Technology and Innovation, Vol. 21, pp. 3-9, 2019 ISSN 1949-8241 • E-ISSN 1949-825X Printed in the USA. All rights reserved. http://dx.doi.org/10.21300/21.1.2019.3 Copyright © 2019 National Academy of Inventors. www.technologyandinnovation.org BLOCKCHAIN PLATFORM FOR REAL-TIME PAYMENTS: A LESS COSTLY AND MORE SECURE ALTERNATIVE TO ACH Nasser Arshadi College of Business Administration, University of Missouri – St. Louis, St. Louis, MO, USA This paper examines the historical development of banking and automated clearing house legacy systems and offers blockchain platform for real-time payments as an alternative. Insti- tutions with legacy systems resist disruptive change unless there are demands by businesses and customers and an opportunity for new products at reduced costs and additional revenues. Although the Automated Clearing House (ACH) in the U.S. has phased in a twice-a-day clear- ing and settlement system, it is still behind real-time models in use in several other countries. ACH uses individual clearance and settlements for large payments and batches for smaller transactions. Using ACH data, this paper calculates the annual opportunity cost of using a real-time model such as blockchain versus ACH’s discrete, twice-a-day clearance and settlement procedure. For 2016, the real-time protocol would have resulted in benefits for businesses and customers of $10 billion. Key words: Blockchain; Payment systems; ACH; Federal Reserve System INTRODUCTION House (ACH) and handles 16% of the total payment Advances in computation technology have transactions and 82% of the total value of the pay- drastically improved the information processing ments. ACH has adopted a same-day processing capabilities of payment systems. Payment process- system that replaces the old one, which took two to ing institutions have shown interest in the new three days to complete a transaction. In 2016, ACH technologies, but their adoption has been slow. In processed 25 billion transactions for more than $43 the meantime, non-banking technology providers trillion (2). have introduced new protocols that promise to sig- Bank regulatory agencies, especially the Federal nificantly improve the speed and security of data Reserve (Fed), are closely monitoring develop- processing and reduce costs for businesses and cus- ments in payment systems. By early 2017, the Fed tomers. The blockchain protocol, a form of distributed had assembled a task force representing banks, tech ledger technology (DLT), has exciting potential for a companies, and regulatory agencies to develop and variety of businesses, including banks. issue a request for proposals for the future of pay- U.S. banks and payment processing institutions ment systems (3). The Fed did not select any single (e.g., the National Automated Clearing Association, proposal as the winner, but it highlighted some for or Nacha) are in the process of exploring their current their success in meeting certain criteria and hence options (1). Nacha operates the Automated Clearing provided credibility to their underlying protocols. _____________________ Accepted: February 1, 2019. Address correspondence to Nasser Arshadi, Department of Finance, College of Business Administration, University of Missouri – St. Louis, MO 63121 USA. Tel: +1 (314) 516-6272, E-mail: [email protected] 3 4 ARSHADI This paper focuses on the ACH payment system the U.S., the payment systems involve banks, private and demonstrates how its protocol costs businesses third parties, and the Fed. The infrastructure in place and customers billions of dollars annually in oppor- is a function of banking history and communication tunity costs. To appreciate why the legacy systems and technology developments. are difficult to change, a brief review of their his- tory comes next. EVOLUTION OF ACH ACH transactions can involve online bank- BANK LEGACY SYSTEM ing payments between person-to-person, For most of its history, banking has entailed a rela- business-to-business, or business-to-customer. The tionship with businesses, and knowing the customer ACH is administered by Nacha and is operated by has been essential for risk assessment and pricing. For the Fed and the Electronic Payments Network, a customers, knowing the bank as a trusted interme- private sector payment network. diary has been crucial in financing decisions. Such At the retail level, a check issued by one party a long, established tradition makes technological to another party is cleared internally if both have changes slow and sluggish at best. accounts in the same bank and externally if they The regulatory structure overseeing banking has have two different banks. In the latter case, the followed the same pattern. The establishment of the check goes to the Fed, which debits the account three major regulatory agencies—the Office of the of the issuing bank and credits the account of the Controller of the Currency (OCC), the Fed, and the receiving bank. The check in question could be a Federal Deposit Insurance Corporation (FDIC)—and paper check, or, since 2010, it could be in the form their subsequent evolution happened as a reaction of an electronic image of the check for a majority to financial crises. The OCC was established as part of cases. The check issued has a nine-digit number. of the Department of the Treasury in the National The American Bankers Association’s routing transit Currency Act of 1863. The OCC is tasked with char- number, on the left side of the check, identifies the tering, regulating, and supervising all national banks issuing bank and the account holder. and thrift institutions and the federal branches and The vast majority of transactions require no check agencies of foreign banks in the U.S. The Fed was at all. If an employer pays salaries to employees established in 1913 as a response to a series of finan- through direct deposit, it goes through an automated cial panics starting in 1907, and its objective was clearinghouse and is considered a credit transac- to promote price stability and economic growth. tion. Similar cases include pushing money online Congress expanded its responsibilities in the after- to accounts in other banks for friends or relatives math of the Great Depression and again during the either once or periodically. The transfers of individ- recession following the Dot-com bubble. The FDIC uals who set up monthly payments of mortgage or was established in the 1933 Banking Act to prevent utility bills from their accounts are considered debit bank runs and restore confidence in the banking sys- transactions. tem following the failure of one-third of all banks (4). The history of ACH goes back to 1974 when ACH Initially, FDIC covered losses of up to $2,500 per cat- associations from California, New England, and the egory, and this has increased several times over the Upper Midwest region came together to form a new years to $250,000 today. entity within the American Bankers Association (5). Over the years, most technologies introduced in the Over the years, it grew rapidly from over one billion banking industry have been incremental, improving in transaction volume in 1988 to 25.5 billion in 2016, existing protocols and reducing costs while keeping with a value of $43 trillion (5). the legacy systems in place. In one area—payment Settlements in early years took days, costing the systems—technologies involved both banks and their participating parties (e.g., businesses, customers) regulators. significant costs both directly in charged fees and The payment systems include institutions that use indirectly through the opportunity cost of not hav- technologies to transfer funds between parties. In ing access to funds in transition. Before the recent BLOCKCHAIN, PAYMENT SYSTEM, ACH 5 shift, the best settlement date available was the next eligible transactions. Remaining ineligible for the day, while banks had the discretion to lengthen avail- same-day ACH transfers are international transac- ability of funds to counterparties to several days. To tions and those greater than $25,000. address this problem, the Nacha undertook an ini- Among remaining inefficiencies are the infrequent tiative to move toward same-day ACH over three processing (i.e., twice daily) and the fees charged. phases (5): Currently, the ODFIs pay the RDFIs 5.2 cents per • Phase 1 (effective September 23, 2016) allowed transaction. For example, if there were 100 transac- for ACH credits to be processed during the tions in one month by an ODFI, it would owe $5.2 two same-day processing windows, all receiv- (.052 * 100). This fee will be handled by an ACH oper- ing depository financial institutions (RDFIs) to ator (e.g., the Fed) in a monthly statement. receive same-day ACH transactions. • Phase 2 (effective September 15, 2017) provided ACH AS A TRUSTED THIRD PARTY IN THE for ACH debits to be processed during the two CLEARING SYSTEM same-day processing windows. In the flow of payment from a sender to a receiver, • Phase 3 (effective March 16, 2018) mandated ACH plays the role of a trusted third party by ensur- RDFIs to make funds available from same-day ing: 1) the sender, who is initiating a transfer, has the ACH credits by 5 PM local time. funds; 2) the funds are credited to the account of the Among benefits of the same-day ACH is a reduc- receiver, and not someone else, at the level promised; tion in credit risk within a narrower transfer window. and 3) the sender forwards the funds only once to the It also supplies better support for payroll needs for designated receiver and not multiple times to others hourly workers and lowers transaction costs between at the same time. payers and receivers. Reducing ACH processing time The current trajectory of ACH services—the same- by one day or a few hours for $43 trillion annually in day payment submission, clearance, and settlement total ACH transactions value creates significant sav- twice daily—is an improvement over the previous ings in opportunity cost.