DLT: Big Enough Now to Matter

Distributed-ledger technology (DLT) may radically telescope the time for a new payments technology to reach significant commercial use. Forty years passed between the chip card’s invention and its widespread use, and 25 years went by from when a patent was issued for check-imaging technology until Check 21 fully exploited image-item processing to move checks between banks without bags, guards, and trucks.

Now, a mere 10 years after DLT’s first use as a financial-transaction platform, a dozen banks—including U.S. Bank, Scotiabank, BNP Paribas, BBVA, and Mizuho (a grouping that covers the world)—and international fintech firm R3 are using DLT for letters of credit.

I’m not surprised that a key player is HSBC, having worked with them and two Haddon Hill Group colleagues to innovate the Tradelink/SPEDI system for digital transmission of non-financial trade documentation. The new consortium has developed a way to use DLT for transmitting letters of credit, the instrument used to pay 38% of the $15 trillion-worth of goods traded annually.

A useful rule of thumb holds that a new payments technology has arrived when it achieves three measures:

1. It provides a level of improvement large enough to justify the cost of swapping out the current method.
2. It performs the function with security equal to or better than what it supersedes.
3. It does so for a significantly large dollar volume of transactions.

The value generated by a new technology is critical when judging if the solution is big enough to matter. An example of a use case that is too small to meet this qualification: mobile-phone payments in which friends use their phones to split the pizza bill. Most of the previously proposed use cases for digital currencies are similarly too small to matter:

– Person-to-person payments (but only between people who use the same digital currency, or two of those few that are exchangeable);

– Purchases (from an alternative-currency equipped seller);

– Donations (if made to an organization capable of receiving the alternative currency);

– A (fluctuating) store of wealth;

– A (speculative) investment;

– A (not SEC-approved) initial public offering.

None of these DLT use cases passes the “pizza test” of being big enough to matter.

But applying the high level of process improvement that DLT enables to a trillions-of-dollars market like letters of credit makes it clear why banks worldwide would team up to create a DLT-based LC system. Furthermore, given that the time it takes to process an LC is relatively the same for shipments by air as it is for shipments by sea, reducing LC processing time cuts out a much larger percentage of the total time of a 12-hour flight than it does of a three-week ocean voyage. And the percentage, by value, of LC-backed shipments made by air has been steadily increasing.

With a letter of credit, two issues are paramount: trust and interoperability. A key aspect of DLT is its approach to trust, which is built into its process in which all parties to a transaction can see and verify the transaction as it moves from participant to participant. Any alteration is immediately visible to everyone with a stake in the transaction. Given the eight or more parties involved in a typical LC transaction, DLT becomes a true game-changer.

Seamless interoperability is essential for LCs because the multiple parties to the transaction in various locations around the world, all of whom must agree before the transaction can be consummated, often have different technologies and protocols.

With trust verifiable via blockchain technology and interoperability handled by R3’s Corda platform, what started out 10 years ago as an alternative-currency scheme in search of a purpose is being turned into something with a big enough business case to matter. And it is happening in dramatically less time than previous payments breakthroughs required to become a part of the regular payments-transaction process.

Having been not so much a skeptic of DLT as a frustrated fan, I applaud these banks and R3. They may well have given DLT the needed transition from fledgling new payments innovation looking for a use case to solution big enough to matter.

—George Warfel • GWarfel@haddonhillgroup.com