Blockchain Technology & the Future of Financial Transactions: Opportunities and Challenges
A trade is comprised of several intermediaries’ such as exchanges, central counterparties (CCPs), brokers, securities depositories (CSDs), custodians and investments managers and so on. The intermediaries need to update their respective ledgers based on the messages exchanged between them in order to complete the business transaction. Therefore, every transaction requires additional processes to be executed which result in additional time and cost. Moreover, to enable a particular transaction and the corresponding ledger updates, intermediaries may need to complete a few additional ledger transfers in the form of realignment, securities borrowing or cash management (Amit, 2016). This results in further delays in the transaction lifecycle which is usually referred to as a settlement cycle in capital markets (Amit, 2016).
To overcome this problem, a shared flat ledger can be created utilizing the blockchain technology managed by trusted processing (Amit, 2016). Using digital signatures, financial intermediaries can update the ledger to complete a business transaction. According to Vijay Michalik, research analyst for consultancy firm Frost & Sullivan, some of the possible benefits of adopting blockchain include simplifying business processes and creating trusted, safe records of business agreements and transactions,. Additionally, some Financial Institutions and FinTech startups are looking at ways to leverage Blockchain in the area of identity and authentication (Amit, 2016). Firstly, all types of data and transactions can be stored in a secure and open way using the blockchain. Moreover, creating an identity on the blockchain, making it easier to manage for individuals, giving them greater control over who has their personal information and how they access it.
A digital ID can be created by combining the decentralized blockchain principle with identity verification, that would act as a digital watermark which can be assigned to every online transaction (Amit, 2016). The solution can eliminate fraud by helping the organizations to check the identity on every transaction in real time. Without having to enter any of the traditional username and password information, Consumers will be able to login and verify payments. Through blockchain solutions, consumers can simply use an app for authentication instead of using traditional methods, such as a username and password (Amit, 2016).
What’s the Story of Bitcoin?
The open-source cryptocurrency protocol, also known as digital currency, or virtual currency, was introduced in 2009 by Satoshi Nakamoto, an anonymous developer (or group of bitcoin developers) hiding behind this alias (Hajdarbegovic, 2015). In the next few years, Bitcoin didn’t see much of a progress and was thought to be nothing more than another internet curiosity reserved for geeks and crypto-enthusiasts (Hajdarbegovic, 2015). However, Bitcoin eventually gained traction within several groups with different interests — ranging from the gathering fans, to black hat hackers, anarchists, libertarians, and darknet drug dealers (Hajdarbegovic, 2015). Furthermore, more legitimate entrepreneurs and major brands such as Dell, Microsoft, and Newegg eventually accepted the Bitcoin technology.
What is blockchain and how it works?
Bitcoin blockchain is the technology backbone of the network and provides a tamper-proof data structure, providing a shared public ledger open to all (Hajdarbegovic, 2015). The process involves simple yet impressive mathematics. The use of specialized hardware to build this vast chain of cryptographic data makes it almost impossible to replicate.
All the confirmed transactions are embedded in the bitcoin blockchain. The integrity of the blockchain applications are ensured by the use of SHA-256 cryptography. A private key or seed is used to sign all transactions to prevent third parties from tampering with it. Transactions are confirmed by the network within 10 minutes or so and this process is handled by bitcoin miners. Mining is used to confirm transactions through a shared consensus system, and usually requires several independent confirmations for the transaction to go through. This process guarantees random distribution and makes tampering very difficult. While there are various bitcoin-based businesses out there, blocchain network has proven very resilient. A large investment in the bitcoin industry is among the key reasons.
Potential Uses and Implications Of Blockchain Technology:
There has been a great deal of experimenting on blockchain applications by thousands of developers and dozens of companies but yet to see large scale projects built around blockchain technology that are not bitcoin or altcoin-based. IoT could bring blockchain technology to the masses (Amit, 2016). Research firm IDC expects the user base to grow at a compound annual growth rate (CAGR) of 17.5% this decade, with up to 28.1 billion IoT devices in the wild by 2020, and revenue passing the $7 trillion mark the same year.
The potential for blockchain is more or less obvious. Decentralizing trust using blockchain will allow the creation of vast, secure networks without failure. This could be considered as an additional layer of the internet that can be used for authentication, signage, secure communications and content distribution, financial transactions and much more (Amit, 2016).
The developers can use Blockchain technology as a simple way of outsourcing security. For example, instead of creating secure IoT devices and networks, much of the heavy lifting could be effectively offloaded to the blockchain, freeing up resources on the client’s side and speeding up development (Amit, 2016).
Moreover, the developer’s ultimate goal is to make the use of blockchain technology invisible to the end user. Blockchain technology can become yet another layer added to various products and services in order to provide more functionality and security, while saving resources and developer man-hours (Amit, 2016).
Bitcoin and blockchain technology are certainly in practice and are viewed by some developers as the next frontier. Therefore, any investments on bitcoin and blockchain technology applications could prove profitable in the long run. In fact, blockchain may even replace law contracts and written agreements with computer code in the long run (Graham, 2016). Both, Bosch and IBM, are looking into ways of harnessing blockchain technology as part of their Internet-of-Things (IoT) development programs (Amit, 2016). Soon Microsoft made its original bitcoin announcement, the company said it was also interested in the technology behind bitcoin for distributed, connected devices (or IoT devices). Moreover, Samsung is on board as well, and presented its blockchain tech at CES 2015, alongside IBM.
Challenges in Adopting Blockchain Technology:
Blockchain technology has the potential to revolutionize financial transactions but companies will have to overcome several challenges in order to experience any benefits, according to industry experts (Graham, 2016).
“The challenges of legacy infrastructure will be the main obstacle. This is coupled with the challenges of technical understanding — the practicality of implementing decentralized cryptosystems falls outside of the traditional IT development skill-set,” (Michalic, 2016).
Market researcher TABB Group has also identified several challenges facing different sectors of the market, which it describes as “insurmountable,” in a report published earlier this month.
“While some issues are significant to particular market slices, they may be non-issues for others, and things that may appear easy from the outside, may actually be very challenging,” said Larry Tabb, CEO of TABB Group in a press release.
“For example, streamlining the allocations process may appear simple from a brokerage or custodian perspective, but problematic for investors; conversely, clearing and netting is a non-issue for investors while challenging for banks and brokers” (Graham, 2016).
Additionally, Amit, the Co-Founder & Chief Curator of Let’s Talk Payments, has mentioned some of the key challenges in adopting blockchain technology in capital market which are as follows:
1. High Standards of Technology: High standards need to be set for the security, robustness, and performance of blockchains. Integration with existing non-blockchain systems such as risk management platforms will also be a requirement in the near future.
2. Upgrading of Regulation and Legislations: New regulatory principles need to be integrated in order to make blockchain technologies an integral part of the market infrastructure.
3. Standards and Governance: Industry alignment will be required on certain design point, such as: whether systems are completely open (as with Bitcoin) or use permission-based access requirements; the principles for suitability in interacting with the ledger; and the interoperability between different networks, which may potentially run different consensus protocols and safeguards against coding errors, thus creating unforeseen knock-on effects.
4. Managing Operational Risk of Transition: Operational risk needs to be minimized. This move will require a quick recovery of participants to revert to the traditional ecosystem as a fallback.
Amit (2016). How Blockchain can help Public and Private Stock Exchanges? (Part 2). Article retrieved from https://letstalkpayments.com/how-blockchain-can-help-public-and-private-stock-exchanges-part-2/
Amit (2016). 12 Companies Leveraging Blockchain for Identification and Authentication. Article retrieved from https://letstalkpayments.com/12-companies-leveraging-blockchain-for-identification-and-authentication/
Graham, L. (2016). The challenges of using blockchain technology. Article retrieved from http://www.cnbc.com/2016/02/29/the-challenges-of-using-blockchain-technology.html
Hajdarbegovic, N. (2015). Blockchain Technology Explained: Powering Bitcoin. Article retrieved from https://www.toptal.com/bitcoin/blockchain-technology-powering-bitcoin
Libert, B., Beck, M., and Jerry (2016). How Blockchain Technology Will Disrupt Financial Services Firms. Article retrieved from http://knowledge.wharton.upenn.edu/article/blockchain-technology-will-disrupt-financial-services-firms/