Blockchain is rapidly increasing its reputation as a mechanism for faster payment services and greater data security.
The current world payment system would, in its fundamentals, be familiar to a 16th century Medici banker. A centralized bank ledger, whether a bound volume or a database, records deposits, transactions, and transfers of value. While a gold coin can be held by only one person, in a world of easy duplication, a stream of bits need some kind of verification. This verification is provided by banks and other financial institutions. The responsibility of ownership and transaction verification has been a bank function for centuries.
But strong drives for change are transforming this system. One possibility for supporting secure financial transactions in the future is the blockchain.
The issues that face the system
Because buyers and sellers can’t trust each other right off the bat, third party institutions, like banks, set up the contracts, transfer the value, and monitor compliance. They provide security and trust, but they also impose overhead. Because of the centralized processes necessary for these responsibilities, some things, such as syndicated loans, take a startlingly long time to settle. Currently, the timeline is nearly three weeks. Even the simple transfer of a stock can take a week. The increasing number of cross-border transfers is becoming a particular bottleneck globally.
Customers are demanding easier and faster payment services at the same time as increasingly sophisticated threats challenge the security of payment and sensitive data transfers.
Blockchain is being proposed more and more as a mechanism for accomplishing those goals.
Fundamentals of the blockchain
The blockchain is the cryptographic system that processes transactions of the digital currency Bitcoin. This digital ledger provides a way to eliminate those metaphorical central ledgers and distribute them among all the participants in the market. It provides the trust, double spend prevention, and asset tracking required for a functioning value-transfer system.
A network of computers has to agree that a transaction is legitimate, and then that transaction is added to the blockchain for that asset. Everyone in the network gets that update blockchain. If someone decides to claim ownership of something by altering their own blockchain, it would not match all the others in the network. Two parties don’t need to trust each other in order to safely transact using Bitcoin.
Blockchain without Bitcoin?
Over the past year, the notion of blockchain as something useful for all kinds of assets other than Bitcoins has increased, Many active startups are fronted by marquee names in software and finance.
A 2015 paper from Santander Innoventures estimated that using blockchain would save the financial industry $15-$20 billion annually by reducing infrastructure costs for payments and compliance.
But what exactly the blockchain would become without Bitcoin is not entirely clear. With Bitcoin, “miners” compete to verify each new transaction as it occurs, and the winner of the competition is paid in Bitcoin for this successful decryption. This verification is expensive in computation time and energy. Miners do it because they are directly incented. It is unlikely that any other motivation would be as strong, so some other method of verification is necessary.
As a result, most proposals for blockchain implementations in finance are in what is called “permissioned” blockchain- walled gardens where participants are known and there is already an established level of trust. This lowers computing costs by eliminating a defining feature of blockchain: its trustless anonymity. Examples include Hyperledger and Ethereum.
How compatible are banks and blockchain?
Banks have a lot invested in a centralized process, with infrastructure, workflows, and staff all focused on centralized ledgers. Blockchain would disrupt much of that.
Still, the blockchain certainly does have advantages to banks. It helps prevent fraud, provides easier ways to demonstrate compliance, and enables security by preventing outside changes to data. Even with a lot of security staff and procedures, banks are still subject to security breaches. Outsourcing verification to a distributed system may well benefit banks, even as they give up a measure of centralized control.
After banks get their hands on it, is blockchain still sexy?
Bitcoin and the blockchain come from a brilliantly innovative idea from an unknown person known as Satoshi Nakamoto. It has been implemented by the kind of intelligent, unbureaucratic people who like distributed systems invented by unknown geniuses that can be used to buy illegal or banned goods and services. In other words, not bankers.
But the romance of Bitcoin needs to be strictly separated from the functionality of blockchain. As banks adapt it to their use, it may start to look like just a sophisticated database that uses some long-vanished outlaw street cred to make bankers feel edgier.
If it enables them to keep transactions reliably secure, reduce transaction times, and keep the financial system operating, who are we to deny them that?