Hong Kong’s DLT Strategy: Building it Block by Block

Following the FSDC (Hong Kong Government Think Tank) paper about Hong Kong’s FinTech strategy to remain a relevant finance in 21st century, a second 80 page report has been published, specially looking at the DLT application for Asia’s leading financial centre.

 

This is a timely update. Whilst the city has been already attracting cryptocurrency companies given the neutral regulatory status of bitcoins, it is clear that the DLT benefits are much broader.

 

Countries have already understood this. While the US and London are typically seen as the leaders of blockchain activities, other regions such as Dubai are catching up on their delay. With a US$275 million fund dedicated to Blockchain proof of concept (PoCs), Dubai is set to become the blockchain hub of the Middle East. The country is currently in the process of gathering all government documents on blockchain with the goal of opening the database to other cities around the world by 2020.

In the meantime the East is also very active with Singapore establishing Blockchain innovation centres and China’s central bank looking into blockchain as a possible technology to develop digital RMB. Hong Kong’s position on the other hand has yet to be clearly defined, however few actions are noteworthy.

 

On top of recent initiatives such as the R3 consortium hosted at Cyberport to explore the potential of DLT, future approaches have been suggested, one of them is a low hanging fruit that few other cities in the world can do: Capitalise on the issuance of digital RMB by the Mainland Chinese Authorities.

 

The DLT Proposition:

 

“Blockchain’s proposition is of a ledger which is distributed rather than centralised”

 

 

Originally considered as the platform for Bitcoin, Distributed Ledger Technology (DLT) is an enabler for ledgers to be distributed rather than centralised, meaning that each participant receives a copy of the transaction record. Indeed, any transacting parties can now maintain the ledger rather than being locked in by trusted authorities (e.g government department, banks or clearing houses).

 

The DLT’s fundamental proposition therefore becomes its distribution and accessibility. Trusted authorities do not hold the ultimate power to write to the Ledger anymore, rather it is now detained by every transacting party in the network. The only question still to be raised is the one regarding its reliability. How can one trust a technology that can be altered by anyone?

 

The answer is simple; beside the fact that each transaction is verifiable, it is also unique and cannot be changed. The process is as follow: the transaction record is sent to computing companies called “miners” which pick up the information and check its validity. After confirming its authenticity, the miners collect other verified transactions and make it into a block sealed by a cryptographic puzzle. The same block will be linked into a chain of already existing blocks, which means that the information cannot be altered unless going through all the subsequent blocks.

 

Infrastructure instead of Currency:

 

The FSDC paper makes no mention of the currency as a potential benefit of the DLT for Hong Kong. Instead, it looks at infrastructure application such as securities trading.

 

As a matter of fact, the FSDC points out towards nine specific use-cases for blockchain in finance:

 

· Global payments

 

· Property and casualty claims processing

 

· Syndicated loans

 

· Trade finance

 

· Contingent convertible bonds

 

· Automated compliance

 

· Proxy voting

 

· Asset re-hypothecation

 

· Equity post-trade

 

This move away from currency towards financial application is also echoed in by the World Economic Forum, mainly about operational simplification or improvement of clearing, acceleration of settlement. Last but certainly not least, the DLT is also greatly affecting regulatory efficiency (i.e. the use of DLT in compliance could reduce by 50% financial institutions’ compliance costs), making it an enabler for RegTech.

 

The investigation of DLT use cases from banks is starting to show results. In fact, Bank of China has won 1st place for its use of blockchain for mortgage property valuation process. This reflects both parts of the FSDC strategy cited above but also the fact that Bank of China is using their blockchain pilot in about 50% of their property valuation. Worth pointing out that two of SuperCharger companies (i.e Neat & Clare.ai) likewise won this government award.

 

Benefits & Challenges:

 

By decentralising the Ledger, DLT transformed it into an independent and trustworthy technology, which can significantly impact the global community. Indeed, Blockchain can have an important influence on industries disrupting beyond financial services.

 

The Digital Identity use case stands out, compared to the two other scenarios proposed. Indeed we could notice an increase interest in this sector with KYC-Chain signing a PoC with Standard Chartered.

 

The paper follows this momentum and argues that in respect of distributed data and identity; Blockchain can have a significant effect on the ownership of data returning process. It strengthens the reliability and security of the sources defining the individual. Leveraging on the power of data, it can also enable a multitude of tailored services, as well as replacing today’s tech giants, which gather data for their own commercial ends.

 

If data is the new oil, does that make Blockchain its major pipeline?

 

 

Despite these positive prospects, DLT is facing many challenges that it needs to overcome in order to deliver its full potential. Most common relevant in context of digital identity is about data privacy. However other financial uses cases will see bottle necks around scalability, latency and the technology’s implications still raise some uncertainty among regulators, governments and users.

 

What is next for Hong Kong?

 

With other regions increasingly looking into DLT innovations, Hong Kong needs to keep track with the fast paced technological environment surrounding it.

 

As mentioned earlier, the immediate low hanging fruit would be to quickly get ready for the issuance of digital RMB. As one of the world’s largest financial sector, Hong Kong should be at the front line when PBC decides to make digital RMB available to banks overseas. As a second step the co-ordination of the Digital Identity and smart city initiative may allow for PoC to be developed & tested in non-critical financial function first.

 

Both these inanities are due to be part of a broader DLT Hub funded by the public sector. On top of building and monitoring a strong blockchain ecosystem and further linking centres in Hong Kong and Mainland, the main idea is to establish a Distributed Ledger Technology Laboratory. The lab would have 3 main goals:

 

1. Reduce cost of testing

 

2. Help synchronise community discussion

 

3. Facilitate the emergence of common standards

 

Hong Kong’s large financial centre could highly benefit from the trust and inclusiveness the Distributed Ledger Technology could enable and sustain. With the many benefits it has to offer, DLT seems to be THE revolutionary technology the world has its eyes on. With Dubai in the MENA region, London in Europe and Kenya in Africa presenting themselves as new-born international DLT hubs, the spot in Asia is still to be defined and Hong Kong better move fast if it doesn’t want to be outrun by its all time favourite frenemy: Singapore.

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