DERIVATIVES: Microsoft clicks on blockchain

4 min read

Microsoft is launching a new service for financial institutions that will enable them to develop blockchain applications for derivatives and securities markets through the software giant’s network of computers.

Called “blockchain as a service” Microsoft aims to provide banks and financial market infrastructures with the ability to develop blockchain solutions “in the cloud”, potentially saving millions in processing costs.

“We want to create an environment for large financial institutions to get involved easily and inexpensively, so that they can compete with fintech companies that don’t have the same regulatory and legacy burdens,” said Marley Gray, director of technology strategy financial services at Microsoft. “Using our system you can start building smart contracts and running complex scenarios without overloading your own systems.”

Banks are running numerous projects to develop blockchain technologies, which allow counterparties to transfer, value and process trades without the need for an intermediary. Instead, validation is based on members of a network solving complex cryptographic puzzles, for which the computing power required is significant.

Processing used to validate cryptographic currency Bitcoin was recently estimated at one exaflop, or a billion billion calculations per second. That is around 1,000 times faster than the processing speed of many super computers. For that reason, scaling of infrastructure is considered one of the most critical barriers to realising the promise of blockchain processing for the financial markets.

Microsoft’s Azure is one of three hyper-scale clouds globally. The other two are provided by Amazon Web Services and Google.

“Our cloud is the size of the other two combined, which means it is a much cheaper environment for running smart contracts based on derivatives,” said Gray.

Potential barriers to banks developing blockchain applications away from their own data centres include concerns over security and oversight.

Identifying risks

Regulation in respect of cloud computing in the financial industry remains relatively undeveloped, but the Australian Prudential Regulation Authority in July pointed out that outsourcing may be risky, particularly when it is driven by a desire to cut costs.

“Risk-management practices, including risk identification and mitigation techniques, are still maturing for these types of arrangements,” it said in a paper.

In a document published this month, the UK’s Financial Conduct Authority set out proposed guidance for firms outsourcing to the cloud.

“The use of third-party providers to deliver services for regulated firms can bring benefits…However, it can also introduce risks that need to be identified, monitored and mitigated,” the FCA said.

Among other things, firms must exercise due diligence and pay due attention to data security, the regulator said in a guidance note.

As blockchain innovation gathers pace, banks are pouring in resources, with an estimated US$1bn budgeted over the next one to two years.

Among initiatives attracting attention, R3 CEV is a New York-based organisation that has signed up 25 financial institutions to promote collaboration and develop standards for blockchain applications in financial services.

In the vendor space, Digital Asset Holdings, run by former JP Morgan executive Blythe Master, aims to reduce settlement latency and counterparty risk through encrypted processing tools, and is focusing on solutions for the paper-intensive syndicated loan market.

“Banks really don’t want to be investing huge amounts of money in computing power and also they can learn a lot from tech companies, which have the knowledge on distributed ledger technology they currently lack,” said Camron Miraftab, a consultant analyst at GreySpark Partners.

(A version of this article will appear in the November 14 issue of the International Financing Review, a Thomson Reuters publication)