Saturday, September 23, 2017

PSD2 Open Banking Initiative and Blockchain Economics

Compulsory upcoming implementations of the European Union’s Revised Directive on Payment Services (PSD2) supporting the Single Euro Payments Area (SEPA) could spur blockchain adoption for two reasons. First, the shared ledger technology provided by blockchain is a crucial underlying functionality for real-time payments. Second, blockchains offer not only real-time payment capability, but also identity confirmation, so that risk management and fraud prevention may be improved for banks.

The objectives of PSD2 dovetail nicely with the capabilities of blockchain. One of the most obvious kinds of functionality to facilitate real-time payments is having a shared ledger of account balances. User identity and balances are confirmed and known in banking blockchains, and reside in a secure and immutable ledger waiting for upcoming transactions. Blockchains render the preliminary validating phase already complete, and therefore qualifying transfers can be executed automatically. Blockchain is the perfect infrastructure for real-time payments.

Regarding blockchain innovation and the development of new payment processes and systems, one implication of the PSD2 requirement for banks to open up their APIs to third parties is that the payments business could become more like a utility. On one hand, this could have banks scrambling to focus on higher margin customers and services. On the other hand, the technically-savvy might see PSD2 as a means of reaching new markets with technology-based solutions. The economic structure is different with blockchain in that the cost of offering services is reduced, while security is improved at the same time through blockchain-based identity confirmation. Banks could use low-cost eWallet solutions to offer light banking services on-demand to customer tiers that were previously unattractive from a credit and margin perspective. Lightweight banking services delivered by eWallet could be the analog to prepay phone services. A surprise benefit of PSD2 could be supporting financial inclusion as a policy result.

One effect of PSD2 is inviting agile fintech companies into the market. These vendors are well-versed in contemporary fintech solutions using Ripple and blockchain-based digital ledgers. This is important because it is not clear that more established payments systems such as SWIFT have the infrastructure to support real-time payments initiatives, despite their efforts to consider blockchain technology as a front-end overlay.

Digital ledger technology like blockchain facilitates payment and also compliance. Future payments regulation such as PSD3 could almost require the technical capabilities afforded by digital ledgers. For endusers, payment services could be more seamless than cash. A further effect of rethinking payments with blockchain could be rethinking other monolithic financial models such as how debt, loans, and capital are structured.

Status of Blockchain Adoption
PSD2 underlines that the industry is becoming more of an institutional investor and enterprise software market. The big source of investment in the sector is existing financial and governmental institutions who are developing private blockchains (where user identity is known and approved with KYC/AML practices; like a VPN).

Private enterprise blockchains could serve as a counterweight to worries about money laundering and other illegal uses of public blockchains. It is not that public blockchains should be banned or heavily regulated. Digital ledgers should be recognized as a new and complex digital venue where illegal activities may be taking place alongside bonafide activities, such that regulatory agencies are called upon to become savvy about the risks presented by the new technology and operate within this domain (anonymity does not mean lack of forensics). This is a small detail against enterprise blockchains as the bigger trend in the digital ledger space at present.