There’s been a lot of attention focused on Bitcoin in recent years but arguably the most intriguing aspect of this crypto currency is the technology that underpins it – the blockchain.
The blockchain facilitates Bitcoin and works by sequentially ordering blocks of transactions into a chain which is distributed to and can be viewed ‘publicly’ by, all parties and allows each to maintain a single up to date picture or ‘ledger’. Companies seeking to harness the technology have received over $500 million in VC investment so far this year thanks to its promise for transforming how assets are accounted for.
By providing a single transparent trail and a distributed ledger, the technology has the potential to significantly transform, or even replace, much of today’s financial infrastructure. The distributed ledger is a peer-to-peer model and doesn’t require a central ‘coordinator’ or hub. Today most of our clearing and settlement infrastructure that intermediate trades or payments between banks operates in a centralised model as a ‘hub and spoke’. It is this that could be affected by the blockchain.
Adoption has multiple advantages: from eliminating error and reducing manual processes, to lowering operational costs and improving accuracy and transparency. Ultimately, this could lead to a large number of ‘back-office’ roles common in today’s banks becoming extinct in the medium term.
However, before investing in this technology I advise organisations to carefully assess its strengths and weaknesses, like any other innovation. For instance, the blockchain adds value where there is a large number of participants, distributed over a wide area, many with low numbers of transaction.
Conversely, in situations where the primary need is about processing high transaction volumes between a limited number of organisations, traditional ‘hub and spoke’ payments infrastructures may well be better.
‘Smart Contracts’ and buying houses on a Saturday
The exciting part is that the ‘ledger’ doesn’t have to be a traditional ‘balance’: It could be any asset that can be represented in digital form. This gives rise to the potential to develop ‘smart contracts’, able to replace the cumbersome processes we have today and very clearly identify and prove ownership. Not only would this further transform financial markets, It may also allow you to buy your next house on a Saturday.
Combining the ‘smart contract’ blockchain with guaranteed payments would tackle one of the oldest concepts in payments, Delivery versus Payment, or DVP. DVP is the principle of understanding that when an asset is handed over the seller has received the payment, and vice versa. Cheques are an example of a payment mechanism that lacks adequate DVP today. You can enjoy a meal, pay by cheque, leave the restaurant and it can bounce.
Today, when you’re buying a house you need to do so within working hours and with your solicitor acting as a mechanism for DVP. When the buyer transfers the money to the seller’s solicitor, his or her own solicitor receives the deeds. This process of ‘exchange and completion’ can take several weeks, and only happens during business hours, usually involving a CHAPS payment made in a branch.
With the blockchain concept of a smart contract, the exchange of the deeds and the funds transfer could be proven, linked together automatically, whilst happening in near real time and theoretically on a 24/7 basis.. The same principles are true for many asset types and purchases, such as buying a second-hand car – a process fraught with risk today.
In short, the potential applications of the blockchain are diverse and that’s one reason why it is attracting such a lot of VC cash. What’s important for those experimenting with this new technology is being clear about where it can add value, and where it can’t.