Will new kid blockchain revolutionise financial services?

Blockchain has been hailed as a radical technology that will forever disrupt the way we share data to buy, sell and verify the authenticity of everything in the world, from property titles to carbon credits. Combining the openness of the internet with the security of encoded information, enthusiasts praise its potential cost savings, efficiency and security improvements and profit maximisation. Doubters warn the leap from small-scale experimentation to widespread adoption is too difficult and costly, especially across borders. Should we be preparing for drastic transformation or waiting and seeing? Is blockchain the future or a fad? Here we examine what it is, how it works and consider the feasible benefits and risks.

Blockchain was developed in 2011 to support the digital currency Bitcoin but it’s important to distinguish the two as separate entities. As with any innovative technology, acronyms and tech speak abound and blockchain is a type of DLT, distributed ledger technology. MIT has a glossary of blockchain jargon which is useful. Fundamentally, a blockchain is a record of transactions akin to a traditional ledger. It needs to achieve two things:

  1. To gather and order data into blocks
  2. To chain them together using cryptography (coding)

It can log money, goods or data movement and allows multiple parties to share access to the same data virtually instantaneously. It stores and distributes information so it’s practically impossible to add, change or delete it without other users’ detection. A time stamp applies to each piece of information in a block and to every completed block so all information is sequential and duplicate entries can be avoided.

Traditional systems verify transactions centrally through authorities such as governments or credit card clearing houses; in blockchain or distributed systems verification is decentralised and comes from the consensus of multiple users. Legacy system transactions take longer and cost more because each party maintains their own data; multiple and sequential data authentication models apply so there are numerous points of failure. In contrast, blockchain enhances procedures so reconciliation is integral to the process and real-time, thus reducing friction. It is a simple, paperless way to establish ownership of money, information and objects.

The ‘hash’ drives blockchain’s security: a unique string of virtually unforgeable characters or digital fingerprint that’s generated from each block’s information. The hash from one block feeds into the data in the next so any attempt to alter completed blocks immediately shows up in the chain. Every participant can view the entire blockchain and can instantly detect if there’s a hash mismatch. This transparency has earned blockchain the reputation as a shared source of truth or, as Goldman Sach’s CEO Lloyd Blankfein puts it, “the technology of trust.”

So, just hype or have tangible benefits already left the starting blocks? Accenture estimates investment banks spend around two thirds of their IT budgets supporting legacy back-office infrastructures. It joined forces with benchmarking firm Mclagan in 2017 to conduct an impact analysis of blockchain and their forecasts included:

  • Finance reportingcosts could shrink by 70% through optimised data quality, transparency and internal controls
  • Compliancecosts may fall 30% to 50% following improved auditability of transactions

The potential impact on human capital is vast and the technology has already shifted from proof of concept to use case applications in financial services. Deutsche Bank posted net profits of $146M in Q.1 2018, meaning each of the 97,000 employees generated approximately $1,505 in revenue. In the same period, cryptocurrency exchange Binance recorded $200M profits, so the estimated 200 employees each made $1M.

In February 2020, Goldman Sachs and Citi conducted a historic transaction: the first equity swap on blockchain and significant effects are already evident in the capital market space. A London Blockchain Summit in February addressing the technology’s impact on financial services revealed Standard Chartered joined with UnionBank of the Philippines and used securities tokenisation platform Bitbond to issue a $185M bond last December. AXA’s Head of IT Strategy, Andra-Maria Maute, predicted the likely influence Six Digital Exchange, the first regulated digital market infrastructure due this year in Switzerland, will have.

Considering the efficiency, cost and risk improvement opportunities the nascent technology promises, should financial service stakeholders be preparing to embrace its opportunities? It’s worth remembering the gap between its capabilities and stakeholder assurance that they work safely. A crucial question to ask first is whether blockchains are ready for business? Even the most established system, Bitcoin’s, can process only five to eight transactions a second currently. In contrast, credit card networks already service 10,000 times that volume so the challenges of scaling up can’t be ignored.

Further, although blockchain has vigorous security and trust at its core, no technology is 100% safe (hence its description as virtually unforgeable) and when large sums of money are involved, hackers will follow. The newness of the systems, lack of technical expertise and unfamiliarity with their processes may deter early adopters. Many will wait until satisfied their security concerns are unfounded. Clearly, reliable governance protocols that can be evidenced and examined will also be key, both to protect client assets and safeguard confidentiality. GDPR’s ‘right to be forgotten’ for data subjects will need attention and cross-border transactions will require regulatory frameworks tailored to the new processes which cater for divergent jurisdictions.

Pre-adoption, a proactive approach to the technology and understanding the regulatory practices that will best serve financial services are fundamental. Being part of the conversation to steer regulation, discuss relationship evolution between parties and agree standards will ensure protocols emerge that make sense.