The Blockchain revolution
The next big thing in technology terms is already here – and it’s not big data or even AI. Blockchain is part of the next generation of the internet, and it’s something that can change the game for financial institutions, says FNZ’s Chief Digital Officer, Phil Goffin.
One of the great benefits of the internet is that it has democratised publishing and sharing information: if you want to know something all you need is an internet connection to reach millions of amazing resources within seconds.
As an author, when you use the internet to move or share information you are actually sending a copy of the information while retaining the original. However, when it comes to financial assets like money, stocks or bonds this model doesn’t work. It’s fine to use a printing press (or indeed a world wide web) to copy and share information, but it would break the financial system if we each have a printing press which can copy and share money. This is called the double payment problem – it’s something cryptographers have been trying to solve for a long time.
In fact, the first version of digital cash was developed 22 years ago by Nick Szabo, for the Netscape navigator initial integration. But the product didn’t make it because they couldn’t solve the double payment problem.
It turns out the system as it stands needs help, to establish trust, to verify identities, to clear and settle the transaction and to keep records. That’s where intermediaries come in and we turn to them for all these important functions. Intermediaries can take many different shapes and forms – banks, obviously, but increasingly digital conglomerates like Facebook, UBER, Apple and Google act as arbiters in the middle of online transactions. Whatever form they take, intermediaries add trust to the system, validating who the parties are as well as their ability to transact.
Blockchain is part of the next generation of the internet, and it’s something that can change the game for financial institutions.
Generally intermediaries do a good job, but they have limitations.
- Centralised systems are open to hacking or to attack or failure – we see this regularly in the news.
- Intermediaries tax the system, especially in financial services. For example, sending money across country borders can cost as much as 5-15% of the transaction’s value. But when was the last time you were charged to send a cross-border email? Both are simply data, so why the tax on payments?
- They continue to exclude significant chunks of the global population: over 2.5bn people can’t use financial services because they are outside the banking system.
- They are slow. Systems like SWIFT, automated clearing and other types of settlement systems are 20-30 years old and running on mainframes from the 70s and 80s – they’re older than most of our employees.
You can also argue that, thanks to our need to establish trust and identity online, intermediaries still capture an asymmetric amount of the value of commerce even more than they did in the pre-digital age.
But what if…?
What if global distributed platforms ran ledgers (essentially like spreadsheets), which were open to anyone with an interest; institutions, individuals, asset managers or servicing agents. Ledgers where not just information but anything of value like money, stocks, bonds, financial assets, titles and deeds to property, scientific discoveries, even votes in an election could be moved stored and managed privately and securely. Ledgers where trust was not established by an intermediary but by mass collaboration, clever code and cryptography.
In 2008, with the global financial system on the brink of collapse, an anonymous person or persons known as Satoshi Nakamoto authored a white paper called ‘Cash for the Internet’. They posed the idea of digital cash, or crypto currencies, a way to make peer-to-peer payments without using an intermediary.
Crypto currencies are based on a technology called Blockchain. For the first time in history, different parties don’t need to know or trust each other to complete a financial or business transaction. That’s because trust is native to the technology itself, rather than being in the domain of the intermediary. This is big stuff. In fact, The Economist claims Blockchain is one of the most important developments of the past 200 years.
Ethereum is a Blockchain started by Russian / Canadian college dropout Vitalik Buterin. Ethereum now has a market value in excess of $1.5bn.
How Blockchain works
In Blockchain, transactions are validated by a community (miners, in the case of this Bitcoin example) who commit resources to solve a problem and reach a consensus. They are then rewarded with new Bitcoin. Every so often the transactions on the network are captured into blocks. Once each block is validated it must refer to the preceding block in the Blockchain, and to every block all the way back to the beginning of time.
Blockchains don’t all look the same, but generally they start with a distributed ledger which doesn’t run on one computer or system but on every single system that has access to it.
Blockchains have smart contracts or software programmes that mimic the logic of the contract and do the enforcement and execution automatically. They also have payment mechanisms that compensate everyone regularly without the need for lawyers or escrow agents.
In financial services processes run like the Rube Goldberg machine – a whole bunch of complicated things happen and in the end a very simple task is completed. For example, tap cards in London taxis seem like a seamless transaction where value moves from you to the driver. But actually, a whole series of intermediaries: processing firms, the driver’s bank, your bank, the cab company’s bank, plus Visa or AMEX network are involved. The money takes 5-7 days to reach its final destination and incurs costs of anywhere between 2 and 10% of the final total (which is why the driver will always ask for cash).
This is an excellent example of the way the financial services system works – and of the problems that Blockchain could solve:
- authentication and attest to value
- transfer value
- store value
- lend value
- exchange value
- fund and invest
- insure value and manage risk.
Blockchain is the future. Its potential to reduce friction and costs within our industry is significant. Talk to us now to get ahead of the curve.
Phil Goffin is Chief Digital Officer at FNZ where he is endlessly fascinated by the potential of technology. With some of the members of the original Ethereum team, he is dedicated to sharing his Blockchain knowledge with clients. If you’d like to talk to him about Blockchain or anything else, please get in touch.