Blockchain: What are the opportunities and risks for FIs?
Blockchain, the technology behind the cryptocurrency Bitcoin, is rapidly gaining credibility in the financial services industry as a potential platform for solving a variety of complex and time-consuming processes.
Opinions on Bitcoin are often split; the currency’s wildly fluctuating value and links to certain black market activities have dampened enthusiasm, especially among financial institutions (FI).
However, investment in blockchain has substantially increased, with nearly two-thirds of organisations believing the technology will disrupt financial services and lead to new payment services and products. A recent Deloitte report said venture capitalists have ploughed roughly $1 billion (£757 million) into blockchain start-up companies, with half of this in the last year alone.
But what is blockchain? How does it work? And what opportunities and risks are there for companies that are considering deploying the technology? Let’s take a closer look at blockchain and how it could affect FIs in the future.
Blockchains are a form of distributed digital ledger where data can be recorded and shared by members of a community. Depending on the size of the community, the blockchain can exist on tens, hundreds or even thousands of computers worldwide.
Every user within the network has access to the blockchain, and it is almost simultaneously updated across all computers when changes are made. Each transaction is added as an update or ‘block’ to the existing ‘chain’ of code, but only once the information has been independently verified.
Complex algorithms connect each block together in a chronological order through an encryption process called ‘hashing’. Blockchains can be open to everyone or restricted to a specific group of participants, depending on user needs.
Typical transactions are confirmed within ten minutes and the requirement for multiple independent computers to verify each one means fraud, tampering and manipulation are considered far more difficult.
What are the benefits for FIs?
A recent survey from Edgar Dunn revealed 80 per cent of FIs believe blockchain has great potential in the industry. The ability to transfer assets quickly, securely and transparently in almost real-time would make the technology a disruptive force in finance, according to 60 per cent of respondents.
Edgar Dunn highlighted three key areas where the technology could bring significant benefits:
Stock markets: Trading and settling shares via blockchain has already occurred on the Nasdaq. In December last year, the index confirmed that its Linq ledger had issues shares to a private investor, bypassing intermediaries and cumbersome administration processes.
Money transfers: Business-to-business and peer-to-peer payments are fairly inefficient, relying on legacy infrastructure and slow, expensive clearing procedures. A faster, more secure system such as blockchain could create significant efficiencies that save time, money and resources.
Asset and collateral management: The ability to verify and potentially execute contracts between parties using pre-defined conditions means blockchain could prove useful with asset and collateral management. The technology’s transparency and near real-time nature could also help reduce fraud.
Despite these opportunities, blockchain is still in its infancy and FIs may want to consider the potential risks of implementing such solutions. Only then can businesses maximise the potential of the technology.
Weighing up blockchain risks
One of the key problems with blockchain is there appears to be a lack of education about distributed ledgers among finance firms. Deloitte noted that data analytics, the cloud and other digital trends are widely understood, but blockchain is more confusing.
This viewpoint is supported by State Street research, which showed 78 per cent of asset managers feel they require further education on the technology. In fact, only seven per cent of organisations had initiatives in place to support blockchain, and 90 per cent of respondents believed security was a concern.
Other areas that FIs must consider include future regulations and compliance. Technology advances are currently outpacing relevant legislation with regards to blockchain, but this is likely to change and firms must be prepared for new laws that could affect their systems.
Eighty per cent of asset owners and managers for the State Street study also said the IT department would feel the greatest disruption from blockchain. As such, finding the right skills and talent to adapt to these technical demands will become increasingly important.
Blockchain clearly possesses significant potential for FIs that want to increase the efficiency, transparency and speed of transactions. However, they must also be aware of the risks that emerging technologies can pose.
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