Tony Virdi, VP and Head of Banking & Financial Services in the UK & Ireland, Cognizant
Big financial transactions have been virtual for a long time, moving around the world via banking and corporate systems, tallied up in spreadsheets. Now, however, we are seeing how everyday money and currencies are going digital with the rise of cryptocurrencies such as Bitcoin, as an alternative to ‘hard cash’.
Crucially, the technology that underpins Bitcoin, Blockchain, has the potential to transform centuries-old mechanisms for transferring money. Our latest research, which surveyed over 300 banking executives on the current payments landscape across Europe, found that cryptocurrency and Blockchain technologies are now seen as real drivers for change. In practice, last month saw nine banks, including Barclays and Royal Bank of Scotland, reveal that they may adopt the Blockchain system, due to the fact that “it is hard to fool, making fraud more difficult, could speed up trading systems and make deals more transparent”.
What is Blockchain?
Blockchain is the technology that enables cryptocurrencies and is built on the principles drawn from cryptography, game theory and peer-to-peer networking. This allows any unique monetary data exchange to get past the problem of double spend by making the ledger (the book of record) available to all participants in the network and by creating a process by which a consensus can be reached in changes to the ledger. However, the method through which consensus is reached for making changes to the distributed ledger differs from one cryptocurrency protocol to another. Bitcoin, for example, makes use of the ‘proof of work’ method, which depends on miners providing proof of computing resources expanded in verifying transactions before being allowed to make changes to the distributed ledger, essentially adding transaction records to the ledger of past transactions.
The Blockchain opportunity
The advantages of Blockchain are not only in its functionality, but also in its secure and resilient architecture that protects against some very powerful attacks, both actual and theoretical. Crucially, it offers the promise of addressing some of the key challenges and pain points experienced in the financial sector for many years. Beyond the security implications and increased transparency of transactions to all parties involved, whether institutions or customers, it can have a beneficial impact on pricing and costs in the market, along with the opportunity for more accurate tracking of customer repayment histories, across borders and banks, reducing the risk of defaulters. For example, Everledger, a permanent ledger for diamond certification, has adopted the use of Bitcoin as a mark of authenticity providing transparency for all parties involved – a clear attempt to prevent diamond fraud.
In the short term, it is essential that any financial services business works to develop specific use cases to understand how the technology could support their organisation. These types of test beds are already being developed around the world. For instance, ANZ is looking at experimenting with Ripple to understand the benefits along the whole customer value chain. Similarly, OCBC in Singapore has talked about identity verification that could be taken up for transactions across borders, using Blockchain technologies. These types of examples being explored have the potential to reduce the time for transactions, dramatically impacting costs, along with eliminating cumbersome back office processes, something which all organisations in this sector are looking to achieve.
Challenges to widespread Blockchain adoption
There are several challenges Blockchain will have to overcome before it becomes mainstream. These include scalability, the time taken to verify the transactions, the cost of transactions and security. A lot of attention recently has focused on incidents of hacking at Bitcoin-based companies and start-ups. However, what has not been covered in detail is that some of the thefts did not originate through the network but were initiated by individual customers. For example, a software wallet, which is basically the Bitcoin equivalent of a bank account, is installed on customers’ own computer or device and controlled completely by the customer. These wallets are stored unencrypted and have been attacked through the hacking of someone’s personal computer. However, if a fraudster wants to make any change to the distributed ledger, it cannot be done unless the fraudster also controls 51% or more of the participants on the network, which is next to impossible in the case of any large network. What’s more, regulation is still not very clear for settlement protocols involving cryptocurrency protocols.
On a positive note, regulators in a number of countries are increasingly taking steps to understand, contextualise and regulate digital currencies. Although there are no restrictions on how financial institutions can use Blockchain to build and manage their own internal networks, external use of Blockchain technology like payments and transfers will be impacted relative to how regulators approach regulating cryptocurrency-based networks. Recent indications from central agencies in the US and UK indicate that regulators are in fact taking a very pragmatic approach to Blockchain technology and the news from the major banks has added further evidence to this pragmatic approach.
It is certainly true that Blockchain has the potential to disrupt the way we bank today, transform traditional interbank and even peer-to-peer payments and open up opportunities to replace existing mechanisms for both the exchange of financial information and how customer records are stored and processed.
Although there are still numerous challenges to overcome before we see real change in how financial services use this technology, it seems certain that businesses need to keep a close eye on Blockchain and be prepared to adapt and transform their services accordingly.