Up till recently, blockchain was a term known only to geeks and specialists. But in the last few months, it has become the buzzword among bankers.
In November, the Monetary Authority of Singapore (MAS) announced that it would soon test how it could issue digital currency using a blockchain-driven system for interbank payments.
The planned proof-of-concept will be supported by blockchain R3CEV, as well as eight banks and an unnamed local stock exchange, Bloomberg reported. The Development Bank of Singapore, HSBC, Bank of America, JPMorgan, Credit Suisse and Bank of Tokyo-Mitsubishi are all said to be participating.
So, what exactly is a blockchain and why is everybody making such a huge hoo-hah about it? We speak to experts from IBM and Misys financial software solutions provider for answers.
So, what’s a blockchain?
To put simply, a blockchain is a secure open ledger system that cannot be changed. This means that everyone on the ledger can see what’s happening with the chain at every moment in the lifespan of the transaction.
“With blockchain, you are combining a distributed database. Rather than a centralised database, you have a database that is copied across the main users,” Alexander Wolff, product strategist at Misys told Asia Finance at the recent Misys connect forum.
“The key benefits of a distributed database over a centralised database is that you get rid of the need for reconciliations because everybody has the copy of the same records,” Wolff said.
How will blockchain change the way banking and financial services work?
Despite being heavily reliant on technology, banking is one of the last parts of the global economy still largely untouched by the digital disruption that has transformed so many other industries. But that’s about to change with the advent of blockchains.
- No central authority
Unlike traditional banking, there’s no central authority in a blockchain system. Rather, it is a peer-to-peer network in which participating computers exchange transactions for inclusion in the public ledger they share.
With all transactions being added to a single public ledger, it reduces the clutter and complications of multiple ledgers.
- Elimination of intermediaries
With blockchain technology, collaborators will be able to work together as free agents instead of under a hierarchy of bosses.
In this vision, blockchain could replace bankers, accountants and lawyers, as well as escrow accounts, insurance and everything else that was invented before this to verify payments and the performance of contracts.
- Faster transactions
Interbank transactions can take up to days for clearing and final settlement, especially outside of working hours. With blockchain technology, transactions times can be reduced to just minutes and are processed 24/7.
- Reduction in operational costs
By eliminating third party intermediaries and overhead costs for exchanging assets, blockchains present exciting potential in its ability to massively reduce transaction fees.
- High levels of transparency and security
Any changes made to public blockchains are publicly viewable by all parties. This creates transparency and process integrity as users can trust that transactions will be executed exactly as the protocol commands. Further, all transactions are immutable – meaning they cannot be altered or deleted.
“This is where consensus protocol comes in and ensures that all versions of the distributed ledger stay in sync and cannot be fraudulently changed. This consensus protocol is the true innovation of the blockchain technology and is what enabled the bitcoin, the first association of a blockchain distributed ledger,” Wolff explained.
Mainstream adoption of blockchain could come as early as 2017
The World Economic Forum thinks that most banks will start using the blockchain in 2017.
Blockchain has the potential to drive simplicity and efficiency by establishing new financial services infrastructure and processes, the forum said, adding that the technology will form the foundation of next generation financial services infrastructure.
A recent survey by IBM also found that 15% of top global banks intend to roll out full-scale, commercial blockchain products in 2017.
IBM, whose findings were based on a survey of 200 banks, said 65% of banks expected to have blockchain projects in production in three years’ time. Larger banks, those with more than 100,000 employees, are leading the charge.
The technology company said that areas most commonly identified by lenders as ripe for blockchain-based innovation were clearing and settlement, wholesale payments, equity and debt issuance, and reference data.
Foreseeable challenges in blockchain adoption
Zelda Anthony, IBM’s head of blockchain, ASEAN said the main challenges surround blockchain integration and cultural adoption. For instance, blockchain applications offer solutions that require significant chances or even complete replacement of existing systems. Companies who wish to make the switch will need to strategize the transition.
Further, blockchain represents a complete shift to a decentralised network, which requires the buy-in of its users and operators.
“This means you need collaboration and you need collaboration throughout the industry. You need to bring these parties together and they need to work on the same solution, and agree that it’s the right solution – that’s the real challenge,” Anthony told Asia Finance.
Meanwhile, Imad Abou Haidar, managing director of Misys in Asia Pacific, foresees issues on regulatory acceptance and legal precedence with blockchain adoption. Modern currencies have always been created and regulated by national government. Hence, blockchain will face a hurdle in widespread adoption by existing financial institutions if government regulation status remains uncertain.
Lastly and perhaps most importantly, many are concerned about privacy and security. While solutions exist, including private or permission blockchains and strong encryption, there are still cyber security concerns that need to be addressed before the general public will entrust their personal data to a blockchain solution.
In February, IBM announced that it would donate 44,000 lines of blockchain code to the Hyperledger Project, providing an open source foundation for building distributed ledgers. The move followed a series of announcements that major financial and technology firms are exploring the blockchain.
The creation of an open source blockchain programme is likely to accelerate the adoption of blockchain in a number of industries.