Dilemma Facing Banks – Tulip Crisis or Internet 3.0?
Should banks implement blockchain technology for their cross-border payments business? Should they utilize the technology across all processes?
Tulip Crisis or Revolutionary Technology
As Bitcoin hovers around $7,000 in November of 2017, up from less than $1,000 at the beginning of the year, sceptics (including financial institutions) are no longer ignoring the megatrend of digital and crypto currencies[i]. Jamie Dimon, CEO of JPMorgan, sent waves through the financial services community when he dubbed Bitcoin as “a fraud”, even likening it to the Tulip Crises of the 17th century[ii].
While Dimon may be a skeptic of Bitcoin, he also vehemently supports its underlying technology, the blockchain, as an undeniable force in the financial services industry. The blockchain is a decentralized, cryptographic record of every transaction, which can be accessed by any node on the network and unchangeable. Blockchain technology will impact several existing functions of banks, including clearing and settlement, payments, trade finance and even identity[iii]. The structure of the blockchain will help to reduce risk and transaction costs, and improve speed, efficiency and transparency[iv]. For example, as estimated by Accenture, banks could save $10bn by using blockchain to improve the efficiency of clearing and settlement[v]. The future of digital payments – particularly cross-border payments, is less clear and banks, along with others in the ecosystem, are in a tussle as to what the future of the payment chain will look like.
Cross-Border Payments – Since the 15th Century
The current cross-border payment system, also known as correspondent banking where one financial institution executes a transactions on behalf of another which has no local presence – is a lucrative one for financial institutions “that has been around since the time of the Medicis[vi].” A 2016 report by McKinsey estimates cross-border transfers to account for over 20% of the $800tr in annual transfers, but over 50% of the $570bn in revenues in 2014[vii]. This business line is at risk of disruption from emerging technologies and services including Paypal, Transferwise, and blockchain-enabled services like Circle and Ripple. Banks are facing increasing pressure from consumers, who view the new technologies and services as less expensive, fast and transparent on cost and delivery times compares to traditional cross-border payments. In addition to the loss in revenue as a result of lower customer transfers, banks are facing pressures on their margins. According to the McKinsey Report, if “the emerging pressures were to drive cross-border revenue margins down to domestic levels, industry revenues would drop by 70 percent, inflicting losses of $230 billion on banks globally[viii].”
The Process Needs Rethinking
In the short term, J.P. Morgan should focus on the customer promise, to deliver cost-efficient timely and secure cross-border transfers. The first step would be to optimize the current internal process for completing a cross-border transfer. About 60% of B2B transfer need a form of manual interference, according to a 2015 study by Traxpay[ix]. J.P. Morgan started in the right direction when it launched a new payment processing network, The Interbank Information Network (INN), that utilizes the blockchain to reduce the number of partakers needed for compliance and other data-related inquiries that often delay payments[x]. “IIN will enhance the client experience, decreasing the amount of time – from weeks to hours – and costs associated with resolving payment delays,” said Emma Loftus, Head of Global Payments at J.P. Morgan “Blockchain capabilities have allowed us to rethink how critical information can be sourced and exchanged between global banks[xi].”
In the medium to long-term, J.P. Morgan must redefine core processes and realign the customer value proposition. Swift, the bank-owned messaging system used to send trillions of dollars’ worth of payments[xii], is no longer adequate to fulfill the customer process. J.P. Morgan must invest in the digital infrastructure that will cater to (i) customer expectations (ii) new-gen regulatory requirements and (iii) greater efficiencies and margins.
While the digitization of the cross-border payments chain is unquestionably beneficial to J.P. Morgan, some questions remain. Should banks like J.P. Morgan disrupt lucrative businesses that make up large revenues of their existing businesses? Will more customers move towards regardless to the non-bank offer i.e. TransferWise, Western Union etc.?
[i] Coinbase, “Bitcoin Share Price,” [https://www.coindesk.com/price/], Accessed Nov 9th 2017
[ii] Jamie Dimon Interview at Delivering Alpha Presented by CNBC and Institutional Investor, <https://www.cnbc.com/2017/09/12/jpmorgan-ceo-jamie-dimon-raises-flag-on-trading-revenue-sees-20-percent-fall-for-the-third-quarter.html>
[iii] FT Five Ways Banks Are Using Blockchain Oct 2017 <https://www.ft.com/content/615b3bd8-97a9-11e7-a652-cde3f882dd7b>
[iv] “Innovation in Payments: The Future is Fintech,” BNY Mellon, (2015), [https://www.bnymellon.com/_global-assets/pdf/our-thinking/innovation-in-payments-the-future-is-fintech.pdf], accessed November 2017.
[v] “Banking on Blockchain, A Value Analysis for Investment Banks,” Accenture Consulting, (2017) [https://www.accenture.com/t20170120T074124Z__w__/us-en/_acnmedia/Accenture/Conversion-Assets/DotCom/Documents/Global/PDF/Consulting/Accenture-Banking-on-Blockchain.pdf#zoom=50], accessed November 2017
[vi] Olivier Denecker et al., “McKinsey on Payments”, McKinsey & Company Global Payments. 9:23 (June 2016), [http://www.mckinsey.com/paymentspractice/knowledge_highlights], McKinsey & Co., accessed November 2017
[vii] Ibid, Data from McKinsey Global Payments Map
[viii] Ibid, Page 3
[ix] “Dynamic Payments for Dynamic Commerce,” Traxpay, [https://traxpay.com/wpcontent/uploads/2014/09/Traxpay_Commerce-Network_FINAL.pdf], accessed November 2017
[x] “J.P. Morgan Deploys Blockchain with New Correspondent Banking Network,” press release October 16 2017, on businesswire website, [http://www.businesswire.com/news/home/20171016005402/en/J.P.-Morgan-Deploys-Blockchain-New-Correspondent-Banking], accessed November 2017
[xii] Martin Arnold, “Five Ways Banks Are Using Blockchain,” The Financial Times, October 16 2017, [https://www.ft.com/content/615b3bd8-97a9-11e7-a652-cde3f882dd7b], accessed November 2017
Student comments on Dilemma Facing Banks – Tulip Crisis or Internet 3.0?
I think disruption in the cross-border payments business for banks is long overdue – the fact that there are such high fees levied on customers when they are transferring money or conducting business in another country is baffling, and seems to be an unnecessary cost of executing transactions in a safe and reliable manner. As mentioned in this essay, non-banking services like Paypal and Transferwise are already attempting to capture transactions in this highly lucrative space, and that is why I believe banking institutions need to get ahead of the curve and integrate blockchain technology in order to keep on delivering their customer promise and not cede market share. Though I agree that the SWIFT system is generally accepted by most people today and will be difficult to move away from at first, it is only a matter of time before consumers realize there is a more efficient, transparent and cost-effective way.
The other applications of blockchain technology in the traditional banking model that were alluded to in this essay are also fascinating. Though most banks have rejected Bitcoin and other existing cryptocurrencies, banking executives seem rather positive on the applications of blockchain technology to their current business. In fact, UBS likened blockchain technology and its disruptive abilities to the internet and how it has transformed our lives. Unfortunately, it may take years to figure out where blockchain technology is most applicable and where it can create the most value, whether that ends up being making clearing houses obsolete or simplifying trade finance. Though there are many hurdles to overcome and behaviors to change throughout the value chain, one cannot help but hope for a future in which financial institutions are forced to integrate technologies that make their product offerings more efficient, cost-effective, transparent, safe and convenient, both for customers and providers.
 Ryan Vlastelica, “Here’s why UBS is bullish on blockchain, but not bitcoin,” Financial Times, October 26, 2017, [https://www.marketwatch.com/story/heres-why-ubs-is-bullish-on-blockchain-but-not-bitcoin-2017-10-24], accessed November 2017
Based on the very helpful and clear description of the underpinnings of bitcoin in this article, Mr. Dimon’s comparison of bitcoin with the tulip crisis actually seems apt.
Much like bitcoin, the 17th century tulip bubble in the Netherlands developed because of a new technology: a virus that infiltrated the bulbs, but rather than killing the flowers made them flare up in interesting color combinations in flaming patterns, which were coveted because of their beauty and initially mainly coveted by the rich. It also made rare breeds more unique, and difficult to copy. Another new technology that acted as a catalyst for the burgeoning flower market were futures contracts, developed a century earlier to support the trade in grain and herring. 
Introduction of futures for bulb trading around the year 1620 increased the supply of tulips, which suddenly made them accessible to the masses. A brief dip in prices was followed to steady gains year-on-year. Many people then realized that by trading futures, they could get involved and not even own a garden. Around 1635, townsmen began to meet at night in local taverns to trade the contracts, as if they were trading stock. 
This sequence of events led to the world’s first speculative bubble and market crash, as experts realized that there was no underlying principle to support the price of bulbs. In early February 1637, bidders for bulbs failed to show up at an auction in the town of Haarlem. News spread quickly to other towns: within a week, prices dropped to 1% of what the value had been. [3,4]
I believe it is not inconceivable that a similar scenario plays out with bitcoin. Whereas the underlying blockchain technology clearly has inherent value, the bitcoin currency itself seems indispensable only for actors in the shadier side of the economy. Unlike other currencies, there is no economic activity that cannot function without it. If in the coming years, 99% of its value is wiped out, I would not be all that surprised.
 Barbour, Violet. Capitalism in Amsterdam in the Seventeenth Century. Ann Arbor: University of Michigan Press, 1963
 Peter Garber: Tulipmania, Journal of Political Economy. Vol 97, No 3
 Dough French: The Dutch Monetary Environment during Tulipmania. Quarterly Journal of Austrian Economics 9/1, 3-14
 Roel Janssen: Grof geld – Financiele Schandalen En Speculatie In Nederland. De Bezige Bij, 2011