“Blockchain is ready to take centre stage”, declared a recent Goldman Sachs report, just one of many indications that this virtual system has captured the attention of the financial services industry.
It is certain that Blockchain has the potential to transform centuries-old mechanisms for transferring money. Our latest research, which surveyed over 300 banking executives on the current payments landscape across Europe, found that cryptocurrency and Blockchain technologies are now seen as real drivers for change.
In practice, nine banks, including Barclays and Royal Bank of Scotland, recently announced that they may adopt the Blockchain system, due to the fact that “it is hard to fool, making fraud more difficult, could speed up trading systems and make deals more transparent”.
Blockchain is the technology that enables cryptocurrencies and is built on the principles drawn from cryptography, game theory and peer-to-peer networking. This allows any unique monetary data exchange to get past the problem of double spend by making the ledger (the book of record) available to all participants in the network and by creating a process by which a consensus can be reached in changes to the ledger.
However, the method, through which consensus is reached for making changes to the distributed ledger, differs from one cryptocurrency protocol to another. Bitcoin, for example, makes use of the ‘proof of work’ method, which depends on miners providing proof of computing resources expanded in verifying transactions before being allowed to make changes to the distributed ledger, essentially adding transaction records to the ledger of past transactions.
Blockchain offers the promise of addressing some of the key challenges and pain points experienced over many years by the financial sector. Beyond the security implications and increased transparency of transactions for all parties, whether institutions or customers, it can have a beneficial impact on pricing and costs in the market. It also provides the opportunity for more accurate tracking of customer repayment histories, across borders and banks, reducing the risk of defaulters. For example, Everledger, a permanent ledger for diamond certification, has adopted the use of Bitcoin as a mark of authenticity providing transparency for all parties involved, a clear attempt to prevent diamond fraud.
In the short term, it is essential that any financial services business works to develop specific use cases to understand how the technology could support their organisation. These types of test beds are already being developed around the world. One example is ANZ, which is looking at experimenting with Ripple to understand the benefits along the whole customer value chain.
There are several challenges Blockchain will have to overcome before it becomes mainstream. These include scalability, the time taken to verify the transactions, the cost of transactions and, of course, security. A lot of attention recently has focused on incidents of hacking at Bitcoin-based companies and start-ups.
However, what has not been covered in detail is that some of the thefts did not originate through the network but were initiated by individual customers. For example, a software wallet, which is basically the Bitcoin equivalent of a bank account, is installed on customers’ own computer or device and controlled completely by the customer. These wallets are stored without encryption and have been attacked through the hacking of someone’s personal computer. However, if a fraudster wants to make any change to the distributed ledger, it cannot be done unless the fraudster also controls 51 per centsa or more of the participants on the network, which is next to impossible in the case of any large network. In addition, regulation is still not very clear for settlement protocols involving cryptocurrency protocols.
Nevertheless, regulators in a number of countries are increasingly taking steps to understand, contextualise and regulate digital currencies. Recent indications from central agencies in the US and UK indicate that regulators are in fact taking a very pragmatic approach to Blockchain technology and the news from the major banks has added further evidence to this pragmatic approach. While it is not yet clear how Blockchain will ultimately be adopted in the financial services industry, it is certain that the future will look very different.
As innovations in technology change the way that money moves around the world, businesses need to keep a close eye on Blockchain and be prepared to adapt and transform their services accordingly.
Tony Virdi, VP and Head of Banking & Financial Services in the UK & Ireland, Cognizant