Blockchain in Finance
The potential for blockchain in finance is significant. Blockchain has the ability to alter core finance functions from centralized administration to decentralized administration. This simple transformation has the most obvious impact of minimizing the importance of national and political borders on financial transactions.
The most famous blockchain implementation is called cryptocurrency – Bitcoin and Ethereum to name a few. The intrigue surrounding cryptocurrency is not without merit.
Imagine currencies with no central bank to determine the amount of currency in circulation. Or imagine governments having no ability to tell a bank to freeze an account due to compliance issues. Finally imagine the ability to buy and sell goods and services without consideration for exchange controls between your country and the country where the seller resides. Cryptocurrency implementations of blockchain enable financial transactions to truly be point to point.
To recognize the full impact of blockchain on the world of finance, we first have to understand what it is.
What is Blockchain
In the simplest terms blockchain is a distributed unchangeable database that carries with it transaction information from the previous transaction and transfers to subsequent transactions information which is then all stored in a ledger whose location is distributed amongst all members of the blockchain. The proper nomenclature in the technology world for something that is unchangeable is “immutable”. Effectively, this means that when we enter data into the blockchain, or database, it cannot be changed without leaving a trail that the data we entered has been altered or tampered with.
The particular beauty of blockchain is that it is not centrally stored or administered. Blockchain is a distributed database that is stored across multiple computers on a network. This provides the blockchain with a high degree of fault tolerance in addition to making the immutability (or unchangeability) of the database even more secure since changes would have to be agreed to across multiple nodes of the blockchain network, instead of in just one central location.
Tampering with the data or executing a fraud would require the agreement of a high percentage of the computers on the blockchain and would also require manipulation of the previous and subsequent records in order to ensure the ledger remains mathematically feasible.
Which brings us to …
The Transaction Ledger
A further feature of blockchain technology is the transaction ledger, which is both updated and synchronized across all the computers comprising the blockchain network. This feature democratizes the access to data residing in the blockchain because any member or participant in the blockchain network with the right access or authorization can view the entire transaction ledger without having to seek permission or be granted access from a central authority.
Smart Contracts
There are other features of blockchains that are relevant to the future of finance. For instance the concept of the “smart contract” which is most equivalent to the automated exercise of an option at a given strike price in finance. With smart contracts, a transaction is automatically executed and closed when previously arranged conditions are fulfilled from all counterparties. The simplest example would be the automatic release of funds from escrow to a 3rd party upon verifiable completion of a task – like conveyance of a deed with subsequent release of keys upon receipt of full payment for a real estate property.
Preparing for a Blockchain World
Blockchain has wide applicability beyond cryptocurrencies like Bitcoin and Ethereum, perhaps the two most well-known cryptocurrencies. Blockchain can save time, money and help businesses and governments alike operate more efficiently.
Blockchain applications are currently used in the following ways:
- Secure medical data transfer
- Tracking of music royalties
- International payments
- Secure personal identification
- Anti-money laundering and anti-fraud
- Supply chain validation and monitoring
- Real estate transaction processing platforms
- Validation of authenticity
- Secure voting mechanism
This is certainly not an exhaustive list but provides a glimpse into the scope and range of applicability of blockchain technology in industry.
How Blockchain Can Apply to Banking and Finance
Many financial and banking institutions have deployed proof of concept blockchain applications.
The Australian Securities Exchange (ASX) is currently developing one of the world’s first blockchain use cases. They are building a blockchain based post-trade system to replace their current 25 year old Clearing House Subregister System (CHESS).
China has announced blockchain as a technical priority and as such they are encouraging their financial sector to adopt the technology to create a new generation payment infrastructure capable of leveraging the unique features of blockchain.
The significance of these technological advancements are two-fold:
- Blockchain is here to stay
- The transparency and decentralization inherent in the technology will give rise to cost savings, transactional security, and speed inducing efficiencies that will be tough to ignore once deployed by a few key players in the banking and finance industries.
The Importance of Blockchain
At minimum, financial services executives should have knowledge of the technology and how the implementation of it within their competitive landscape may impact profitability and threaten or enhance their market share.
It is not an over-exaggeration to view the dawn of blockchain technology as a disruptive force akin to the impact the internet has had on the financial services and other industries.
When faced with such a technologically impactful market entrant, the best approach is knowledge and preparation.