UBS has been experimenting on developing financial instruments based on the blockchain technology.  The Swiss bank has developed prototypes of a bond and a loyalty card program using the Ethereum blockchain.  

 

"We've decided to explore how we can use smart contracts to revolutionize our business and how they may threaten our business," says Peter Stephens, executive director, group technology at UBS in Hong Kong, speaking at Finnovasia conference in Hong Kong.

 

The promise and the threat of blockchain is in disintermediation of trust.  While today the integrity of the financial system relies on trusted institutions, the blockchain technology has trust built in at the level of software. It provides automated mechanisms for reaching consensus on truth and transaction transparency.

 

"There's a single representation of the truth, even though it's distributed across multiple places; one integral version of the truth which we can all see and share," says Stephens. "This changes everything!"

 

Ethereum is the "next generation" of blockchain, the cryptographic technology that underlies the Bitcoin.   While the original blockchain allows for transmission of virtual assets (the Bitcoin and other "coins" that piggy-back on it), Ethereum also provides ability to implement more sophisticated functions, for example rules-based or conditional payments.  

 

UBS's experiments are proofs of concept.  "It was the first toe in the water," says Stephens.  "How do we even create a financial instrument on a blockchain?" 

 

The bank's Ethereum-based smart-bond platform supports the bond's issuance lifecycle and coupon payments.  UBS has also created its own "Bondcoin" to facilitate settlements.  Unlike the fully-virtual Bitcoin, Bondcoin is a blockchain representation of a fiat currency.

 

The second experiment, the loyalty card program allowed the developers the freedom to experiment "more open-mindedly" because in the real world loyalty cards are less tightly regulated, while supporting similar concepts.  The prototype showed it could deliver the program's benefits to merchants almost instantly, while today they may have to wait up to 40 days to see them. 

 

The experiments give UBS a glimpse into a possible future of financial instruments, where "the intermediaries were no longer needed, and that included ourselves," says Stephens. "This confirmed to us the threat and the opportunity; we need to get ahead of this technology."

 

Stephens lists four benefits that the blockchain technology promises: lowering of systemic risk, reducing administrative burden, lowering the cost of financial inclusion and improving the convenience of regulatory reporting.  It has also underscored the importance of developing the concept of digital identity, to support KYC and AML requirements.

 

The work is being done at UBS's Innovation Competence Centre in London.  Its purpose is to explore new technologies in collaboration with start-ups, entrepreneurs, innovation accelerators, research institutions, private equity, venture capital firms and strategic vendors.