Blockchain is a bit of a buzzword at the moment, with one independent research company describing it as a ‘game changer’ capable of saving financial institutions as much as $16 billion a year in back-office costs. It is also a concept that is surrounded by some mystery, confusion and quite a lot of hype.
So what exactly is Blockchain, who is using it and why?
Blockchain, first popularised outside of computer science circles by the crypto-currency Bitcoin, is a ledger, like an Excel spreadsheet, where records of all transactions from the beginning of time are maintained in linear chronological order. The transactions can’t be duplicated and don’t have to be authenticated by a central authority as authentication is done by distributed entities known as nodes. Participants interact with each other using pseudonyms, and their real identities are encrypted.
The ledger uses public-key encryption, which is virtually impossible to break, because a message can be unlocked only when there is a consensus among the group. The idea being, that this makes it more secure and removes the need for a central authority to approve transactions.
The term Blockchain is derived from the way transactions are stored. For example, every time a transaction takes place, the ledger automatically creates a new transaction record composed of blocks of data, each encrypted by altering (or hashing) part of the previous block. The cryptographic connection between each block and the next forms one link of the chain. This process compounds the mathematical difficulty of committing a successful fraud, because blocks of transactions, as well as individual transactions, are continuously validated. The algorithms also incorporate an ID for each buyer and seller in a transaction, adding those IDs to the block.
While Blockchain is currently best known as the technology behind Bitcoin, it also has the potential to be used for many other things. In fact, Wall Street wants to use Blockchain to simplify the way it processes transactions, which if effective, could eliminate a large number of back-office jobs and costs. (Hence the $16 billion, or 30 per cent, annual savings on back-office operations by 2021 predicted by London-based research institute Autonomous Research.)
Earlier this month JP Morgan said Blockchain has the potential to “change everything” as it announced the start of a trial project that utilises Blockchain technology. Together with New York-based start-up Digital Asset Holdings, JP Morgan is hoping to address liquidity mismatches in its loan funds and generally reduce the cost and complexity of trading.
The Financial Times cited Daniel Pinto, head of JP Morgan’s investment bank, as saying: “To sell a loan is a very cumbersome, time-consuming process; settlement can take weeks. It makes all the sense in the world to explore Blockchain’s potential to improve that process.”
JP Morgan’s decision to investigate Blockchain’s potential is confirmation that many people believe the technology has wide-ranging implications for the financial services sector. Last year Swiss bank UBS announced plans to open a technology lab in London to explore how Blockchain could be used within the financial services industry, and at the time, Oliver Bussmann, the bank’s group chief information officer, told Financial News that Blockchain had the potential to change not only the way the bank manages payments, but also to change the whole trading and settlement topic. He described Blockchain as the technology with the biggest potential to disrupt services and trigger “massive” simplification of banking processes and cost structure.
Deutsche Bank and Singapore-based DBS are already transacting with each other using Blockchain, and even the Bank of England has expressed support. Its Chief Economist, Andrew Haldane, reportedly said the technology has real potential and “on the face of it, solves a deep problem in monetary economics: how to establish trust in a distributed network.”
It’s not just the financial services sector that are showing an interest either. IBM and Microsoft are both making their own forays into the technology, with IBM introducing its own Blockchain-as-a-service, which is available to developers on the cloud.
Moreover, Sir Mark Walport, the UK’s chief scientific adviser, earlier this year released a report in which he advised the government to adopt Blockchain technology to run various public services, such as tax collection, benefits or the issuing of passports.
If experiments by the likes of JP Morgan, UBS and IBM are successful, it is possible that Blockchain could indeed become a game-changing force in any venue where trading occurs, trust is at a premium, and people need protection from identity theft. This covers a wide range of areas, such as managing public records and elections, healthcare, large-ticket purchases such as auto leasing and property, and of course, financial services.
Still, while the potential to process transactions with more efficiency, security, privacy, reliability and speed make Blockchain an attractive proposition, it is also an uncertain one, and we should be careful not to view Blockchain as an all-fixing panacea. Distributed ledger technologies are new, complex and prone to rapid change, making their performance difficult to predict.
In August last year, the Gartner Group said crypto-currencies, which are based on Blockchain, were part of a traveling hype cycle that, having passed through the peak of inflated expectations, was now headed for the trough of disillusionment. Meanwhile another research firm, Forrester, has advised enterprises to wait five-to-10 years before introducing Blockchain into their business operations because of the uncertainty around its future development.
After all, Bitcoin, once the apple of the technology world’s eye, is now at a crossroads after suffering a raft of problems, including the collapse of one its main exchanges, Mt. Gox. In addition, disagreements over the technology’s direction have prevented the code from being updated to allow it to cope with increased volumes, casting doubt over the ability of another Blockchain-based technology system being able to cope with the vast number of financial transactions that take place every minute around the world.
Then there is also the question of security. Is any technology unhackable, and if it is, are people not going to find other ways to attack it? After all, the failure of Mt Gox wasn’t the result of the system being hacked, rather that some individuals exploited a loophole that allowed them to request that the same transactions were carried out multiple times. It is definitely feasible that independently launched Blockchain networks could become susceptible to data breaches and the low hashing, or computer power, supporting the network could leave transactions and sensitive data vulnerable to attacks.
Mike Hearn, one of Bitcoin’s leading developers recently walked away from the Bitcoin project, describing it as a ‘failed experiment’. He said what was meant to have been a new decentralised form of money that lacked ‘systemically important institutions’ was now controlled by just a handful of people and was on the brink of technical collapse.
He described it as an experiment, adding that like all experiments, its creators knew it could fail.
In conclusion, there is no doubt that Blockchain is an exciting development that shows promise for many different industries, including the financial services sector. However, while there are significant potential benefits to applying the technology, doing this successfully is a challenge. Whether it can be done remains to be seen, but one thing is for certain – a lot of money will be spent trying.