Blockchain is one of the buzz words of 2016. By the financial industry, blockchain is seen as the future. Its impact is compared to how internet has revolutionized the computer and global communications, like nothing before. Especially, financial parties seem to be investing in blockchain and the potential advantages this technology may offer to them. Undoubtedly many know what blockchain is all about. But probably even more don’t. This article is aimed at the latter. In order to help understand what this “buzz” is all about, blockchain is demystified in four consecutive parts:
Part 1. What is blockchain?
Part 2. Transparency, Security and Governance.
Part 3. Thoughts around the regulatory environment on blockchain.
Part 4. Impact of blockchain on the financial sector.
Extra. Impact on Corporate Treasury
Part 4. Impact of blockchain on the financial sector.
When we say blockchain, we are not talking about Bitcoin. Agreed, Bitcoin is probably how most people heard about blockchain to begin with, but blockchain and Bitcoin are not synonyms. Bitcoin is a cyber-currency. Blockchain is the underlying technology that provides trust, transparency and efficiency in the exchange of practically anything. According to the experts blockchain technology will have a profound change in how the world works, more or less to the extent of how internet changed the world.
Blockchain is technology that creates the digital foundation that offers trust due to traceability and real authenticity. By adding things like trade finance, anti-money laundering, identity management, KYC (know your customer) and tracking, this digital foundation will be strengthened even more. But there will be some key principles that go in place to make this happen, there will need to be governance, there will need to be standards. Blockchains will have to be immutable, meaning, you can’t change them, you can’t delete them. Only permissible transactions can be done. It is similar to how the World Wide Web happened, it’s why things and standards like HTML came about and platforms were created.
The idea of a blockchain will also be part of financial institutions’ digital foundation. According to the experts this will happen in a disruptive way. Age old established business models and the way financial institutions conducted business for decades and decades will change. Banks historically have always been the systems of record. They have been the financial ledger for everything that happens in terms of economic activity around the world. Because blockchain works on an open ledger concept where each of the participants can self-authenticate and do transactions, blockchain disintermediates banks. Redundancy of the middleman creates and enables a very different level of economic activity where you can have real time payment, self-authenticated, all across the world. It truly takes away the heavy lifting that banks have to do in the middle and back-office process for the next five or ten years. The way banks function and the way blockchain will propagate are going to fundamentally disrupt the traditional financial services landscape.
But blockchain brings opportunities too. Other than disrupting or disintermediating whole parts of banking, the technology could be used to improve the infrastructure of banking in general. One of the core functions of banking, making payments between accounts, could however be disrupted by Bitcoin and other digital currencies. Whether or not this will occur needs to be seen. Transferring Bitcoins using blockchain is done instantly, without an intermediate clearing house, securely and at a fraction of the cost. However at both sides of the transfer of Bitcoins (where money is put into the system – Bitcoins bought, and where money leaves the system – Bitcoins sold) banks still play a role. Bitcoin doesn’t seem to be able to replace the traditional fiat currency systems. However if central banks were to make a national currency a truly digital currency, in that case the record of who holds the currency, would be part of a global ledger.
Most of the focus of banks related to blockchain, has initially, understandably, been in the area of payments. But the settlement frequency needed for payments (tens of thousands of transactions per second) settlement in the blockchain is still a major concern. Much more is expected of technology being smart enough to execute business logic, making it possible to manage complex situations through smart contracts. This can then be used for many of the banks’ processes.
The following video explains this very well. Please excuse me for introducing an ING commercial, but as the Chinese say: one image is worth a thousand words. (Click here)
If blockchain poses a threat to banks, why are they so excited about it? What is the great irony? Banks want to use blockchain technology to beef up security and make their processes more efficient. Agreed, Bitcoin found a way to eliminate the role of banks in transactions. However, where any digital currency interacts with the physical world, banks still seem to be indispensable. Admittedly, Bitcoin has brought forward regulatory concerns and bad press. But let’s be clear, Bitcoin is not blockchain. Blockchain is this new technology that enables movement of assets. And since banks historically have always been the financial ledger for everything that happens in terms of economic activity around the world, no wonder they are exited. But a threat (if any) is not limited to just banks. Any and all conventional way of recording and transferring anything of value is in the crosshairs. For now we should see blockchain as something that will change the way we go about our daily life (like internet has). But exactly how, is difficult to predict. The landscape is still evolving at a rapid pace. Eventually a new balance will be struck.
Coming up in the last post:
Due to feedback received, this series of originally four, will be expanded by a fifth part. Some would call this agile. In this last part, we take a closer look at the areas of concern to Treasury.