Blockchain is possibly the most talked about financial innovation of this decade and over the past 12 months, there has been a significant increase in interest surrounding the technology.
A new research report from Credit Suisse on Blockchain and the technology’s potential highlights that there are three fundamental properties of Blockchain that make it appealing to users, businesses and developers.
“A shared ledger requiring consensus to update, with tamper evident properties that is economically unfeasible for any single entity to retrospectively alter is a bigger disruptive threat. We find blockchain more easily optimizable to different objectives than bitcoin and think three key properties—disintermediation of trust, immutable record and smart contracts—endow the technology with real advantages to legacy systems.” — Credit Suisse
Credit Suisse writes that Blockchain’s most valuable trait is its inbuilt level of trust, which removes the need for a trusted third party. Take equity transactions, or credit card payments for example. In both of these cases, a trusted third party — broker, clearinghouse or payment processor — stands between the buyer and the seller. This model has a single point of failure and requires transaction costs as the middleman takes a cut.
With blockchain, the trusted third party is supplanted by the implementation of a shared public database, alteration of which requires the consensus of all participants. Cryptography is used to maintain a peer-to-peer time stamped consensus ledger of all past transactions. Each transaction is then aggregated with others into a block of transactions giving a chain of blocks, each connected to the last. As each block needs to be agreed by consensus before being added to the chain, records cannot be forged, censored or reversed once a block is added. Simply put, blockchain removes the need for a trusted third party, increases security, produces a trail that cannot be tampered with and lowers costs as there’s no middleman fee required.
Credit Suisse gives an example:
“Think of an art broker with links to a wide network of collectors. One has a Cézanne for sale, another wants a Cézanne. The dealer’s specialization in Post-Impressionist art and research of the particular paintings provenance enables the dealer to confirm it is owned legitimately by the seller, and is authentic. The broker then buys it from the seller, and sells it on to the buyer, the spread is his commission. Thus the trusted third party art broker enables two collectors who lack a relationship to transact value without trust.”
“Were art ownership and provenance stored on a blockchain (as Deloitte’s ArtTracktive proof of concept shows is possible…), the Cézanne collectors could transact with each other without the broker. The process becomes simpler, less exposed to the three sins of a centralized ledger (see Figure 6), and cheaper.”
Blockchain is enough to revolutionise many different industries
So, it’s clear that the level of trust brought in by blockchain is enough to revolutionize many different industries but Credit Suisse sees eight key challenges that have the potential to limit the utility, and therefore reduce adoption, of blockchain systems:
- Security vs. cost tradeoff
- Do you actually need blockchain? ‘If it ain’t broke, don’t fix it.’
- Critical mass is essential: Blockchain-based solutions rely upon multiple users. The industry will be unable to develop a less it becomes mainstream
- What you get out is only as good as what you put in… The level of information displayed on a chain of blocks is only as good as the barriers put in place to ensure the quality of data being added is high.
- The bigger the network the easier it becomes to hack a blockchain system.
- Credit Suisse writes that transaction data on blockchains cannot be encrypted for the simple reason that nodes have to see it to verify it — an issue for data privacy.
- Assets on-chain essentially become bearer instruments. The issue with bearer instruments is that you can lose them quite easily.
- A forked road: “The DAO attack exposed flaws in smart contracts on Ethereum which should act as a reminder that nascent code is susceptible to bugs before it is truly tire-kicked, and even then, complete surety is never guaranteed. The ‘hard fork’ undertaken by the Ethereum community also shows that blockchains are only immutable when consensus wants them to be.” — Credit Suisse
Blockchain has many drawbacks but it also has significant uses, and industry leaders are throwing their weight behind the technology. A survey at the World Economic Forum of 800 executives this year found that 58% of respondents expect 10% of GDP to be stored on blockchain before 2025. 73% of respondents expect tax to be first collected on-chain pre-2025.
Profiting from the rise of blockchain
How should investors position themselves to take advantage of blockchain’s rise? Credit Suisse has some tips:
“…supportive for payments companies (like Worldpay) and card networks (like Visa), and is neutral for Media. We see the biggest impact in areas like financial services, exchanges and post trade settlement, where T+3 settlement looks ripe for optimization. In particular, we see scope for vertical integration across exchanges, clearing, settlement and registration. The winners and losers from this consolidation are still not clear, but the market appears to be overlooking risks for exchanges (ASX) and, we would argue, unfairly pricing the registrars (Equiniti and Computershare) for disappointment.
With the ASX due to report the results of its blockchain trials in 2017, we believe this will be a key debate for investors over the next 18 months.” — Credit suisse