In part 1 of our Blockchain Technology series, we delved into the technology behind the blockchain and the various features that make this revolutionary way of sharing information unique. This was followed by part 2, in which we explored the real-world impact the blockchain could have on the healthcare industry.
In the third instalment of our series, we look at how the blockchain could disrupt banking and financial markets and transform the way these sectors operate.
The blockchain is an encrypted way of distributing information in a shared database. When new information is added to the database, every computer on the network is updated in real-time.
These characteristics of the blockchain make it an attractive technology for the banking and finance industry, who are beginning to recognise its potential as a comprehensive and accurate library of information on a decentralised, transparent and secure platform.
How can the blockchain be used in banking and finance?
Sharing information through a decentralised online platform is nothing new. It’s called the Internet, and we all use it. But when it comes to transferring value – for example, money – we’re usually forced to fall back on old-fashioned, centralised financial establishments, such as banks.
Even electronic payment systems, such as PayPal, generally require integration with a bank account or credit card. After all, it’s the banks’ role to keep our money safe and secure.
However, blockchain technology provides a safe, decentralised and transparent way to transfer data, information and money, giving us the intriguing possibility of eliminating the ‘middleman’, aka the banks.
It does this by fulfilling three important tasks that are traditionally carried out by the financial services sector: recording transactions, verifying identities and establishing contracts.
Recognising the potential of the blockchain, the banking industry is beginning to explore its commercial applications in order to take advantage of the technology as a safe, secure, reliable and relatively cheap solution for transferring money. Major banks, including Bank of America, Barclays and Morgan Stanley, have publicly spoken about their exploration of and involvement with the technology.
What are the key features of the blockchain that make it useful for the banking and finance industry?
It’s a distributed ledger of transactions maintained in a decentralised form
The Internet allows anyone to publish and distribute information to anywhere in the world. In a similar way, a blockchain allows anyone to send value anywhere in the world where the blockchain file can be accessed.
Each chain is an online database, stored in a distributed, peer-to-peer fashion among its users. The information on the blockchain is encrypted and protected using complex mathematical algorithms that can only be decrypted using private keys. If you possess the private keys required to edit a part of the blockchain, you also ‘own’ that part of the blockchain, and the value of whatever is stored there.
What that means is, if you give your keys to someone else, you effectively transfer the value of whatever is stored in that section of the blockchain. This is how Bitcoin works – keys can be used to access addresses that contain units of currency with financial value.
This satisfies the first of the three crucial roles that financial institutions play – the recording of transfers. The key difference is that using the blockchain to record transactions is a much cheaper alternative to employing staff to record transactions.
Because no one can edit a blockchain without owning the corresponding keys, it also fulfils the second key function of banks by establishing the identity of the user. The blockchain carries out cryptographic checks whenever anyone tries to edit the chain. If edits are not verified across the network, the changes aren’t accepted. Of course, the keys, just like gold or cash, can theoretically be stolen.
It should be noted that there are risks associated with the use of cryptocurrencies. The sector is prone to hacking, theft, scams and user error. For example, you might lose your private key or send it to the wrong address. Or a currency exchange might be the victim of a scam, sending it into voluntary administration (and there goes all your bitcoin).
But risks aside, this new system presents an opportunity where work that has traditionally been carried out by legions of staff tasked with recording transactions, verifying identities and preventing fraud, can now be achieved far more quickly and accurately with mathematics and the power of the blockchain. It’s also an undeniably cheaper solution.
Blockchain allows for transparent and conflict-free smart contracts
Smart contracts, otherwise known as blockchain contracts or digital contracts, are a digital tool for the exchange of money, assets or anything of value. They are contracts that have been converted into computer code, are stored on the blockchain and are supervised by the network of computers that run the blockchain.
Smart contracts enable the blockchain to fulfil the third role that banks traditionally play – establishing and verifying contracts.
So how does this work?
Blockchains can be used to store any kind of digital information, including computer code. This code can be programmed to execute when two or more parties enter their keys, indicating that all parties agree that the contract has been fulfilled. So smart contracts can be designed to automatically sign off when stated conditions are met. Blockchain contracts can also read from external data feeds, such as stock prices, weather reports and news headlines.
The technology allows businesses to validate transfers based on delivery of service. For example, a certain number of buying orders would signal to the blockchain-based smart contract that conditions had been fulfilled for an invoice to be paid. The payment could then be made automatically through a blockchain-based payment system. There’s no need to use (or pay) intermediaries such as banks or lawyers to establish deposits.
The blockchain empowers users to make peer-to-peer transactions with greater speed and access to worldwide markets, all at a significantly reduced cost.
Blockchain and the future of banking and finance
With the popularity of cryptocurrencies at an all-time high, the banking sector is recognising the potential of the technology as a solution to a lot of the problems facing financial organisations.
As a secure, accurate and transparent method of recording transactions, verifying identities and establishing contracts, the blockchain provides an opportunity to establish a global payment network that is able to achieve much lower costs than the current system.