This article aims to highlight the reasons why the distributed ledger technology cannot revolutionize the financial world like cryptocurrencies do.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
It’s hard to think of a subject matter causing more hype in the fintech world than the blockchain. The aficionados of this technology have been anticipating for years that it will trigger groundbreaking changes in various domains and the finance sector in particular. However, its purported prospects aren’t backed by statistics thus far.
David Einhorn's Greenlight Capital returned -2.9% in the second quarter of 2021 compared to 8.5% for the S&P 500. According to a copy of the fund's letter, which ValueWalk has reviewed, longs contributed 5.2% in the quarter while short positions detracted 4.6%. Q2 2021 hedge fund letters, conferences and more Macro positions detracted 3.3% from Read More
The global investments in fintech exceeded $31 billion last year. The share of blockchain projects boiled down to $512 million across 92 deals. Just to compare, insuretech raised four times as much money ($2.1 billion) across more than twice as many deals (247).
Of course, these numbers don’t mean that the blockchain is a worthless technology without a bright future. Quite the opposite – there are industries that look forward to implementing it. The breaking news in this regard is that Cognizant, an American IT services corporation, has partnered with 14 Indian insurance companies to develop a blockchain-based platform for secure data sharing. The parties involved believe that this solution will reduce the risk of fraud, money laundering and data breaches. This, in turn, will save them a lot of money and time. The changes will cover insurance business models proper, which is unlikely to make insurances cheaper but will definitely make them more convenient.
However, most initiatives of that sort end up being pilots and memorandums. Only one financial institution, the Santander bank headquartered in the UK, has reportedly adopted the “transaction-friendly” blockchain for its business processes. It is leveraging Ripple’s proprietary blockchain-based protocol to streamline customers’ international payments.
The impression you get from the project description, though, is that it was tailored for an appealing press release and in order to somehow justify Santander’s investments in Ripple made three years ago. Essentially, the Santander One Pay FX service introduces no novelty from an end user’s perspective. Quick fund transfers had existed long before it went live. Didn’t the unique characteristics of the blockchain allow the parties to come up with something truly useful and tangible?
Actually, the reasons why the blockchain continues to be a delightful, yet impractical technology are fairly prosaic.
The certification issue
Large corporations love employees’ certificates. There is a great deal of controversy about true professionals’ attitude toward documents confirming their expertise, but there tends to be an “equals” sign between a certificate issued by a reputable authority and qualification for a job.
Today’s blockchain world is dominated by autodidacts. No matter how talented they are, the management of the average corporation will treat them like impostors. They cannot be assigned a project that touches the core business areas. The lack of official certification is, therefore, a serious hurdle in this context. A quick keyword lookup might return a list like this, which bizarrely combines things like the “IBM Blockchain Foundation for Developers” course and a 1.5-hour (!) video training “The Basics of Blockchain” that costs 11 USD to watch. Yes, all of these courses do issue certificates, but their value is disputable.
Another caveat has to do with blockchain security experts. They probably don’t even exist, because the attack vectors targeting the new tech are still a mystery. This isn’t about old phishing attacks against cryptocurrency exchange services. This is about creating a database of real-world incidents where public and private blockchains were compromised. The challenge is to also elaborate the mechanisms to prevent these incursions.
It’s kind of naive to anticipate a mass implementation of the blockchain by critical industries until IT giants like Oracle and Microsoft step into the niche of blockchain experts certification.
The hurdle of slow standardization
The fact that there are many different blockchains is not a problem. This is how things tend to go at early stages of standardization, where the variety doesn’t impact implementations. The idea is to simply pick the best variant and stick with it. The issue with blockchains is that they are not as fast-performing as the ostensibly “obsolete” corporate databases. Public blockchains are dozens of times slower, whereas private ones are multiple times slower.
There are industries like insurance or transportation, where the transaction time isn’t critical. However, the benefits of implementing the blockchain for classic financial transactions aren’t obvious. If a man in suit finds out that the net cost of a blockchain transaction is relatively high due to the expenses for maintaining a large data volume (electricity, storage space, bandwidth), it becomes virtually unrealistic to get him authorizing the project.
The scalability challenge
Scaling a centralized database up or down is easy. Cloud services and virtualization have turned the process of scaling traditional platforms into a routine that doesn’t require any particular prepping. In the case of a blockchain solution, the increase in the number of servers or computational cores isn’t directly linked to productivity. The amount of resources that need to be allocated depends on the type of data on the blockchain due to the peculiarities of the tech itself. It should come as no surprise if adding passport scans to the database suddenly overloads the virtual machine or vpn connections slower the speed. It’s impossible to estimate the scope of the influence in advance. Therefore, the complications in such a scenario are a combo of purely technical issues and project budgeting caveats. Men in suits don’t like that.
The snowball of uncertainty
Imagine you are up to implementing the blockchain in your organization. Your motivation is to keep up with the times, make things high-tech and avoid license payments for commercial databases. But when you start getting into detail you figure out that:
- a) Specialists are extremely hard to find
- b) With the same computational power in place, the system will work slower
- c) It’s only possible to estimate the scalability expenses when the project is underway, not at the beginning
Obviously, you will be offered to create a test environment to see how it pans out, take your time with the headhunting, and maybe in a couple of years…
In fact, this is how it’s done at this point. Only one European bank (the Credit Agricole and SETL deal) has invested in a blockchain platform during the first four months of 2018. This isn’t about purchasing a solution, though – it’s about taking a minority stake along with S2iEM, Deloitte, and Citi. Other banks prefer investing in the optimization of capital markets technology.
There’s no denying that cryptocurrencies have changed the financial world. But the blockchain, which is at the core of the crypto revolution, has not become the game changer for the conventional financial institutions. In order to do it, it will have to start wearing a suit, defend project budgets and keep track of KPI.
Another option is to come up with something that, from a regular user’s perspective, turns the classic into the outworn. Or perhaps we expect too much from simply a more secure database?