Blockchain technology stands for a new generation of online transaction processing that provides trust, accountability and transparency while streamlining business processes. It’s a technology made famous by bitcoin, but its uses go much further. As Jamie Dimon said on CNBC, bitcoin is just a crypto-currency that goes nowhere, but blockchain is a proven, real technology.
With the help of blockchain, you can re-imagine the world’s most fundamental business transactions and open the door to inventing new styles of digital interactions. This technology has the potential to vastly reduce the cost and complexity of cross-enterprise business processes. The distributed ledger technology represents the easy way to create cost-efficient business networks where virtually anything of value can be tracked and traded—without requiring a central point of control.
This emerging technology is showing great promise across a broad range of business applications. It allows securities to be settled in minutes instead of days, and it can also be applied to help companies manage the flow of goods and related payments, or help manufacturers to share production logs with OEMs and regulators in order to reduce product recalls.
How does Blockchain work?
There is a network of computers whose role is to validate and keep track of bitcoin payments. The network records the payments and adds them to an ever-growing list of all the bitcoin payments that have been made.
- “The Bitcoin Blockchain” – A file named “The Bitcoin Blockchain” is a part of this process. It is resident on thousands of computers around the world. In this context, the word “blockchain” means “database” or even “list”. This file includes data about all the bitcoin transactions (that is, payments of bitcoins from one account to another) that have ever happened. Another name for this is a ledger, because it’s something like a bank’s ledger which keeps a record of payments between bank accounts.
- The bitcoin network – The computers that store this file also run software that keeps them connected over the internet to the other computers running the same software. This creates a network of computers that can talk to each other to relay information about:
- New payments;
- Updates to The Bitcoin Blockchain (every 10 minutes or so, a new “page” or block of valid transactions is confirmed and needs to be added to the files on all of the computers).
Bitcoin payment execution is followed by an instruction sent to the network. Then the computers on the network validate the instruction and relay it to the other computers. After some time has passed, the payment gets included in one of the block updates and is added to The Bitcoin Blockchain file on all the computers across the network.
- Peer-to-Peer (P2P) – The distribution of data works on a peer-to-peer basis, rather than client-server. Peer-to-peer can be described as a gossip network where everyone tells a few other people the news, and eventually the message gets to everyone in the network. This is completely different in comparison to client-server, which is more like a conventional organization where a boss tells subordinates the news, and the boss is the central point of reference—and potential failure. An advantage of P2P over client-server is that with P2P the network doesn’t rely on one central point of control which can fail.
Why does it matter?
“In lots of areas it looks like the blockchain will work, and it is easy to see how it could revolutionize finance.” – Rhomaios Ram.
When it comes to big banks, scrambling to modernize their often outdated IT systems in the face of pressure from regulators, digital challengers and cyber criminals, blockchain will certainly change a lot of things for the better. Blockchain technology has the ability to provide an unforgeable record of identity, including the history of an individual’s transactions. Insurers believe that its intermeshing records could prove highly useful in cross-checking an individual’s actions.
According to David Grace, global financial crime leader at PwC, the professional services firm, a secure distributed ledger could be used to store validated ‘know your customer’ data on individuals or companies.
The blockchain technology could also be beneficial for governments. They have already started investigating its potential: Honduras is using blockchain to handle land titles, while the Isle of Man has begun testing the technology with a registry of companies on the island. Longer term, a tamper-proof ledger could be used to hold medical records or develop transparent voting systems.
Blockchain in the future
Even if they understand its potential, many financial institutions are still trying to work out whether blockchain technology offers a cost-cutting opportunity or represents a margin-eroding threat that could put them out of business. Banks have developed many approaches in their search for answers.
Some of these are in-house models, such as Citigroup’s creation of Citicoin, a digital currency being tested in the bank’s laboratory. Some other firms have chosen to invest in a specialist: Goldman Sachs led a $50m funding round for Circle Internet Financial, which aims to use bitcoin to handle consumer payments.
One more way to test this technology has been to find a partner. Commonwealth Bank of Australia has teamed up with open source software provider Ripple to build a blockchain system for payments between its subsidiaries. In yet another approach, Barclays and UBS are working with blockchain start-ups through a technology incubator or accelerator program.
UBS funded a team of eight working in London’s Canary Wharf alongside start-ups and named it Level 39 incubator. The purpose of this collaboration was to investigate bond trading and the creation of its own currency, and this exposes a major problem that financial institutions are grappling with: whether or not membership in a distributed ledger network should be invitation-only, and therefore more controlled.
Bitcoin’s open source blockchain, also called a “permissionless” system, is decentralized and open to anyone. UBS and Microsoft are both working with blockchain start-up Ethereum, which uses a similar open source technology and allows for smart contracts that can execute trades automatically.
Most of the banks are very cautious because they are concerned about losing their grip over operations or upsetting regulators. They therefore see the future in closed, or permissioned-only, networks.
Some of the world’s largest banks, like JPMorgan, UBS and Barclays, have thrown their weight behind R3 CEV, a start-up venture, in order to set up a private blockchain open only to invited participants who between them maintain and run the network. This forms part of an effort to build an industry-wide platform to standardize use of the technology.
According to Hyder Jaffrey, head of the blockchain team at USB bank, this won’t be feasible with everyone working on their own. You can find about 300 technology start-ups, mostly in the US and UK, developing ideas on how to make blockchain work for financial services, according to PwC. Most of their founders are former senior executives at big banks, like Blythe Masters, formerly of JPMorgan and now leading the blockchain start-up Digital Asset Holdings.
There are some predictions that it will be between two and five years before real-world, practical applications emerge. The blockchain technology will have to overcome serious obstacles to be proven robust and secure, and it will also need to win regulatory backing.
There is an interesting Fortune video showing what blockchain technology could look like in the future:
Question of safety
“The question in the end is how safe is all of this and would you put your life savings on the blockchain? What do regulators and central banks do about it and can banks and regulators guarantee it?” – Mark Buitenhek
According to Vitaly Kamluk, principal security researcher at Kaspersky Lab, which advises clients on digital security, the decentralized nature of distributed ledger technology has yet to be reconciled with how such databases can be maintained cleanly and securely. He says that the problem of malicious actors can be quite easily solved with a centralized technology, but hasn’t been solved yet for decentralized architectures where each participant has equal rights and cannot enforce a sole decision.
The US Securities and Exchange Commission fined California’s Sand Hill Exchange $20,000 for offering trading in derivatives linked to private Silicon Valley companies, using the blockchain for settlement. The SEC ruled that Sand Hill was “illegally offering complex derivative products to retail investors.”
On the other hand, the Bank of England is studying the technology and said in a recent paper that “it may be possible in the future—in theory, at least—for the existing infrastructure of the financial system to be gradually replaced by a variety of distributed systems.”
Blockchain technology is already handling serious business. On an average day more than 120,000 transactions are added to The Bitcoin Blockchain, representing about $75m exchanged, according to blockchain.info. There are now 380,000 blocks; the ledger weighs in at nearly 45 gigabytes.
Despite the benefits and the already significant usage, only time will tell whether blockchain technology eventually becomes universally accepted in the world of finance. For example, it is not yet certain that the technology can be scaled up in an efficient enough way to meet the challenge.