Prospects of decentralised solution in a finance world. The case of blockchain

With contributions from Adriana Minovic.

One of the major forces of the Internet is of course its power to drive economic change. This is a common goal for all actors in the digital arena. Users want connectivity. Companies want to make a profit. Governments want equal development. Understandably, e-commerce is a large part of the world business now, and it is significantly related to development issues.

In the past few decades, banks and financial institutions embraced the emergence of electronic solutions and implemented strong cryptography in order to secure their business and solidify the trust of their customers. Known for their traditional and cautious approach, financial institutions carefully waged implementation of innovations. This boosted the development of new ‘FinTech’ (financial-technology) start-ups and businesses. They were cleverly filling this gap with the ambition of moving the innovations ahead. Today the FinTech sector is growing rapidly. Many companies have established themselves in the traditional area of ‘bank work’ (credit cards, online payments, etc). A large number of these companies are exploiting the emergence of a new technology called ‘blockchain’.

Blockchain technology was developed for the first crypto currency Bitcoin. Bitcoin attracted a lot of fans mainly because this new technology proved to be efficient and secure. Blockchain is an open source software, distributed via the Internet and is, in essence, a ledger of data (in this case – Bitcoin transactions). It is used as an overview tool for all transactions ever made in the Bitcoin system. Therefore, the Bitcoin monetary system is decentralised. It was tested and proved to be resilient many times during the eight years of its existence. This simple cryptographic solution (data packets with verified transactions aligned with timestamps forming a chain) has attracted a lot of attention. It already has remakes in the form of alternative cryptocurrencies (only last year Bitcoin lost 10% of its market share to these alternative cryptocurrencies). Every day there are new ideas to be used for many other things in need of a global distribution network. In the crypto world, the concept of a distributed ledger was taken to the next level with the developments such as Ethereum project, which offers virtual contracts whose automatic realisation is ensured thanks to blockchain technology. The blockchain model can be modified to validate any set of data and make it trusted. This feature launched it from the small circle of crypto enthusiasts into mainstream financial world focus.

In recent developments, banking institutions are testing and engaging in joint research efforts to develop blockchain applications for their systems. Organisational cost reductions created the initial impetus to explore blockchain. According to reports, at the opening of the Sibos conference in Switzerland on September 26, Thomas Jordan, President and Chairman of the Board of Switzerland’s Central Bank stated: ‘Decentralization, not centralization, now appears to promise the greatest efficiency gains.’[1] He added that the best possible future development would actually be a blend of centralised and decentralised solutions, where security information is on a blockchain.

Blockchain also features in more recent reports. UBS and other banks will try to use blockchain in their settlement solutions according to the Financial Times. Bank of Tokyo and tech giant Hitachi are to use it for cheque digitalisation. UBS is to use it for potential loan market improvements, researching the impact that blockchain may have on stocks. The list goes on. Still in a proof-of-concept phase, almost all blockchain applications are implemented in cooperation with the third-party FinTech companies.

Banking institutions are aware that the new age of innovations will herald an in-depth change in their relationship with their customers. In a reasonable business move, banks will eventually go further and try to ‘close the circle’ technology wise. This will include not just software solutions like blockchain, but also the hardware components of the future devices. This is evidenced by the recent example of the acquisition of the British semiconductor marker ARM by the Softbank Group, who has started work on implementing Internet of Things (IoT) solutions into its services. In perspective, financial institutions and national and commercial banks may offer many other services backed by this blended approach to centralised/decentralised solutions. Innovations in e-commerce and demand for a global responsiveness will move things in this direction. They will for sure, try to offer best of both worlds.

In a new Gartner, Inc. report – Gartner’s 2016 Hype Cycle for Emerging Technologies – which provides a cross-industry perspective on technologies and trends, blockchain is almost at the peak of inflated expectations. ‘Cycle depicts the dynamics of the diffusion of digital innovation. It starts with the “technology trigger” – the moment of innovations and inventions – and builds up to the peak of inflated expectations, characterised by “blue sky” coverage of new technology in the media. At this point in the cycle, the fortune turns downwards. All big promises face reality-checks and an inevitable disillusionment, which generates cynical comments on the new technology. This dynamism turns into the slope of enlightenment, which reaches, after some time, the plateau of productivity. This is what “remains” of technology.’ [2]

It may be a long way from implementing blockchain solutions down the ‘trough of disillusionment’ into practical technology. Innovations can be overturned, even made obsolete, in a matter of months. On other hand, central banking authorities, financial institutions, and commercial banks, are actors who are pushing the global agenda and impacting related policies. They are experienced in governing macro systems. Knowing the scale of efforts for global development and having a clear agenda towards this goal, it is reasonable to believe that some distributed ledger solutions will reach the ‘plateau of productivity’. Traditional financial institutions, FinTech companies, and regulators should, and will work together on ensuring the transition to a digital economy era. Development is a long-term project. Time is ahead of us.

Follow the latest updates on e-money and virtual currencies on the GIP Digital Watch observatory.

Notes:

[1] Coindesk: Swiss Central Banker: Blockchain Turning Finance ‘On Its Head; Financial News: UBS looks to build ‘settlement coin’ alliance

[2] Consult Dr Jovan Kurbalija blog post, Digital Diplomacy in Three Graphs