During the spring of 2017, Russian Prime Minister Dmitry Medvedev twice referenced blockchain in his speeches: in March, he proposed that the Ministry of Economic Development and the Ministry of Telecommunications think about how to reduce bureaucracy via the blockchain technology, and in mid-May, he called for a discussion of the legislative framework for blockchain. In February 2017, German Gref, Sberbank’s CEO, forecast that in 2.5 years blockchain would be used on a commercial basis in Russia. According to a forecast by Accenture, a consulting company, during the 2018-2024 period, blockchain will cover many types of assets, and by 2025, this technology will become a significant and integral part of global capital.
A Place for Blockchain
Although the concept of blockchain is mostly known due to bitcoin cryptocurrency, it can be used in many other ways.
Konstantin Goldstein, a technology evangelist at Microsoft, says that the financial sector is a key blockchain consumer: this segment needs the increased protection of online payments which can be provided by the decentralized technology. Mr. Goldstein thinks that other promising spheres for blockchain include healthcare, insurance, retail, real estate property, property registration, and the music industry.
Yuri Mazurov, Deputy Head of the Commercial Division of Asteros, Russia’s systems integrator, says that the next zone for using blockchain may be copyright and other rights’ protection. Russian authors’ societies, universities, and the Skolkovo Fund are already working to develop a blockchain platform to manage intellectual property. According to Mr. Mazurov, blockchain has a positive outlook in the logistics sphere: it will not only increase the transparency of operations but it will also reduce the time required to prepare collateral documents and to transport cargo on the route. The technology can also control the status of material assets and associated work, repairs, and upgrades.
Moreover, blockchain is useful for organizing any type of voting and elections, for arranging reliable document interchange between agencies, organizations, and citizens, for managing pension, and for the safekeeping and exchange of medical data, Mazurov adds. A representative of the Ministry of Telecommunications considers blockchain to be applicable for banking document interchange: scoring, bank letters of credit, trades involving pledged instruments, powers of attorney for managing accounts, real estate property sales and purchase deals, and operations that transfer the cumulative part of a pension to non-governmental pension funds.
What Is Blockchain?
To understand the concept of blockchain, we can use the analogy of a card index where each card is owned by one person, explains Vladislav Pavperov, Senior Manager of the Prospective Technologies Consulting Group, KPMG. All cards are connected (including in a chronological way). This way if the record on one of the cards is changed (for instance, an asset has been transferred to another owner), then information about this change is reflected in other cards. The expert points out: it is impossible to change anything in the card index post factum. Each data block includes the calculated control sum of the previous block (a similar technology is used in torrent files). Thus, blocks are integrated into a chain, and it is impossible to change a block in the middle of a chain or extract it, because this will be discovered when the next blocks are checked. Moreover, this is a distributed technology, i.e., the chain of encrypted data is maintained by each participant in the process, so an unauthorized change and the re-calculation of the control sum are practically impossible.
Sergey Putyatinskiy, IT Director, National Settlement Depository, is sure that the distributed ledger technology is applicable when it is necessary to create a system that works with digitalized data and includes many participants who have limited trust in each other and who must work with the same data. If data has not been digitalized, or if the system functions via a centralized server or a cloud solution (and all participants are happy with this), blockchain does not provide additional advantages. According to Mr. Putyatinskiy, 90% of business processes for the financial infrastructure do not need blockchain. A Sberbank representative agrees with Mr. Putyatinskiy – there is no sense to switch to blockchain processes that are only associated with the service provider and which do not include direct information or value exchange between different participants. He refers, for example, to ticket sales for Russian Railways trains.
According to Alexey Arkhipov, a representative of the Association for Financial Technologies Development, blockchain will be useful where there is a need during the complex transfer of assets to have confirmations from many parties and inter-agency interactions. A representative of the Federal Anti-Monopoly Service (FAS) objects, saying that inter-agency interactions should not be switched to blockchain. Instead, FAS has launched a blockchain-based document interchange with only a handful of commercial organizations – Sberbank, Russian Coal, Aeroflot, and Forteinvest. Andrey Tsarikovsky, Deputy Head of FAS, told Vedomosti that this pilot project is called Digital Ecosystem, and FAS considers it to be very successful. According to Mr. Tsarikovsky, the absence of intermediaries (document interchange operators) reduces costs; using participants’ networks avoids the need for reserve equipment; the document interchange becomes quicker and more transparent. In the meantime, expenses to develop the service were minimal due to the use of open standards and interfaces, and there was no need to purchase additional equipment, Mr. Tsarikovsky stated.
The Entry Threshold
It is not necessary to buy any special equipment or develop non-trivial software solutions, according to Maxim Azrikyan, Chief Technical Architect of Alfa Bank. He believes that blockchain developments based on open source code are accessible to everyone, and using these solutions is quite simple. Mr. Mazurov from Asteros thinks that the Ethereum platform (the platform on which most of the solution are being developed) is the standard for blockchain.
Mr. Goldstein from Microsoft agrees that Ethereum is one of the most popular blockchain platforms. It is popular in Microsoft’s own Azure Blockchain as a Service (BaaS), in which blockchain infrastructure may be opened with a single click, he says. BaaS uses a few blockchain solutions: Ethereum, Chain Core, Corda, Nxt, Lisk, and Waves. Microsoft says that their clients include Roseurobank. Alexander Vasilyev, Deputy Director for Innovations in the bank’s IT Department, adds that this is a pilot project to develop a remote identification system.
IBM has a solution called Blockchain for Hyperledger Fabric; according to a representative of the U.S. corporation, it is being tested by some banks and companies. The IBM representative adds that it does not require a significant upgrade for each customer. The representative is convinced that there will be blockchain demand in Russia. He refers to an IBM survey in which more than half of senior managers at banks expect that in the coming three years blockchain will be put into commercial operation.
Mr. Mazurov highlights the fact that the Bank of Russia, in conjunction with major banks, has launched a masterchain platform that allows the banks to conduct online payments, quickly confirm the relevance of client data or transaction data, and rapidly create financial services. The platform is built on the basis of Ethereum and Russian cryptography, adds Mr. Arkhipov from the Association for Financial Technologies Development. He considers the masterchain to be convenient for exchanging information between parties that do not trust each other. According to him, the technology decreases the involvement of intermediaries, and makes information available to stakeholders only when changes are made. The technology also can control the transfer or exchange of rights to financial instruments or assets.
The Bank of Russia, together with Qiwi, Sberbank, Alfa-Bank, Otkritie Bank, and Tinkoff Bank, tested the masterchain prototype in October 2016. The regulator reached the conclusion that the technology allows for the quick confirmation of the relevance of client data and the rapid creation of financial services.
First Transactions
In September 2016, the first real blockchain-based transaction was reported: British Barclays Bank, the Israeli technological startup Wave, and the Irish dairy producer Ornua opened a $100,000 letter of credit as collateral for exporting Ornua’s cheese and butter to the Seychelles Trading Company in less than 4 hours. Usually, this would have taken from 7 to 10 business days due to document processing.
“The costs were lower, because it happened faster than via any financial organization, as there are always intermediaries working with banks which conduct clearing operations,” commented Oleg Tinkov, an owner of Tinkoff Bank. “In this case, everything was more transparent and cheaper.”
In late September [2016], Delovaya Sreda, a Russian company which is Sberbank’s subsidiary, announced that the first Russian blockchain-based transaction had been conducted by Trademarket, a Russian company, and Hangzhou Xiaoshan Tianyu Machinery, a Chinese machine tools manufacturer.
In December [2016], S7 Airlines replaced traditional paper letters of credit with the blockchain technology, using Alfa Laboratory’s (an Alfa-Bank company) blockchain platform.
In the end of May 2017, information became known about a project being developed by Citigroup and NASDAQ. Citigroup’s corporate payment services are linked to NASDAQ’s blockchain system, which is used for the sale and purchase of shares. The partners say that they have already begun using the system to pay for trade operations, and Citigroup has been receiving fees for conducting these payments.
According to Mr. Goldstein, the mass implementation of blockchain will change the financial market’s infrastructure, as well as the job market: clearing companies and intermediaries will disappear, as will executors of contracts, outdated models of payment systems, and brokers.
What Does the State Do?
The Ministry of Economic Development and the Ministry of Telecommunications executed the Prime Minister’s instruction. The Digital Economy draft program submitted to the Russian government includes a pilot project to implement the blockchain technology in government agencies, but it does not clarify which ones exactly, says Elena Lashkina, a representative of the Russian Ministry of Economic Development. The representative of the Ministry of Telecommunications adds that the program assumes the legislative framework for blockchain.
A representative of the Ministry of Finance names conditions for implementing blockchain in the financial market: the confirmation of the economical practicality of using blockchain and the observance of current laws (including those related to security). A representative of the Bank of Russia specifies that currently distributed ledger technology is not prohibited by Russian laws, and that companies and agencies can use it at their own discretion. The Bank of Russia sees the same set of advantages for blockchain as FAS does.
A decision to implement blockchain is related to changes in the current legal framework, says a VTB representative. The State Duma has already considered bills related to amending Federal Law № 115-FZ, which is focused on the use of the Unified System of Authorization and Authentication, as well as a bill on introducing an electronic pledge of real estate property, the representative of VTB (a state bank) remarks. According to him, both bills should be adopted during the 2017 spring legislative session and put into effect in 2018. There are regulator’s regulations on issuing bank guarantees or letters of credit in an electronic format, as well as for their storage in distributed electronic ledgers, points out the VTB representative.
In mid-April, Alexey Moiseev, Deputy Minister of Finance, stated that to counteract illegal transactions, in 2018, Russia might recognize bitcoins and other cryptocurrencies. He said: “At any moment, the State should know the participants at both ends of the financial chain. If there is a transaction, the persons who conduct it should understand who they are buying from and selling to, like with banking operations.”
Open Issues
Despite clear advantages, there are some issues regarding blockchain; these questions have been raised by the representative of the Ministry of Telecommunications. There are unclear mechanisms for distributing information and dividing access to it. This may lead to a loss of control over confidential information. The novelty of the technology means that it is not possible to assess the scalability of networks using it. There are no solutions certified by the Federal Security Service and the Federal Service for Technical and Export Control. There is no regulation, and there are no unified requirements for identifying network participants, and no responsibility for the quality of data uploaded by participants. And finally, there is no judicial practice regarding blockchain-based transactions, says the representative of the Ministry of Telecommunications.
The flip side of blockchain’s reliability is that it can conduct only a small number of transactions per second, points out Oleg Tretyak, a representative of the IT Infrastructure Department from Raiffeisenbank, and Anatoly Orlov, Chief of the Big Data Laboratory of the Internet Initiatives Development Fund (IIDF). According to Mr. Orlov, if a standard money transfer held via a bank is just a change in the numbers in the two accounts, the same transfer conducted via a blockchain system represents a calculation of a complex mathematical function. A standard payment system process up to 45,000 transactions per second, but blockchain cannot maintain this speed: it can process no more than 3 or 4 transactions per second, adds Sergey Alimbekov, Director for Technological Development, IIDF.