If recent forecasts from the World Economic Forum (WEF) are to be believed, blockchain – the technology behind bitcoin – is set to become “the beating heart of the financial system”.
But some in the industry might not be entirely clear about what blockchain even is, let alone the impact it could have on how banks do business.
Read on to find out a bit more about this technology and its significance for the financial services industry, now and in the future.
A blockchain refresher
Blockchain is the technology that allows bitcoin, the digital currency launched in 2009, to function. It’s essentially a database that serves as a public ledger of bitcoin transactions, giving users of the currency the ability to connect to a particular network, conduct transactions and create new blocks.
Blocks are added to the chain in a linear, chronological pattern and each block contains batches of individual transactions, along with a timestamp and a link to a previous block. The database uses cryptography to ensure that each user can make changes to the ledger securely, without the need for a central authority.
One of the ways that the blockchain system functions in financial services is by allowing the various parties involved in a particular transaction to reach agreement without the potentially costly and time-consuming process of going through a middleman, such as a central clearing house. Each bank included in a particular network is given a copy of the blockchain ledger and uses a shared system to communicate with other participants and reach an agreement on the transaction.
Just how important is blockchain?
According to the WEF, blockchain has the potential to “profoundly alter” the way banks conduct their business worldwide, partly by reducing operating costs and making financial services more secure and accessible. The technology could improve regulatory oversight and offer better protection against financial bubbles, while consumers could benefit from lower fees.
The report predicted that “bread-and-butter” activities of financial institutions such as international payments, wire transfers, repackaging of mortgages and compliance reporting to regulators could all be replaced by blockchain.
However, it also noted that some of the biggest effects of blockchain innovation are likely to be “hidden” – new processes and architecture, for example, rather than “radical fintech innovation” or new currencies like bitcoin.
Giancarlo Bruno, head of financial services industries at the WEF, said: “Rather than stay at the margins of the finance industry, blockchain will become the beating heart of it. It will help build innovative solutions across the industry, becoming ever more integrated into the structure of financial services, as mainframes, messaging services and electronic trading did before it.”
It’s important to note that there are some significant obstacles for blockchain to overcome before it becomes a widely accepted part of the global financial system, one of which is the need for enterprises to agree on common network protocols and technologies to ensure the system can function. The WEF acknowledged in its report that collaboration between competing financial institutions is key if blockchain is to overcome its early challenges.
The Wall Street Journal noted in its CIO Journal blog that there are ongoing concerns around security and privacy. Todd McDonald, co-founder of R3CEV, a consortium of companies working to implement distributed ledger technologies in global financial markets, said there are unanswered questions about how to keep certain details of transactions private, while sharing the necessary information with network participants to enable them to verify the trade.
Rob Galaski, a partner at ‘big four’ accounting firm Deloitte, said the transformative potential of blockchain is beyond doubt, but also stressed that it shouldn’t be seen as a “blanket cure for inefficiency in financial services”.
“At this stage of evolution, the critical task is knowing where to focus your efforts,” he noted. “Blockchain will have the greatest impact when applied to business problems involving a shared repository of information, multiple writers, minimal trust, the presence of intermediaries and interdependencies between transactions. Without these conditions, blockchain may not be the answer.”