How can 'Blockchain' Revolutionize the Financial Services Industry?
(This article is an extract of the Research Paper of the Author, published in ‘ Trinity Journal of Management, IT & Media’)
What is Blockchain Technology?
Block-chain took root with the Bitcoin whitepaper written by visionary Satoshi Nakamoto in 2009. The whitepaper outlines the details required for a protocol that establishes a decentralized currency, operate it on a trustless network that is not controlled by individuals with a bias towards a particular country or governing body.
Vitalik Buterin, one of the writers for Bitcoin Magazine which tried to popularize the technology in early 2012, witnessed the problems in the Bitcoin implementation like wasteful mining hardware, centralized mining community, and lack of network scalability. In 2013, at the age of 19 years, Vitalik described his vision for Ethereum by extending the concept of Bitcoin beyond just currency. He proposed a platform where developer community and entrepreneurs could build a distributed application for the Blockchain network. Vitalik referred to this concept as ‘smart contracts’.
A blockchain, originally block chain, is a growing list of records, called blocks, that are linked using cryptography. Blockchain technology, by facilitating digital information to be spread, generated the mainstay of a new type of internet. Initially devised for the cryptocurrency, Bitcoin, the tech community is now looking for other potential uses for the technology.
The concept of Blockchain is akin to a sales ledger – which is a comprehensive and ever updated accounting record which depicts who holds what or who transferred what to whom. This sales ledger is a secure decentralized database that remains in the public domain. Blockchain can record anything, from physical assets to electronic cash. Thus the concept is based on distributed ledger technology and helps participants to work on common areas of interest.
Blockchain is a distributed ledger of records that is nearly incorruptible. Every block links to a previous block and has a time and date marking thereon. It is self-monitored and does not require coordination and regulation from others.
A blockchain is a kind of digital storage medium, maintained decentrally by several participants, in which transactions bundled into blocks can be stored securely enabling it to be free from tampering. Blockchain has enabled the recording of electronic money i.e.Bitcoin.
When a digital transaction takes place, it is grouped together in a cryptographically protected block with other transactions that have already occurred and sent out to an entire network of transactions. Different members and users in the network are able to verify the transaction before taking any crucial decision involving a financial transaction.
Advantages of Blockchain Technology:
The main advantage of block-chain technology is that a special encryption mechanism ensures that the data cannot be manipulated by any participant. Some potential uses in the financial sector would be, for example, the international transfer of funds, or securities trading. Use of blockchain technology can make payments and securities transactions much quicker and cost-effective, and keep them safe from fraud.
In its present condition, block-chain has the potential to help overcome the impediments in achieving the desired growth in the Internet of Things (I oT), due to the following properties:
1) Scalability - it is virtually scalable;
2) Standardization- it has the abundant potential to standardize the entire network;
3) Inbuilt security - as the block-chain is distributed across millions of computers, hacking it is almost impossible or unrealistic. This is one of the main reasons why there is such a big hype in the banking industry over the applications of blockchain technology;
4) Transparency - as the cryptographic public address of the sender and receiver of every transaction is recorded, and everything is available for inspection;
5) Privacy- it can also facilitate great improvement in terms of privacy, as users are generally pseudonymous and can execute transactions instantly without the need for any personal verification.
6) Immune to censorship - as no single authority has general control over it due to its de-centralized structure blockchain technology ensures immunity to censorship. With block-chain, users can have open access, without any potential risk of interruption.
7) Immutability: One of the most important features of blockchain is its immutability- once it has been saved into the chain, it cannot be altered or deleted afterward.
8) Applications in compliance- Block-chain can be used for keeping track of the steps required by regulation. Recording actions and their immutably in a block-chain would create an audit trail for regulators to verify compliance.
9) Facilitating collaboration- it enables collaboration with several unknown parties that are situated in different geographical locations.
Is the Banking Industry adopting Block-chain Technology?
According to results of the survey conducted by Accenture, most of banks are still in the early stages of adoption, with about 75% either involved in a proof-of-concept, formulating their blockchain strategy, or just started looking into it. Cross-border remittances, corporate payments, and inter-bank cross-border transfers are receiving comparatively less attention as compared to intra-bank cross-border transfers. But wherever they think of deploying blockchain, executives expect a wide range of benefits, including lower costs, quicker settlement, fewer errors and new revenue opportunities.
And that’s probably why a majority of financial service leaders say that the speed of technological change concerns them. There is no doubt, whether blockchain technology will disrupt and revolutionize the banking industry. Leaders feel that it coming fast and will stay. Some are ready to face it but most of them are not. But how is blockchain going to disrupt the banking industry over the next decade? To answer that question, we have to know how blockchain technology works.
How does blockchain work specially in the context of banking?
In order to understand how blockchain will transform the banking and finance industry, one needs to comprehend how it works. Just think of block-chain as a mathematical instrument for processing, securing, and finalizing transactions. Banks process a huge number of transactions each day and hence they should be the main industry to adopt the most from this technology.
The block-chain process is simple. First, someone requests to make a transaction - usually using cryptocurrency. Once they do so, computers, or “nodes,” jump to work processing the transaction. When the nodes are over, blockchain verifies the transaction, gives it an exclusive identity, completes it, and places it as a new block within the constituent string of existing blocks as shown in figure 1.
Now that you have a fair idea of how blockchain technology works, you may ask - is it really going to have a significant impact on the banking industry? Or is this just another innovation that will fade away in the course of time. ‘Harvard Business Review’ says that blockchain will do to banks what the internet did to media. Over the last few years, Blockchain technology has had a significant impact on supply chain finance especially, within the financial service sector.
In the year 2016, about 60% of financial organizations contemplated using blockchain for international remittance, 23% for security clearing and settlement, and 20% for KYC regulations and anti-money laundering services.
Why is it safe to transact through block-chain?
A blockchain is a chain of digital “blocks” that contain records of transactions. Each block works in collaboration rather than in isolation -it is connected to all the blocks before and after it (see Figure: 2). This makes it virtually impossible for a hacker to tamper with a single record because he would need to change the block containing that record and also those linked to it to avoid detection. In addition, blockchain has some other inherent characteristics that provide additional means of security.
The records on a blockchain are secured through cryptography. All the participants in the Network have their own keys that are assigned to the transactions they make and act as an individual digital signature. If a record is altered, the signature will become invalid and the peer network will know right away that something wrong has taken place. Early notification is essential to averting further damage.
Blockchains are decentralized and distributed across peer-to-peer networks that are continually updated and kept in sync. As they are not centrally located, blockchains do not have a single point of failure and cannot be changed from a single node (computer). It would require great deal of efforts for a hacker to access every instance (or at least a 51 percent majority) of a certain blockchain and alter them all at the same time. So larger your network is, the more tamper-resistant your blockchain will be.
How exactly does blockchain provide more security than traditional transaction processes? Let’s take a look at the figure : 2
A promising road ahead for smart Banking
Blockchain and distributed ledgers have a bright future. As real-time and reliable platforms that safely transmit value and data, blockchain technology enables banks in reducing the cost of processing remittances and producing new products and services thereby generating significant new sources of revenue.
The most important key to turning blockchain’s potential into reality is a collaborative effort among banks to create the network essential to support global payments. By all probability, most of the banks are or will be starting creating their own currencies and using blockchain technology for transactions within the next ten years. If for no other reason than the fact that it will save them plenty of efforts, money and time. After all, these are the most convincing reasons to make any change.
Challenges
Speed is often mentioned as a big issue for the wider adoption of blockchain. Performance of blockchains is significantly sluggish as compared to the typical or conventional database. The cryptographic component, which is one of the most fascinating features of blockchain is highly calculation-intensive. For instance, the data capacity of bitcoin is around 7 transactions per second as compared to the average of 2,000 transactions per sec handled by the VISA payment system. In view of foregoing, concerted efforts are being made to build blockchains capable of high yielding performance.
CONCLUSION