Blockchain promises to open the door to a whole new type of financial industry- one where banks aren't a necessity.
As blockchain technology picks up speed in various areas of the business world, more and more people are trying, and often failing, to fully understand just what blockchain is. That’s the way it is with new technology: it’s a complete mystery until it becomes simple enough for the public to use without having to understand the gritty details. Blockchain technology is no different.
To gain a better understanding of the upcoming technology myself, I spoke with Scott Foote, founder of Protinuum, with hopes that his wealth of knowledge on blockchain technology would offer some clarity. For now, we’ll focus on three main concepts in the context of the financial industry: how blockchain works, its impacts on the financial industry, and its adoption into general usage.
What is blockchain technology?
Scott began by describing blockchain as a ledger that is distributed amongst a digital community. Looking at blockchain as a distributed ledger, or a distributed database, helps us to understand a new concept in the context of something familiar. Right now, ledgers are manual recordings of financial accounts and transactions. They are generally kept in one specific location and are only accessible by a small number of users, be it the bank, the customer, or accountants.
In a distributed ledger, everyone within the community can see when a transaction occurs. The transaction records are then stored on tens of thousands of computers, including both home and business servers. Because of this visibility, the community must agree (or disagree) that a transaction occurred for the right amount of money. “Because everyone sees the transaction,” said Scott, “everyone must agree the transaction is valid, otherwise it doesn’t happen.” The potential for disagreements is what generates trust and honesty among participants.
When a transaction occurs in a blockchain community, it is not a copy of the file that is exchanged (like what happens when you attach a file to an email). Instead, the participants in the transaction are transferring ownership of the single, original copy. How do you know it is the original instead of just another copy? Each file exchanged on blockchain is cryptographically signed. That is, it is encrypted to guarantee that the receiver becomes the new owner of the original copy.
How does blockchain work?
Blockchain uses virtual currencies in a digital community that enables transferring ownership of soft products, such as photographs, songs, or other files, in a peer-to-peer network. The most talked about cyber currency right now is bitcoin, but different blockchain communities use different currencies. To make things simple, we’ll use bitcoin as a consistent example. Members of blockchain communities have an account that stores their bitcoin. This account is similar to one you would have at the bank, but each account has a long, secret code to give the individual control over only their own transactions.
However, unlike the exchange of cash, when transactions occur, the actual bitcoin doesn’t move. Instead what changes is the ownership of both the bitcoin and the soft product that is being exchanged. Once a certain value of bitcoin has been exchanged, the original owner has no more control over that value and what the new owner does with it. The validity of the original copy is ensured by the encryption mentioned earlier. This is transformative because, prior to blockchain, there was no way to distinguish ownership and authenticity of digital products among identical copies.
How can someone even get cybercurrency to use in a blockchain? “Most banks have an account on the blockchain. You can go to your bank and say you want $100 worth of bitcoin. They would say give us your bitcoin ID and the money, and we will transfer $100 worth of bitcoin into your account” explained Scott. The value of bitcoin changes like any other currency, but it generally depends on how much it can be traded for. Most importantly, Scott emphasized, “You don’t need to go to your bank to track your bitcoins. You just need to go to your blockchain. The blockchain is the new intermediary.”
How will this technology disrupt the financial industry?
To understand a simple overview of how blockchain will impact banks, think about a card file in the library. Hard to remember what that looks like, right? Well, that’s kind of the point. Libraries act as a centralized medium that record where books are stored and exchanged. Blockchain provides a similar service because it tracks the movement of a file. However, libraries are becoming obsolete due to easy accessibility to soft copies of books on the Internet. The key difference here is that blockchain technology takes advantage of the internet, as opposed to falling victim to it.
Turning back to the financial world, banks act as a similar central intermediary to libraries, but for financial exchanges. They store our money, track our transactions, and offer additional services such as credit cards, loan consolidation, and credit monitoring. However, Scott says that blockchain is eliminating the need for a middle man by “undermining the entire concept of a community needing a central authority.” Blockchain creates a community in which members can complete transactions immediately without having to go through the bank. The idea of a central authority to control money is becoming obsolete.
With blockchain technology, you can manage your own ledger. The visibility and encryption within each blockchain community allows us to have digital, trust less transactions between peers. Formerly, the two sides of a transaction would both have to trust the bank with their exchange. Now, we turn our trust to technology.
Although blockchain threatens the success of existing bank services, there is an opportunity for financial institutions to adjust their current services to meet the new needs of customers using blockchain. Banks hope to provide a re-intermediation platform offering updated services, once customers realize there is a lot of overhead in financial transactions they don’t want to deal with. Because society is currently beginning the process of disintermediation, meaning the need for a central authority is decreasing, the need for these potential opportunities are far in the future. But banks recognize the threat that blockchain technology poses, and they’re already taking action. As Scott said, “banks either need to provide more services, or be blocked out of the [financial] industry entirely.”
The World Bank has appointed economist Rosanna Chan to lead a team of 60 employees in researching potential blockchain solutions, not just domestically but globally. As of April of this year, 75 banks from around the world (including Bank of America) have signed with Ripple, a “blockchain as a service” community that allows banks to provide overhead work.
In May, Fidelity announced their integration with Coinbase, a digital asset exchange company, to support certain services they want to offer for their customers in blockchain. The goal is to offer similar services as they do now, but at lower costs. Other areas banks could take advantage of are transactional maintenance and insurance. A major concern with blockchain is a lack of federal insurance on money stored in a digital ledger. Banks have the opportunity to back certain blockchain ecosystems and provide insurance for its users.
When can I start using blockchain?
Right now you’ll mostly hear about blockchain being used in ransomware. Because of this bad rep, a common misperception of blockchain is that it’s illicit. But blockchain isn’t just for bad guys! Blockchain technology is also currently used by larger institutions focused on moving commodities back and forth. These usages sound abstract and un-relatable, and they are for most of us. In order for blockchain to be generally accepted, it must be simplified to the point where we don’t need to understand the technology in order to use it. Once it becomes easy to use, blockchain will become just another digital wallet.
While blockchain technology poses undeniable threats to the financial industry as we know it, banks aren’t backing down. They’re developing new services and researching solutions to the risks in an attempt to secure their relevance, even in a digital world.
Thank you to Scott Foote for offering up his knowledge and experience with blockchain and helping to foster an understanding of a complex concept in simplified terms.