Blockchain’s evolution in Banking
What if we could do transactions on the Internet and know that hackers can never get our personal information?
What if we could do business with each other and not need a bank?
What if we could buy a house and eliminate the fees and paperwork with a single transaction?
These are some of the scenarios being promised by Blockchain technology. There has been a lot of talk about Blockchain and most of the discussion has hailed the technology as the most revolutionary since the invention of the Internet. It is an exciting technology that has very specific use cases in multiple industries. But not everybody will use the public Blockchain, for example, banks are planning to use private replicas of the technology, R3 (R3 press release), rather than the original Blockchain that underpins Bitcoin.
A quick overview of BlockChain
Most people have heard of Bitcoin and understand it is a ‘digital currency’ that has gained in popularity in the last few years. There is an ongoing debate as to the long-term viability of Bitcoin, according to a recent post by one of it’s core developers (Mike Hern, The resolution of the Bitcoin experiment), however what is not in dispute is that the technology that makes Bitcoin possible is Blockchain.
Almost all transactions today are recorded in some kind of ledger or database, usually within the systems of the company we are doing business with. The Bitcoin Blockchain uses a new distributed bookkeeping system, where every node in the network maintains its own identical copy of the ledger. The ledger is completely transparent and all transactions are recorded and confirmed anonymously. It’s a record of events that is shared between many parties and once information is entered, it cannot be altered. The anonymity and security of these transactions is achieved through encryption.
Effectively the distributed ledger is a network of encrypted ledgers that are synchronized to make sure there is always only one version of the truth.
Is it all about trust?
The internet has transformed the entertainment, transportation, and communications industries to name a few. Most of this transformation has been driven by the introduction of technology that eliminates legacy business processes that can now be done cheaper and more efficiently online. Today we have to trust that the entities we deal with are telling us the truth about our transactions with them and that our data on their systems is secure, whether it’s your banking, online purchases or even your health records.
Companies like Facebook, EBay, Amazon, Apple and Uber make money because, at the core of their business model, they keep all our information stored in centralized private data pools and intermediate every transaction.
A major issue with the digital economy is trust. We have seen companies struggle with cyber intrusions and subsequently our trust in their ability to keep our information safe has diminished. It is these very businesses that depend on centralized private data collection, that are vulnerable to disruption when Blockchain powered alternatives emerge.
With the Blockchain in place to act as a trusted authority, we can circulate currency securely on our own and transact directly with counterparts without an intermediary storing our data and charging fees for processing. Decentralized protocols (Blockchain) with crypto currency (Bitcoin) will change how we execute these transactions and will have a transformative effect on many industries. They will do this by creating common, decentralized data sets to which any one can plug into enabling the peer-to-peer transactions.
Use Case: Capital Markets Clearing and Settlement
There are many impediments to industry wide implementation of Blockchain that will have to be overcome, most of which is not technology but business and regulatory related. In the case of T+0 settlement for example, the Boston Consulting Group (BCG) 2012 report Cost Benefit Analysis of Shortening the Settlement Cycle, is a good case study of how complex the financial system is. A combination of regulation, industry resistance, legacy system integration and lack of compelling return on investment has stalled an effort that everybody intuitively believes is the right thing to do. It also highlights the simple fact that sometimes even though the technology is available, to solve industry problems, it takes time to move the industry to adopt it. (Shortening the settlement cycle the move to T+2).
Blockchain usage in financial services will be complex, a mixture of public, private and consortium Blockchain technologies as discussed in Vitalik Butyrin’s article: On Public and Private Blockchains. The key to which one is most suitable depends on what attributes are most important to the business driving the solution. As Vitalik points out in his article “A fully private blockchain is a blockchain where write permissions are kept centralized to one organization. Read permissions may be public or restricted to an arbitrary extent. Likely applications include database management, auditing, etc internal to a single company, and so public readability may not be necessary in many cases at all, though in other cases public auditability is desired.”
A case in point is the recent announcement by the Australian Stock exchange to implement a new clearing and settlement system for equities which will use the startup Digital Asset Holdings blockchain system..
I believe that block chain will be impactful in the financial services industry in the long term and the impact will be very focused and driven by specific business needs.
Christopher Giancarlo (Commissioner of the Commodity Futures Trading Commission) gave a lecture at the Harvard business school in December 2015 where he outlined a number of areas that will transform financial services in the future. He spoke specifically about Blockchain
“Distributed open ledgers have the potential to revolutionize modern financial ecosystems. Unlike current settlement processes, distributed ledgers use open, decentralized, consensus-based authentication protocols. They allow people “who have no particular confidence in each other [to] collaborate without having to go through a neutral central authority.” Distributed ledgers will have enormous implications for financial markets in payments, banking, securities settlement, title recording, cyber security and the process of collateral management that is made infinitely more complex by new regulations. Open ledgers may make possible new “smart” securities and derivatives that can value themselves in real time, automatically calculate and perform margin payments and even terminate themselves in the event of a counterparty default.”
Adoption of blockchain will take a very specific set of circumstances to allow markets, participants and countries to migrate their data standards, processes and systems to the new technology. In the case of the Australian exchange they have a captive market, since they are effectively a monopoly that can dictate the data standards, technology and schedules. That’s why blockchains have the greatest chance of success in areas where the world has not already agreed to a central counterparty for clearing and settlement.
Finally I think that Blockchain will evolve to meet the specific business and regulatory challenges and the transformation will eventually change how banking is done globally. I will address specific solutions that are being proposed in the banking industry in a follow up post.
Thanks for reading
Best regards: Norman King
If you enjoyed this article, please hit the like button; leave a comment or share with your network. Also, please check out my other posts here. Available for consulting, advisory and speaking engagements. email: normanking@brook-port.com
Reference:
PwC’s 3 Predictions for Blockchain Tech in 2016 — CoinDesk
https://bitcoin.org/bitcoin.pdf
open-assets-protocol/specification.mediawiki at master · OpenAssets/open-assets-protocol · GitHub
NASDAQ is using Open Assets — Coinprism Blog
Coinprism Blog — Bring the color to your Bitcoin wallet
Openchain — Blockchain technology for the enterprise
The W3C’s Mission to Standardize Web Payments | Ripple
www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/feb/BlockChain-In-Capital-Markets.pdf
Euroclear: You Don’t Need a Blockchain to Fix Securities Settlement | Ripple
Startup Management » The Ultimate List of Bitcoin and Blockchain White Papers
Joel Monegro — The Blockchain Application Stack
www.blockstream.com/sidechains.pdf
Block Chain 2.0: The Renaissance of Money | WIRED
www.ust2.com/pdfs/ssc.pdf
T+2 Settlement
Images are from Pixabay.com,
