Goldman Sachs filed a patent application for blockchain-focused technology, which bitcoin is based upon, earlier this month, and now the debate about possible uses for crypto-currency and crypto-technology has received a refresh. As it turns out, the technology is already in use in low-activity applications by NASDAQ and other firms.
But just what does blockchain mean for the financial industry as a whole and are we on the verge of seeing it go mainstream? Probably not, one expert tells ValueWalk. In fact, we could be as long as a decade away from seeing the technology being used in high-activity financial applications.
What is blockchain?
When bitcoin first arrived on the scene, most people didn’t know what to think about it, and many still don’t. The value of a bitcoin skyrocketed, climbing higher and higher over the course of a year or so even though the average investor didn’t know much about it.
On April 9th 2021, Bruce Greenwald, the founding director of the Heilbrunn Center for Graham and Dodd Investing at Columbia Business School, sat down for a Fireside Chat with Li Lu, the founder and chairman of Himalaya Capital as part of the 13th Columbia China Business Conference. Q1 2021 hedge fund letters, conferences and more Read More
Then some of the biggest bitcoin exchanges started going bankrupt. Mt. Gox, the Japanese exchange that became synonymous with bitcoin, buckled after a security breach in which cyber-thieves somehow made off with millions of dollars’ worth of bitcoins.
Can blockchain remain truly open?
When bitcoin was at the height of its popularity, tech gurus emphasized that it was the technology behind the crypto-currency and not the currency itself. That technology is called blockchain, and it basically works as a public ledge and system for verification.
Blockchain is inherently unregulated, and regulators from multiple countries have been trying to figure out if they can regulate and how to do so, particularly because of bitcoin’s popularity among criminals because it provided a way to transfer payments without revealing the information of the buyer.
Firm58 shared a copy of its recent whitepaper entitled “Blockchain firm “Technology & the Back Office What Capital Markets Firms Need to Know” with ValueWalk. The paper’s authors explain that blockchain’s success depends on its “status as an open platform.” Further, there are concerns that it could disrupt the entire capital markets industry, and as such, firms that are at risk may look for ways to close the blockchain platform to protect themselves.
Blockchain probably won’t change everything
Firm58 founder and CTO Jim Mullen added that because of blockchain’s openness, many clearing, settlement and banking firms will become obsolete if it becomes widely accepted. He’s not the only one who sees potential problems for “middle man” firms. Goldman analysts also warn that such firms may be in jeopardy, but they add that the world’s central banks could also be at risk from the technology.
However, Firm58’s analysts also believe that much of the financial industry’s infrastructure might be left intact. They say blockchain-based markets essentially make traditional clearing, settlement and reconciliation “nearly instantaneous,” meaning that traders’ funds wouldn’t be tied up for as long as they are now, which in some cases can be up to three days.
They add that broker dealer firms are probably safe even with widespread implementation of blockchain because they’ll still be needed to secure loans and execute trades. Also they think broker dealer firms might even see new kinds of opportunities in handling new kinds of “digitalized assets,” this expanding their role.
Further, they believe that exchanges will also be safe because buyers and sellers would still need a “pairing mechanism,” and venues may be safe as well although they may swap some new responsibilities for old ones. What would become automated would be the mechanisms for trust and verification, but matchmaking, executing of trades and dispute arbitration “would remain uniquely human activities,” the Firm58 team believes.
Blockchain already in use
The firm highlighted in its whitepaper that blockchain isn’t ready for mainstream use right now, although it is in use in some applications already. The problem, according to Mullen, is that its processing speed is just too slow, which means it’s not ready to handle the U.S. stock market’s trading activities because of the need for high-speed transactions.
He highlighted five examples of firms which are already using blockchain technology. Perhaps the most well-known firm to use it currently is NASDAQ, which has implemented it for low-activity applications like private equity placements. Also London-based Real Asset Co. uses it for gold transactions, while Blythe Masters’ Digital Asset Holdings uses it to settle corporate debt and short-term government bonds.
MeXBT, which is basically Mexico’s version of bitcoin, enables migrant workers to send money to Mexico and withdraw money from ATMs using blockchain-based technology, while London-based Everledger uses it for diamond transactions, specifically to track diamonds from mine, to dealer, to buyer.
Mullen thinks it will take five to ten years for blockchain to become fast enough to be able to be used for high-speed financial activities. In fact, he thinks it’s more likely “that a whole new capital markets ecosystem will emerge with blockchain as its foundation.” He thinks the new ecosystem will gradually replace the old one.
How vulnerable firms may defend against blockchain
However, barriers still exist, and it isn’t just the speed at which it can handle transactions. Regulation is also a concern.
“Much like the Internet, attempts to centralize authority or otherwise segment access to the blockchain threaten to preemptively short-circuit its potential,” the Firm58 team wrote in their whitepaper.
Also firms which see their livelihoods as being threatened by the technology will not readily accept it. Mullen explains that the industry doesn’t want to see peer-to-peer trading between parties without middle men because it eliminates massive streams of revenues for firms all over the world. He believes capital markets firms will attempt to close blockchain to protect their business.
“As an example, 30 large banks formed a consortium called R3 CEV, to develop a closed/private blockchain,” he said. “This defeats the purpose of blockchain and prevents meaningful change in the capital markets supply chain. We’ve seen this behavior before, when new disruptive technology looks displace the status quo, companies try and control the technology by developing and marketing private protocols, processes and products. Ultimately open standards and open technology win.”
Mullen said that at first, firms may seem to support blockchain even though they worry about the technology eliminating the need for their business.
“They [banks and settlement organizations] need to protect their expensive habits,” he added. “Technology isn’t preventing banks from improving the speed and efficiency by which they move money. It’s their own business model and processes that prevent it. But when I can order an item on Amazon and have shipped faster and cheaper than wire transferring money from my bank account to my trading account, it’s time for a change.”
A land grab is next
Goldman Sachs’ patent application for its own blockchain system may be just the first of many preemptive strikes from financial firms trying to protect their futures. Mullen believes it demonstrates that Goldman is trying to protect its territory while undermining blockchain’s openness.
“It [the patent] also provides them with two revenue sources,” said Mullen. “First, by patenting this broad technology, Goldman is creating a private trading venue, monopolized via patent, that is open only to those who submit to their rules. Second, it’s land grab opportunity that they can use to extract royalties from any company that violates their patent.”
He expects to see more patents for blockchain-based technology as firms attempt to “protect their turf.” Additionally, he expects “a land grab for new turf.”