Blockchain Technology - The Next Disruptive Computing Innovation

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Yamini Kona has around 15 years of experience in Financial Services. She comes with a strong research and business analysis background and has authored various case studies and thought papers in the past.

Blockchain is not just for crypto currencies

Blockchain technology, invented by Satoshi Nakamoto in 2008 to launch Bitcoin transactions, is the latest buzzword in Tech universe. It’s being touted as the next major disruptive technology in computing world, in the same class as personal computers, Internet and social media. The still nascent technology is expected to bring sweeping changes, especially in finance, by establishing a trustless system eliminating intermediaries, achieving money and asset transfers in almost real-time with tamper-proof record maintenance system.

Blockchain today is a sophisticated software protocol on its own, going beyond cryptocurrencies. However, how this revolutionary technology works and its potential for financial services is still a grey area for many.

Blockchain is so called because Bitcoin transactions are stored as ‘blocks’. When a Bitcoin is created or changes hands, a new transaction record gets created comprising blocks of data about transaction request, authorization, execution, sender and receiver. All blocks are linked via an encrypted algorithm creating a chain and, hence, the name Blockchain.

It’s distributed because instead of a central database, records are distributed across all participating network member computers. Entire network collectively creates, approves the transactions and maintains the records. Thus, encryption and decentralization are the heart and soul of Blockchain technology.

What’s unique about the working Blockchain Technology

Unalterable encryption of records in a transparent distributed ledger is the unique value proposition of Blockchain technology. Each transaction block is encrypted by creating a unique ID for the buyer and the seller and adding those IDs to the block. Each consecutive new block in the transaction network is linked to the previous block by hashing part of the previous block. The ledger grows as new blocks are created in a linear and chronological order, each linked to the other via encryption process. Entire transaction history is digitally recorded in these encrypted blocks.

Data in each block is continuously validated by all network members and a transaction is approved only upon mutual consensus of all. Once a transaction is committed to the ledger it becomes unalterable and effectively tamperproof since it requires the consent of each participating computer in the network. The mathematical difficulty of tampering the unique IDs encrypted into each block in the chain makes Blockchain immune to fraud.

By entrusting validation responsibility to entire network, distributed ledger completely eliminates the role of a third party central bank or a clearing house which is crucial in traditional payment structure. Since there’s no need for a third party validation, there’s no T+n process (trading day + number of days needed to complete the transfer of ownership in a traditional trading system) and asset ownership can move immediately after the transaction is approved by Blockchain protocol.

While records are open to entire network, transacting parties are anonymous and usually pseudonyms. Transactions records are created and maintained without personal information of transacting parties. That’s why it is called ‘trustless’ system.

In short, the five distinguished differentiators of Blockchain technology packing a powerful punch are: - Decentralized or distributed bookkeeping - Total digitization of records - Absence of intermediary - Untamperable records and - Near real-time transfer

How Blockchain technology can be leveraged in Financial Services

A secure, fraud resistant system coupled with speed and efficiency can revolutionize the way financial industry does business in an age of money laundering and cybercrimes. Especially if achieved via a mass-collaborated, encrypted distributed ledger instead of intermediaries charging hefty fees.

Tens of thousands of banks across the world use more or less the same traditional system – transaction databases maintained separately, in-house. Blockchain promises the vision of all banks hooking up to one distributed ledger. Same goes for securities trading firms, underwrites, stock exchanges and insurers. Blockchain can be a true game changer if financial institutions can get rid of individual networks by adopting a near universal distributed ledger. To name a few mind-boggling potential benefits:

  • Unalterable digital records simplify KYC and identity theft management
  • No scope for redundancy or reconciliation problems since blockchain processes each transaction only once
  • Trade settlement can be T+0 instead of T+3 to T+1 for stocks, bonds etc.
  • Faster settlement means banks don’t need to hold huge cash reserves or other collaterals against settlement risk
  • Immediate settlement cuts down the impact of inflation and currency fluctuation risks
  • Loans can be underwritten the same day instead of waiting for weeks
  • Unbanked population can avail financial services like bank accounts and loans by establishing their credentials on the strength of being part of a distributed ledger
  • An immutable ledger ensures stricter auditing and regulatory compliance

A proven success with cryptocurrencies, Blockchain is no longer a theoretical concept in finance either. Many leading firms are investing in in-house Blockchain laboratories and partnering with technology start-ups to explore the possibilities.

  • NASDAQ successfully executed a private securities transfer in December, 2015 via NASDAQ LINQ, an in-house distributed ledger
  • Citi Innovation Lab developed 3 internal blockchains for payments and trading applications
  • UBS opened a Blockchain research lab in London in April, 2015
  • In April, 2015, PayPal and ebay announced that they will accept Bitcoin payments. PayPal partnered with CoinBase, BitPay and GoCoin whereas ebay partnered with Braintree
  • R3, a New York based Blockchain technology company, started a consortium in September, 2015 to research into Blockchain usage in finance sector. Starting with 9 big players such as Barclays, Goldman Sachs, JP Morgan, UBS, BBVA, Credit Suisse, Royal Bank of Scotland, State Street and Commonwealth Bank of Australia, the consortium is now 42 member strong which should speak for the growing interest and confidence of financial majors in the potential of Blockchain technology.

Blockchain adoption by Finance industry will be gradual and cautious

Blockchain will not replace the traditional structure any time soon due to numerous valid reasons.

  • Global blockchain to become a reality, all or majority must join the same network which will not happen overnight
  • Apprehension due to lack of regulation
  • Since blockchain records are transparent to the network, financial organizations, or even customers, will not be comfortable opening the books to everybody
  • Banks, underwrites and brokerages earn sizeable fees as intermediaries. They not only have to sacrifice this income but also must invest in new technology
  • Bitcoin got hit by scandals such as Silk Road (online illegal drug market) and Mt. Gox (Tokyo-based Bitcoin trading exchanging closed and filed for bankruptcy due to missing assets). These incidents highlighted the importance of trusted position held by financial organizations as intermediaries validating the authenticity of monetary transactions.

Given this, an intermediary free financial world may still be a long way to materialize. While breakthrough benefits of Blockchain seem too good to ignore, it is still too new and is gaining entrance into finance world only at an experimental level on chosen pilot projects. First phase of implementation will come in the form of successful experimenting with internal networks. Next phase may extend to connecting to a proven and secure external network governed by set standards and regulation where all major players may partner to transact via distributed ledger. Even then, banks will not immediately replace the existing payment systems but will augment the internal systems by connecting to industry wide distributed ledger.