Cryptocurrencies such as bitcoin may have captured the public’s fancy – and also engendered a healthy dose of skepticism — but it is their underlying technology that is proving to be of practical benefit to organizations: the blockchain. Many industries are exploring its benefits and testing its limitations, with financial services leading the way as firms eye potential windfalls in the blockchain’s ability to improve efficiency in such things as the trading and settlement of securities. The real estate industry also sees potential in the blockchain to make homes — even portions of homes — and other illiquid assets trade and transfer more easily. The blockchain is seen as disrupting global supply chains as well, by boosting transaction speed across borders and improving transparency.
These uses are merely the tip of the proverbial iceberg for a nascent technology whose development stage has been compared to the early years of the internet. “We’re very early in the game,” said Brad Bailey, research director of capital markets at Celent, at a recent Blockchain Opportunity Summit in New York. He likened the blockchain’s current status to the web of the early 1990s, heralding a coming wave of new ideas and uses. “This will impact the world.”
The blockchain technology came about initially as a way to verify bitcoin transactions online and to enable two parties to transact business without having to know or trust each other. It was designed without a central authority in mind, such as a bank or government, to oversee transactions. Essentially, the blockchain is a shared virtual public ledger where encrypted transactions are confirmed by outside parties. In the bitcoin world, these outside parties are called “miners” — computers that solve complex mathematical problems to confirm transactions and earn fees. Confirmed transactions are placed in a “block” and added to the chain. Since the ledger is shared by everyone on the network, it is thought to be nearly impossible to remove or change the data – a premise that turned out to be false in some cases.
Today, the concept of the blockchain has expanded beyond its use by cryptocurrencies. Instead, the benefits of the shared ledger and its seemingly immutable record of transactions accessible to multiple parties are being explored by a variety of industries. Experts said there won’t be a “mother blockchain,” but multiple ledgers with different purposes. Varying versions of blockchains have popped up, too: While the original bitcoin blockchain was open to anyone, some companies’ blockchains are private and “permissioned” — they restrict access to approved parties. The latter approach is preferred by companies fearful of being hit with government fines and lawsuits if they get hacked, said summit participant Sarab Sokhey, chief technology leader of new product innovations at Verizon Wireless. They’ll stay private until the technology matures and industry standards are set.
“[The blockchain] could provide an identity to those who don’t have it, or promote financial inclusion.” –Saikat Chaudhuri
While the blockchain’s business applications are clear, it has social implications as well. For instance, it can create identities for individuals apart from those sanctioned by governments and not limited by geographic boundaries. The blockchain also allows less-technologically advanced nations to participate in global transactions more easily. “Blockchains are exciting, undoubtedly,” said Saikat Chaudhuri, executive director of the Mack Institute for Innovation Management, which was an official partner for the summit. “It’s much more than about transaction efficiency or flexibility. It’s really beyond that. It could provide an identity to those who don’t have it, or promote financial inclusion. Therein lies the power of this whole thing.”
‘Nervous’ Financial Institutions
According to a survey by the IBM Institute for Business Value and the Economist Intelligence Unit, one in seven companies it calls “trailblazers” expect to have blockchains in production and at commercial scale in 2017. Respondents were interested in taking advantage of the blockchain’s multiple benefits, which include cost reduction, immutability of records, transparency of transactions and the potential to create new business models. For example, the blockchain would eliminate the need for keeping multiple records at banks and other parties doing currency trades. The survey tracked responses of 200 global financial markets institutions.
The survey also said “trailblazers” were focusing their efforts on the following business areas: clearing and settlements, wholesale payments, equity and debt issuance and reference data. The report added that in recent years, financial institutions have “swarmed to blockchain pilots and proofs of concept” — opening innovation labs, holding hackathons, partnering with financial technology startups, joining consortia and collaborating with regulators.
To be sure, banks have a vested interest in participating. “Banks provide essentially escrow services for the transfer of value, and here comes a technology that threatens to eliminate that service,” said Chris Ballinger, global chief officer of strategic innovation at Toyota Financial Services. “So they are nervous about that, because it’s a huge revenue stream” that could be taken away. How? “With the blockchain, you can run a network that transfers value among untrusted nodes, and therefore you can eliminate the middle man and you can eliminate all the costs associated with the middle man,” he said. “You’re essentially turning assets into something like cash that you can hand to somebody and they will accept. That makes the transfer of assets extremely efficient.”
Another unique benefit of the blockchain is that it separates someone’s identity from the transaction they’re making. In general, a blockchain uses a digital signature – not real names and other personal information – that is activated by a private key or secret code held by the one doing the transaction. Compare that to current credit card or bank transactions, which tie one’s personal information such as a name and address to purchases and other financial activities. This separation improves the security of one’s data. “Today, the payments information and identity are [bound] together. The combined is a tempting honey pot for hackers,” Ballinger said. “By separating the financial information from the identity, there’s no honey pot, no central place to hack, no incentive to go after.”
In December 2015, Nasdaq executed its first trade on a blockchain, through its Linq ledger. The exchange said the blockchain promises to expedite trade clearing and settlement – all the steps needed to transfer the asset from seller to buyer including recording the transaction — from three days to as little as 10 minutes. That’s because the trades remove many manual processes and bypass third parties. As such, “settlement risk exposure can be reduced by over 99%, dramatically lowering capital costs and systemic risk,” according to Nasdaq. Other stock exchanges tinkering with the blockchain include ones in Australia, Myanmar, Germany, Japan, Korea, London and Toronto.
Overstock.com is on the cusp of issuing its first security using the blockchain. “We are in the process of proving out the first public trading of a blockchain security,” said Ralph Daiuto, Jr., general counsel of tØ, a subsidiary of the e-commerce retailer. While the company has kept its clearing firm, it is using digital wallets for the actual transfer of assets in settlement of the trade. “The goal is to shorten the settlement cycle and [avoid] all the ills that can go wrong with that cycle.” He added that the company can cut its equity