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A TIMELY REMINDER: BLOCKCHAIN AND ITS POTENTIAL FOR FINANCE

Senthil Radhakrishnan, VP Capital Markets, VirtusaPolaris

 Blockchain has been making plenty of headlines over the past few months, and seems to have well and truly emerged from Bitcoin’s shadow. There seems to be plenty of hype around blockchain at the moment, but less actual understanding of how the technology works. If Blockchain does realise its potential, this understanding will be crucial for finance professionals.

So what is it? It’s a ledger which keeps track of transactions between two parties. Yet while most ledgers are kept in banks or accounting departments, Blockchain is a distributed ledger in which copies arekept within various computers, or ‘nodes’ – each one under different owners. Each block represents a financial transaction andcomprisesa set of transactions, which have been captured as a sequence based on time.Plus, any time a new transaction is added to the chain, it needs to be approved by a set of computers on the network.

Making transactional sense

Much of the current hype is based on the idea that blockchain solves most digital transaction issues, such as:

  1. Security:Any individual on the chain is identified by a public key, which is available to everyone in the same way that an email address would be. As with all encryption, this key is mapped to a private key, which only the owner knows about. This system underpins privacy on the blockchain.
  2. Point-to-point exchange:When we pull out our banking apps and send money through them, the bank is still involved in the process. With Blockchain, the exchange of money between two individuals happens directly without any kind of intermediary.
  3. The ledger:In general, allpeer-to-peer transactions are logged in a ledger, yet with Blockchain, a copy of this ledger is present on many computers in the ecosystem, hence the term ‘distributed’. Every transaction, or ‘block’ in the ledger is non-reversible by design.As such, this distributed ledger (which everyone involved can see) becomes a permanent record of cash and digital transactions. This helps increase the trust factor.
  4. Node proofing:Each new transaction on the ledger is approved by a set of nodes. Each onehas to solve a series of complex mathematical problems to be eligible to approve (andget a small commission for) this work. The system is designed to prevent computer nodes from colluding to rig the overall system.
  5. Digital coins:Remember Bitcoin? It’secosystem started with a fixed number of coins with rulesdeciding whencoins could and couldn’t be issued. The issued coins can be bilaterally exchanged by users, witheach individual’s balance orcoin wallet determined by traversing the blocks in the Blockchain tree.

What’s the point?

All of this gives Blockchain a number of advantages, such as:

  • Cutting down on double spending–Double-spending is a long-running bugbear for many, and easily done. Anything digital like a photo or file can be copied and duplicated, yet currency notes in the real worldcan’t be used again. Blockchain solves thisproblem through the immutable ledger that’s visible to everybody.
  • Checks and balances– The technologythat ensures that the distributed ledger can’t be compromised follows a ‘proof of work’ system. Though the ledger is available to everybody, it can’t be hacked bya collusion of nodes, as mentioned above.Therefore, each transaction is approved with a foolproof method before it is captured in the ledger. Essentially,this provides the distributed ledger with integrity without the need of a central authority.
  • Going global – Since the currency is digital and not tied to a country, it is useful for cross border money transactions. There aren’t any costs for foreign exchange conversion, correspondent banking fees and other delays. Plus, the time for a new Blockchain transaction is typically just minutes, whereas currentcross-border transactions can take hours or even days.
  • Cross border trading– Typically, currency conversion comes with certain implications; the cost of imports or revenue from exports can significantly impact companies.These swings in revenue aren’t related to thequality or performance of underlying products or services – a globally accepted digital currency could help to solve this problem.
  • No single point of failure – In a central authority based system,all trust rests, rather unsurprisingly, with the central authority. So if the central authority fails,the entire system collapses. In the Blockchain model, where the ledger copy is kept at several nodes, this can’t happen.

Going beyond digital currency

By this point, the potential for blockchain in future has been made clear. Yet while there are several ideas currently being explored, many are still in their early stages of maturity.One early suggestion that we hope to see used in practice in the coming years is the storing of intellectual property rights, where Blockchaincouldidentify the owner of the right, the time of IP/node creation and IP contents at the time of filing.This could be used for trade settlement; overseeing the settlingof tradesbetween two counterparties and even underpinning the security of that transaction. Blockchain could even be used in a rewards program, for closed user-group membership points and rewards management.

It’s too early to predict the wholescale success of Blockchain, despite its recent buzz. It hasn’t been properly tested in terms of volume of transactions, variety of usage scenarios and mass user-experience. But aswe head into the digital economy, there is a need for a global payment platform which doesn’t rely on any one country. Given the potential and limited alternativesavailable, it is one of the best financial innovations in recent times.