Select Page

Blockchain

 

The Wall Street Journal reported successful tests of blockchain technology back in April, with banks including J.P. Morgan Chase & Co. and Citigroup Inc. The test was on credit-default swaps, and the success of these tests could mean a big change in mainstream finance down the line. From the WSJ: “The swaps are essentially insurance contracts that pay off if a bond goes bad, and the process of keeping track of the over-the-counter products can be a burden. Banks match buyers and sellers, transmit the trades via a service run by data provider Markit Ltd. and send a record to Wall Street’s central bookkeeper, Depository Trust & Clearing Corp.”

 

From Forbes: “In short order, an unlikely alliance was forged. Startups with names that have barely entered the public conscious (e.g. BitFury, BitGo, Bitnet, Bitstamp, itBit) are now working with the U.S. Justice Department, the FBI, and the Commodity Futures Trading Commission. Still, the most ardent supporters of blockchain came not from Silicon Valley, but from Wall Street.”

 

While no tests have cracked the code and caused large-scale overhaul just yet, more tests are happening all the time and the focus on implementing the technology is huge.

 

Using the blockchain technology as an open ledger between the parties that anyone involved can view is similar to multiple people editing a Google Document at the same time. Changes can be viewed by anyone at any time. These successful tests are in their infancy, and much more discussion and testing before they come to the conclusion that blockchain should be implemented at all, let alone on a large scale such as live trading.

 

The potential for blockchain technology cutting out middlemen, saving money, simplifying currency exchanges, and reacting faster than current systems is drawing a lot of eyes in the financial world. “Analysts at Autonomous Research say using blockchain could cut trading settlement costs by a third, or $16 billion a year, and cut capital requirements by $120 billion. A recent report by Citigroup forecast that automation including blockchain could eliminate two million banking jobs, largely in processing, over the next decade.” said the article.

 

The test was worked out amongst the banks involved by technology firm Axoni, which is a company with it’s sights set on applying these technologies to established financial institutions. There have been several conceptual and developmental projects in this vein, but this current test was the best “proof-of-concept”.

 

Any actual structural changes in the financial systems of stock trading, banking, settlements or the Federal Reserve are probably quite some time off. There are those reluctant to embrace the new systems, in fear of adding complexity to the current processes or may lead to challenging their market share.

 

So what IS blockchain technology?

 

The idea behind blockchain is a technology that provides a tamper-proof data structure with a shared public ledger, available to all. While developed as the backbone of bitcoin and other crypto currencies, the idea behind bitcoin is a secure and easily verifiable way to make transactions easily and immediately, with no central authority in the middle. It is secure enough that it lowers risk of fraud and the potential for hacking, and is faster without being passed through a central third party.

 

To explain it simply, most payment transactions go through a third party. To go from Bob to Jane, from Bob to Department Store, or from Bob the Stock Trader’s company to Jane the Stock Trader’s Company, there has to be a bank or a credit card company in the middle. Most banks and credit card companies charge a fee for every transaction. The banks and credit card companies must be trusted with your secure financial and personal information, keeping your money safe from fraud, theft, and clerical errors. People have tried to work out a system that cuts out the middleman in the equation, but then you come across the issue of proof of payment. How do you prove that you’ve given money to someone, or that you even have that money at all, without a third party holding the money and vouching for it?

 

If Bob tells Jane he’ll give her $20 for her shoes, and she gives them to him and Bob really only has $10, what will Jane do? If Bob gives Jane the money and she says he didn’t pay her so he can’t have the shoes, how would he have proof of giving Jane the money for the shoes? The blockchain technology gives the individual the ability to record a transaction in a public ledger, and it then becomes extremely difficult to change or remove.

 

If you want to add to or take away from this ledger, participants in the network run algorithms to evaluate and verify the legitimacy of the proposed transaction. If the majority of the nodes independently come to the conclusion that the transaction appears valid and matches the history of the blockchain, the new transaction is available to to be approved and a new block is added to the chain. As a result of this community of nodes and systems participating publicly, an attempt to “trick” the system is significantly more likely to be caught by system’s participants. It will be rejected from the chain and fail as a transaction.

 

As a decentralized and open platform for bitcoin, no one person, government, or financial institution in the world can levy fees on payments or control when and where it is used. As a tool for the financial institutions that society has built over hundreds and hundreds of years, it will probably remain more private between the institutions involved, and the Depository Trust & Clearing Corp believes that U.S. regulators will be needed with oversight from a central body.

 

Bitcoin itself is volatile as a currency, and mired deeps in legal battles as it has become the go-to for unscrupulous and untraceable weapons buying, ransoming, prostitution, drug-selling, and more. It has also been built around the idea of a finite amount of bitcoin existing in the world permanently, so companies over the years buying the bitcoin and hoarding it could result in it being an unusable resource. It remains to be seen if the currency that the system was built around will have longevity, but these tests show that even if the currency dies, the system built to support it may live on.