Blockchain Technology: What Will Be Its Biggest Bang?
Blockchain technology has been hailed as a potential “second generation of the Internet.”
A whole vocabulary has sprung up around it, with an emphasis on key words like distributed ledger, cryptography, and trust.
But what is blockchain, exactly?
It’s basically a database where recorded transactions are copied to a participating network of computers. Since the information is disseminated across multiple computers using sophisticated cryptography, it can be viewed by all those with access rights to the network. Once the data has been entered, the information cannot be modified.
That means we wouldn’t need confirmation from our bank to know that we paid our utility bill, and our utility company couldn’t claim it hadn’t received remuneration. Once we made the payment transfer, the information would stay on the network for people to see.
This is how blockchain establishes trust among all parties: Trust that is driven by technology.
In October, we asked CFA Institute Financial NewsBrief which area of fintech will bring the most significant changes to the financial services industry. Blockchain was the clear winner.
Although blockchain has enormous promise, it has yet to gain many entry points into the finance industry. So where is the technology most likely to be applied over the next five years?
For more insight into this question, we asked CFA Institute Financial NewsBrief readers what specific aspect of finance will be most transformed by blockchain technology in the years ahead.
Over the next five years, in which of the following areas of finance will blockchain technology make the most inroads?
Payments earned 50% of the 466 total responses. The World Economic Forum (WEF) report, “The Future of Financial Infrastructure,” listed the benefits of applying blockchain technology in global payments, observing that blockchain “enables the near real-time point-to-point transfer of funds between financial institutions, removing friction and accelerating settlement.”
Dubbed “The Internet of Value Exchange,” blockchain should yield tremendous efficiency gains once it achieves its potential, particularly in the realm of global payments. The increasing interest of American Express, SWIFT, and Visa suggests that the enthusiasm among our poll respondents is justified.
Digital currency was also a popular choice, receiving 23% of the vote. With blockchain as its underlying technology, digital currency requires no central issuing authority. Bitcoin, the most popular digital currency, is arguably the only example of large-scale blockchain implementation in finance today.
Although the concept of a currency that is not backed by the full faith and credit of a government may strike some as anathema, many central bankers are converts. The Reserve Bank of Australia (RBA), Bank of Canada, People’s Bank of China (PBOC), and the Bank of England are just a few of the institutions exploring its possibilities.
Capital markets drew 17% of the respondents’ votes. Quite a few blockchain applications fit within this category, digital assets and smart contracts among them. Digital assets are an extension of digital currency just as stocks and bonds are extensions of cash, albeit with extra conditions and features built into them. According to the WEF report, a benefit in the collateral process is that it “provides market participants with an improved line of sight into assets, enabling improved risk evaluation and decision-making.”
Smart contracts may be better known outside of finance. They are essentially contracts that self-execute according to agreed-upon criteria. This technology has many promising potential applications in finance. So why aren’t readers convinced? Perhaps it’s because payments and digital currency are more fundamental and well-known applications on which smart contracts and other technologies would be dependent.
Digital identity came in at 9%. Know Your Client (KYC) and credit ratings are two examples of how blockchain-backed digital identity technology can be much more efficient than the current practice. With blockchain, there is little need to check someone’s identification to open an account or to fill out the risk tolerance questionnaire that many regulatory authorities require before clients can open a securities trading or investment account.
Financial institutions can determine a potential client’s investment experience, risk tolerance, and other attributes through the blockchain, which as an added benefit, could help cut down on identity fraud. The credit rating business will likely be transformed as a result: Reliable credit histories could be available to all who need access to them. Of course, this raises potential privacy concerns, so technology solutions will have to be developed to allow users to safeguard their personal data.
How accurate will these predictions be? We’ll find out in five years, if not sooner.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
What puzzles me about bitcoin and distributed ledger technology is that the transactions are recorded across multiple computers/servers/processors, so that multiple users (those with access) can view to verify the transactions if they want to. Yet, it was often said that bitcoin was used to finance illegal activity because it was more difficult to trace than conventional payments.
Robert,
Great question. The answer lies in the fact that the trust established in the blockchain world is tied to the digital identities. Legitimate users have ways to connect the digital identities with themselves but the working of blockchain is not dependent upon that connection being made. Check out this article (https://www.wired.com/2016/03/must-understand-bitcoin-regulate/) for an interesting illustration.
As always, thank you for visiting our blog and leave your comments.
Warm regards,
Larry
Well written and have a great insight for future transactions. The concern is for developing countries, where sophisticated technology is yet to in place to guard their financial transactons. For example, the recent heist of Bangladeshi reserve from Federal Reseve Bank. And it is behind question that this countries have a great potential to depict a greater impact in world economy.
Anup,
With properly-implemented blockchain solutions, there should be fewer crimes such as the Bangladesh Bank heist. Although the world we live in today is still very far from there, whether one is in a or developing country. It is certainly an interesting angle to evaluate future developments.
As always, thank you for visiting our blog and sharing your thoughts.
Warm regards,
Larry
Hi Larry,
For this distributed ledger technology to work, it will need to make copies of the updated record on every server in the world. What are your thoughts about the issues of scalability in electricity usage to power and maintain those servers, power outage handling, and concurrent updates for frequent and rapid transactions? Thank you.
Hi Frances,
These are great questions. I am sure they are on the minds of many other readers as well so thanks for raising them.
There are a couple of issues that might be worth clarifying before we get into the specifics: First, although blockchain and distributed ledger are frequently used interchangeably, in reality they are overlapping but not identical comcepts; second, blockchain is a nascent technology that is still developing and there are many variations in its application, so it’s often difficult to make categorical statements about it.
There are few existing blockchain applications in finance, with bitcoin being the major exception. Based on what we know about bitcoin, the records are not replicated on every server in the world. There is also a distinction between open (public) and private blockchains, with the latter explicitly only available to people accepted into the network.
Transaction speed is a criticism often leveled against blockchain and it is probably a fair one for many of the applications being tested and in development. There is no evidence that suggests this won’t improve over time though, just like any other technology.
Power outage handling is probably in the plus column for blockchain. If some (less than half, to be exact) of the servers storing a particular record are experiencing power outages, people can still access and verify the record replicated on the remaining servers. A centrally administered system can be far more vulnerable.
Warm regards,
Larry
it seems Blockchain Technology is next big things for banking sectors. Thanks for great infomative article. May I know which technology used in Blockchain?
Mitesh,
If you are asking what technical skills are required, those who work in developing and implementing blockchain applications typically have degrees in computer science, although more and more professionals working in fintech are getting business training by enrolling in an MBA program or getting a CFA charter.
As always, thank you for visiting our blog.
Warm regards,
Larry
Thanks For Sharing this!