Bitcoin, that infamous digital currency, has captured the imagination of many people, but has failed to penetrate mainstream finance, even though it is recognized as a currency and can be exchanged for conventional currency. Probably it is most well known for its use by criminals and fraudsters.
The technology that underlies Bitcoin, on the other hand, is brilliant, and is beginning to have an impact on mainstream finance. This technology consists of two main elements – blockchain and distributed ledgers. There has been quite a widespread fascination with these two technologies and their potential.
Blockchain essentially organizes transactions into blocks of information. All of the blocks are timestamped and linked together and cannot be changed after they are linked and closed.
Distributed ledgers complement blockchain by providing a means of recording transactions in a way that is open and transparent and secure. They differ from conventional ledgers in that they instantly produce copies of the transactions in different locations. That is, various people involved with the transactions, and others, will have a copy of the transactions and will know immediately if any of them are changed.
Blockchain and distributed ledgers have attracted the attention of financial institutions because of their transparency and the secure way in which they can preserve the integrity of the transactions. For example, in a report by the UK Government Chief Scientific Adviser, titled “Distributed Ledger Technology: beyond block chain”, the technologies are recommended for a variety of financial functions because of their potential for security and integrity.
The report points out, for example, “The security and accuracy of the assets stored in the ledger are maintained cryptographically through the use of ‘keys’ and signatures to control who can do what within the shared ledger. Entries can also be updated by one, some or all of the participants, according to rules agreed by the network.”
A major distinguishing feature of blockchain and distributed ledgers is that they are transparent and there is a record of all transactions that cannot be changed. Another major feature is that because all transactions can be recorded at the same time in different venues, it is possible to settle transactions instantly. There are numerous transactions in finance, such as share swaps and derivatives that take too long to settle, and being able to settle them instantly is extremely attractive.
Despite these attractions, some have raised concerns and doubt as to whether the banking system is ready for change of this magnitude. They point out that adoption of blockchain and distributed ledger technology would require major changes in their IT systems. Since these systems are very critical to large volumes of transactions currently taking place, any changes would themselves be critical and very sensitive.
There would also be issues of integration with other systems that are not directly affected by the transactional systems involved with the adoption, but nevertheless need to interact from time to time.
In the end, blockchain and distributed systems offer up some real advantages to the banks – advantages that should override the issues around systems change. Major among these is the unquestionably high level of security they provide Banks. They need to have secure systems, and the present ones do not offer enough security at all.
Existing commercial systems do indeed need a major overhaul in terms of security capabilities and blockchain offers up an innovative and effective solution. And the ability to settle transactions on the spot is something that is badly needed in certain areas of finance. These technologies are likely to gain more mainstream support in future.