The jury may still be out on the long-term prospects for virtual currency such as Bitcoin. While its use has been growing, it has not approached the acceptance levels of government-backed currencies.
Bitcoin has shown an inability to keep consistent value, and many potential users were scared by the collapse of one of the world’s first Bitcoin exchanges, Mt. Gox. Its underlying technology, blockchain, however, is starting to gain real traction in arenas outside virtual currency. Many larger financial services organizations are investing serious dollars to develop applications for a wide range of activity. For example, Chain, Inc., a leading provider of blockchain technology solutions to financial institutions, is backed by $30 million from Visa, Nasdaq, Citi Ventures, Capital One, Fiserv and Orange. In addition, J.P. Morgan has deployed blockchain to a client test group to see whether it can be repurposed for currency clearing and settlement to give clients faster turnaround times and reduce the bank’s risk.
Blockchain offers promise for two industries that have faced challenges with large-scale asset transfers. In the financial institution industry, the ability to transfer mortgage servicing rights is critical to the American dream of home ownership. In the debt collection industry, the sale of overdue debt is critical to organizations that originate large amounts of consumer debt. Both industries are under tremendous regulatory pressure to do a better job giving consumers continuity of adherence to regulatory guidelines.
What Is Blockchain?
Blockchain is a distributed system in which all parties involved with a type of transaction have agreed up front on what information needs to be shared for the transaction to be considered valid. Blockchain automatically generates a public ledger of all transactions as they are executed. When one party initiates a transaction, the other parties’ portions of the system interrogate the transaction, screen it for validity, accept or reject it, and record the activity. Legacy transactions tend to be much more serial in nature – one party starts a transaction and then hands it to a second party, which uses its own system, and so on. Often there’s an intermediary, such as an exchange, in the middle. The new players looking to use blockchain beyond virtual currency are looking for efficiency gains in addition to increased data integrity.
The Challenges
Buyers and sellers have to get it right.
Since the financial meltdown, both mortgage servicers and debt collectors have been under increased pressure to do a much better job at transferring mortgage servicing rights and consumer debts. It is easy to point fingers at regulators here, but the fact is that our society does not accept taking away the American dream – home ownership – through foreclosure, if the homeowner is not treated appropriately.
These transfers assist all market players.
In both the mortgage banking and debt collection worlds, the ability to sell assets or transfer servicing rights is important for the overall liquidity and capital positions of the debt originators. Any asset that cannot be sold is almost automatically worth less than a marketable one. Also, transferring an asset such as an overdue consumer debt to a firm that has specific expertise in collecting that type of debt introduces increased efficiency into the process.
Transfers are relatively complex transactions.
When purchasing a home and getting a mortgage, one signs many documents that serve to notify the municipality, insurance companies, etc., that something important has occurred. Unwinding that transaction, when a homeowner is distressed, is very complicated. Many moving parts exist, and those parts can’t be stopped because two financial organizations are going to execute a transaction. The consumer/homeowner will continue to take actions that affect the debt being bought and sold.
The Potential
Creating a blockchain transaction among market participants forces
agreement on what constitutes valid transactions. For example, what is the definition of a valid transfer of, say,
a portfolio of overdue credit card accounts? All players would have an opportunity to weigh in. This could obviously include regulatory requirements. As with many processes in American business, current practices evolved over a matter of time. Blockchain offers the opportunity for a paradigm shift.
Through its efficiencies brought about by removing intermediary participants, blockchain can improve the timeliness of data, thereby introducing increased integrity to the process. For example, if a consumer made a payment on the same day as the transfer, it could be captured much more easily than current systems and processes allow.
The Potential Risks
Obviously any fundamental change from a legacy, serial process to a new concurrent process offers opportunities for growing pains, slip-ups and errors. Also, coordinating a multiparty process to come to agreement on what constitutes valid transactions will be difficult, and traditional sellers may want to provide much less data than traditional buyers want.
On the Horizon
Blockchain presents a fundamental change and opportunity to improve efficiency and accuracy in transaction processing and recording. Movement toward using it in many arenas is growing – heavyweight IBM is offering a version of its blockchain in a user-configurable test form so that potential users can actually see how it will work. This could take a great deal of the “newness risk” out of the equation. Given the challenges present since the financial meltdown, blockchain needs to be considered in areas such as mortgage servicing transfers and consumer debt purchases/sales.
Brian Lane, A partner in the Financial Services group of Baker Tilly Virchow Krause, LLP. [email protected]
Kevin Sullivan, The director of the Financial Services group at Baker Tilly Virchow Krause, LLP.[email protected]
Russell Sommers, A senior manager in the Financial Services group at Baker Tilly Virchow Krause, LLP. [email protected]
Published March 30, 2016.
