An inside look at CommBank’s blockchain experiment, and how it works

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Blockchain is a technology that has the potential to change everything.

Governments are testing it for storing records, stock exchanges for trading shares, and the Commonwealth Bank is experimenting with it to foster faster transactions, and unlock huge savings for customers and itself.

The blockchain is essentially a series of public records, stored in multiple locations. Think of it as a shared spreadsheet. The blockchain details who owns what, adding a new record with every transaction, and for changes to be made, the majority of the participants in the system must agree with it. This means the blockchain contains a certain, verifiable record of every transaction ever made.

Individual banks already have databases to log transactions and who owns what, but they are all operated independently and can’t talk to each other. This is why it takes time for transfers to clear, and why banks have to hold capital against transactions – to account for counterparty risk. The blockchain offers parties on the blockchain a way of transacting with each other quickly without a centralised institution. The blockchain would become a single database across institutions.

“Currently banks use a type of database or ledger that only they can write to. There are a variety of different technologies, but the crux of it is that the only entity that can make changes to that ledger is the bank themselves,” says Michael Eidel, Executive General Manager, Cash Flow and Transaction Services, Institutional Banking & Markets, Commonwealth Bank.

“Inside a bank it makes a lot of sense just to have the bank in control of that database. Where blockchain really come into its own is where multiple entities are trading with each other.”

The goal is to create a private or permissioned blockchain, operated by all of the banks. They would all keep a copy of the ledger, and everyone would be able to initiate transactions. The Commonwealth Bank was one of the first banks in the world to join the R3 consortium, a group of 43 banks attempting to create a set of principles for a private blockchain.

“Under the current system, I maintain a copy of my database, you maintain a copy of your database, and there is a lot of effort involved in checking and making sure all of our copies of the database are the same,” says Eidel.

“With the blockchain the database effectively keeps itself in sync. There is one golden central record that everybody agrees on. It means you don’t have to expend substantial costs in checking and checking again that all of our copies match.”

While the protocols of a future inter-bank blockchain are being worked out, Commonwealth Bank has completed a number of experiments using the blockchain. This includes looking at intra-bank transfers and a number of applications in back-office processing.

In a separate series of experiments, with the R3 consortium, the Commonwealth Bank has connected with a number of global banks to initiate financial transactions instantaneously, evaluated different blockchain solutions for a global ledger and also successfully used blockchain to trade short-term public debt between financial institutions. The market for commercial paper is largely paper-based, and where risks, long settlement times and errors add to the cost of doing business.
“The commercial paper market, and other over-the counter markets, are very significant opportunities for improving what are otherwise manual and paper-based processes,” says Eidel.

“There are a lot of situations where the bank is trading with other large organisations and each party maintains their own record. With the blockchain and the shared golden record, there’s substantial opportunity to cut that cost and cut the risk of errors that is currently embedded within the system.”

Cutting down on transaction times is one of the main goals of these experiments. If blockchain can reduce transaction times, it could be rolled out in many other areas. Numerous markets feature delayed settlement – transactions of cars, shares and property all take a number of days to clear. Extended settlement time adds to the risk, and increased risk adds to the cost.

“Wherever there is delayed settlement, there is risk,” says Eidel.

“In financial market transactions you have to hold capital against counterparty risk. You can imagine if that counterparty risk was reduced, the cost of the transactions would reduce as well.”

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