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Getting to grips with blockchain

By:
Peter Lee
Published on:

Banks have suddenly cottoned on to the power of the blockchain technology beneath Bitcoin. Inside their own treasuries and innovation labs, and increasingly in collaboration, banks are testing uses for rebranded distributed ledgers to replace their costly, proprietary systems. Enthusiasts see banks creating a new fabric for payments transfer and financial markets, an internet of money. Doubters sense it’s all hype. Big challenges remain, but markets from private equity and syndicated loans to corporate bonds and derivatives may go on private blockchains within months.

 Blockchain
It’s mid 2015 and Euromoney has been talking to the head of markets at one of the largest global banks about the changing structure of fixed income trading. As the meeting ends and we head to the lifts Euromoney asks what news from the OTC interest rate derivatives desks, now transitioning onto swap-execution facilities. 

"The derivatives markets? Oh, they’re all going OBC," says the banker. Euromoney makes that quizzical face we all learn in journalist training school. They’re doing what? "They’re going on blockchain," the banker grins; the lift doors close and he ascends. In the days after, Euromoney tries to follow up but, unusually for him, the banker goes strangely silent.

A couple of months later and the blockchain is all you hear from the banks. It is as if the entire industry has decided that the whole of finance is going on blockchain and all that remains to be decided is just how and when.

Blockchain is the technological infrastructure underpinning bitcoin, and its association with the cryptocurrency has delayed appreciation among mainstream banks of the transformative power, elegance of design and genius of the mechanism for value exchange it embodies.

At its heart, the blockchain is a series of incentives and limits for the creation, validation and secure maintenance of an open, shared, transparent and immutable ledger of record for all transactions and shifts in ownership in an asset: in the original case, the asset being bitcoins.

Participants in the bitcoin marketplace can spend their bitcoins – transfer them to other parties in payment for goods or services – knowing that other participants in the network will recognize and validate that exchange or payment and record it in a system-wide ledger that no one central source owns or controls. 


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The so-called miners that perform this validation must show proof of work – in electricity consumed and computing power used – and are themselves paid in new bitcoins. They confirm each other’s work by consensus before a new page – or block – of the ledger is established, so ensuring that an owner of bitcoins cannot spend the same coins twice and that the receiver will not subsequently find his ownership of those transferred bitcoins challenged or his payment reneged on.

That’s a lot of weird sounding concepts. What does it all mean? 

It means a peer-to-peer payment network where Mike in Mexico City can transfer payment to Sam in Singapore directly and securely in about 10 minutes flat, without any 'help’ from a bank in the middle that may take days to process the same transaction through its correspondent banking network and charge a fat fee for the privilege of inserting its inefficiencies into the process. The blockchain takes out the middleman. 

Indeed it removes the need for middlemen by replacing the key trust element that has kept banks at the heart of the payment system for centuries. Mike and Sam may not think much of their banks’ systems, but they do trust their banks. Mike may never have met Sam, but if he wants to buy something from him, he knows that if he puts $500 in his bank and asks his bank to pay it to Sam’s bank, all of that will eventually happen, even if it takes days and costs a hefty percentage of the transaction. Mike knows that, eventually, Sam will be able to take out that $500 from his own bank. 

Simon Taylor, Barclays
 My role has flipped in a matter of months from trying to interest people here in thinking differently about the potential of the blockchain to struggling to contain their expectations. It isn’t the answer to all banks’ problems

Simon Taylor,
Barclays

Blockchain technology uses encryption and a balance of incentives and checks such that the system as a whole can be trusted to work without any of the individual participants within it necessarily trusting each other – or even knowing each other beyond the lines-of-code pseudonyms that act as identifiers of individuals on the network. 

Banks are used to sitting on vast databases of proprietary data protected at the perimeter by password access. Blockchains embed encryption into every transaction and interaction between users and the ledger. Users have their own encrypted keys. 

The final genius of the bitcoin Blockchain is this. Enough malign forces acting together could subvert it – perhaps a handful of users pretending to be many more by using multiple pseudonyms – if they together accounted for just over half the computing power on the network. But by the time they got to that point, these forces would have amassed so much bitcoin wealth, that destroying trust in the network and thus in the value of bitcoins – which goes up the more they are used – would be utterly self-defeating. The system colonizes its own would-be invaders. The bitcoin Blockchain has been attacked but it has never been hacked.