech geeks buying and selling on Amazon with Bitcoin – you’re talking potentially millions of transactions that might eventually grow to billions of transactions. In terms of data architecture, that is kind of manageable. But the question becomes, what happens when this stuff goes beyond billions, to trillions of transactions?
If you look at the economy as a whole and say the entire economy is going to blockchain, you have to have guys to sit there and verify each transaction and then maintain data on the history of all those transactions. And that’s where the system can potentially become unwieldy. So, size and scope is something that people need to think about as they walk down this path. How big can this thing eventually become and what does that mean in terms of infrastructure needs?”

What are the financial challenges?

“At the end of the day, the basic question is, how much is this going to save me and how much is it going to cost me to put it in place?
Just like the guy that spent $1M 10 years ago and swore it was the last technology they’d ever need, he had no idea about Internet 2.0 and probably had no idea what the internet was capable of. The seeds of new technology are being sewn today that could potentially obsolete blockchain in 20 years. So that makes you have to think, ‘ok, I’m going to change my entire operational structure and subject my firm to this much cost and disruption, so I can be the coolest kid on the block for the next five to 10 years.’ And that’s where the really smart decision maker has to take a deep look.”

Could this introduce new problems that we haven’t even thought of?

“We’re very dismissive about the potential for some kind of mischief to occur with the hacker community with respect to blockchain. What you tend to find with that community is, if you throw down the gauntlet and say this can’t be defeated, it’s like issuing a challenge to them, to figure out how to create mischief – it’s the nature of the beast.”

Thank you Jim.

Jim O’Donnell is a veteran asset manager with rich and varied experience, familiar with every aspect of capital markets and asset management solutions. He is passionate about building innovative investment solutions that meet client needs. Follow him on Twitter @JimODonnll
Are you an asset manager considering blockchain technology? We’d love to hear your thoughts on the topic. Drop us a comment below or tweet us @kurtosys

courtney mcquade

courtney mcquade