Blockchain technology has been a hot topic in the finance world for the past year. In order to keep abreast of current trends in the financial services industry, it is critical to understand how the technology works, who the big players in this new industry are, and how this new implementation is at odds with the technology’s original culture.
Brief explanation of blockchain technology
In simplest terms, the blockchain is a means of storing information in a public ledger so that transactions between parties can be verified. Each time Bitcoin is sent and received, the time-stamped transaction is recorded in a set of transactions called a block. Every transaction must be digitally signed using a private key, which serves a similar function as a pin number. Each block is created as a result of solving a mathematical equation called a hash function. The people solving these hash function equations are called miners, and for each block they create they receive a per-block reward as well as the fees offered within the transactions themselves. Each block contains the hash from the previous block, which links the blocks together, forming a chain. Each node (computer connected to the Bitcoin network) contains a copy of the blockchain, which allows new information to be recorded in each node and broadcasted to other nodes. The value of this is that it does not require outside verification to validate a transaction. With every party having full information of all previous transactions, there is theoretically no need for a regulatory authority. Furthermore, the hash function becomes more difficult to solve over time as an automated means of hedging against inflation in Bitcoin.
Why firms are interested in it, and who are the big players
Many Wall Street firms are interested in the application of blockchain technology to streamline the administrative process of complex financial transactions while also automating trust in financial markets. Championing the charge, Blythe Masters, former head of global commodities at J.P. Morgan, key player in the development of the credit-default-swap, and current CEO of Digital Asset Holdings, sees blockchain technology as a means of reducing the transaction costs associated with an array of financial transactions. Through their acquisitions of Hyperledger, Bits of Proof, and Blockstack.io, she and her partners at Digital Asset Holdings see the potential for private blockchains, separate from the Bitcoin network, to expedite the process of verifying syndicated loans, U.S. Treasury repos, and equity shares in private companies. Masters and JPMorgan have recently begun trialing the efficacy of blockchain technology by testing its functionality with respect to loans. So far, they are pleased with the results. Aside from Digital Asset Holdings, there are a plethora of companies applying blockchain technology to other areas of finance. The London-based firm Real Asset Co. has created their own gold-backed cryptocurrency called Goldbloc and are allowing their customers to record their bullion on the blockchain. The London startup Everledger is applying blockchain technology to diamonds and eventually other commodities like designer bags, fine art, and high end watches in order to combat fraud. Nasdaq is looking to the blockchain to create a system for trading shares. The San Francisco based firm Chain is creating tools that allow companies to use the ledger to exchange virtually anything, including airline miles. With blockchain technology disrupting the financial services industry, the possibilities appear endless. However, it is important to consider how these applications deviate from the roots of Bitcoin.
How it’s at odds with the reason Bitcoin was invented in the first place
Beyond the hype surrounding the blockchain and its industrial applications, it is critical to be reminded of the fundamentals on which Bitcoin and blockchain technology were created in the first place. In the blockchain’s recently heightened publicity, the principles of Bitcoin are rarely discussed. One of the biggest selling points of Bitcoin is that it is a decentralised cryptocurrency, free from the political pressure of traditional currencies and central banking authorities. It is a currency designed to replace financial institutions with peer-to-peer networks. This cultural identity of Bitcoin is important; it is a culture of transparency and collaboration that embraces the use of technology. This appears to be at odds with the perceived culture of the financial services industry, whose major profits have historically stemmed from the exploitation of asymmetry of information. Joi Ito, director of the MIT Media Lab, Chairman of the Board of PureTech Health, and board member of the Sony Corporation, New York Times Company and others, is concerned about the cultural disconnect between the Bitcoin core and those with a vested commercial interest in the technology. He defines the Bitcoin core as the small number of people who fully understand how cryptography, systems, networks, and code operate within the Bitcoin framework. It is comprised of the individuals who helped create the network and have a vested interest in it for its own sake. He argues that there is over investment in the Blockchain space with less communication than there should be between between the creators and investors. This communication gap is discouraging developers, leading them to drop out, which severely undermines any potential that blockchain technology may have. Without the Bitcoin community, blockchain technology could devolve into an iteration of the current transaction system, lacking the trustless networks and decentralisation that characterise it. An open discourse between the original developers and those seeking commercial applications for the technology is critical.
Collaboration is key to the successful use of blockchain technology
While the innovative application of blockchain technology to the financial services industry is excitingly disruptive, it is creating a rift between the original developers and those just now seeing the merits of the blockchain. It is imperative that these two groups communicate clearly to resolve these tensions so that the potential gains from this innovation can be realised.