Monday 20 February 2017 6:00 am CFA Institute Talk

How Blockchain technology will change the financial services industry

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These are articles written by professionals for investment professionals. They are contributions from external subject matter experts who do not work for CFA Institute, but may be a CFA charterholder as well as a member of a CFA Society. All are experts in their field and strive to deliver useful insights that help investment professionals make better decisions.

Blockchain technology has been hailed as a potential “second generation of the Internet.”

A whole vocabulary has sprung up around it, with an emphasis on key words like distributed ledger, cryptography, and trust.

But what is blockchain, exactly?

It’s basically a database where recorded transactions are copied to a participating network of computers. Since the information is disseminated across multiple computers using sophisticated cryptography, it can be viewed by all those with access rights to the network. Once the data has been entered, the information cannot be modified.

That means we wouldn’t need confirmation from our bank to know that we paid our utility bill, and our utility company couldn’t claim it hadn’t received remuneration. Once we made the payment transfer, the information would stay on the network for people to see.

This is how blockchain establishes trust among all parties: Trust that is driven by technology.

In October, we asked CFA Institute Financial NewsBrief which area of fintech will bring the most significant changes to the financial services industry. Blockchain was the clear winner.

Although blockchain has enormous promise, it has yet to gain many entry points into the finance industry. So where is the technology most likely to be applied over the next five years?

For more insight into this question, we asked CFA Institute Financial NewsBrief readers what specific aspect of finance will be most transformed by blockchain technology in the years ahead.

Over the next five years, in which of the following areas of finance will blockchain technology make the most inroads?

ver the next five years, in which of the following areas of finance will blockchain technology make the most inroads

Payments earned 50 per cent of the 466 total responses. The World Economic Forum (WEF) report, “The Future of Financial Infrastructure,” listed the benefits of applying blockchain technology in global payments, observing that blockchain “enables the near real-time point-to-point transfer of funds between financial institutions, removing friction and accelerating settlement.”

Dubbed “The Internet of Value Exchange,” blockchain should yield tremendous efficiency gains once it achieves its potential, particularly in the realm of global payments. The increasing interest of American Express, SWIFT, and Visa suggests that the enthusiasm among our poll respondents is justified.

Digital currency was also a popular choice, receiving 23 per cent of the vote. With blockchain as its underlying technology, digital currency requires no central issuing authority. Bitcoin, the most popular digital currency, is arguably the only example of large-scale blockchain implementation in finance today.

Although the concept of a currency that is not backed by the full faith and credit of a government may strike some as anathema, many central bankers are converts. The Reserve Bank of Australia (RBA), Bank of Canada, People’s Bank of China (PBOC), and the Bank of England are just a few of the institutions exploring its possibilities.

Capital markets drew 17 per cent of the respondents’ votes. Quite a few blockchain applications fit within this category, digital assets and smart contracts among them. Digital assets are an extension of digital currency just as stocks and bonds are extensions of cash, albeit with extra conditions and features built into them. According to the WEF report, a benefit in the collateral process is that it “provides market participants with an improved line of sight into assets, enabling improved risk evaluation and decision-making.”

Smart contracts may be better known outside of finance. They are essentially contracts that self-execute according to agreed-upon criteria. This technology has many promising potential applications in finance. So why aren’t readers convinced? Perhaps it’s because payments and digital currency are more fundamental and well-known applications on which smart contracts and other technologies would be dependent.

Digital identity came in at 9 per cent. Know Your Client (KYC) and credit ratings are two examples of how blockchain-backed digital identity technology can be much more efficient than the current practice. With blockchain, there is little need to check someone’s identification to open an account or to fill out the risk tolerance questionnaire that many regulatory authorities require before clients can open a securities trading or investment account.

Financial institutions can determine a potential client’s investment experience, risk tolerance, and other attributes through the blockchain, which as an added benefit, could help cut down on identity fraud. The credit rating business will likely be transformed as a result: Reliable credit histories could be available to all who need access to them. Of course, this raises potential privacy concerns, so technology solutions will have to be developed to allow users to safeguard their personal data.

How accurate will these predictions be? We’ll find out in five years, if not sooner.

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