Blockchain: Hype or Radical innovation?

Fintech Technology

In the past year interest in blockchain has soared (see Google trends), VC funding in Blockchain breached the 1bn milestone, 500mln only in 2015 but we still have to see familiarity with this technology across the financial industry.

The goal of this article is to try, according to my own understanding, to address the opening question, is this an overhyped technology or is it truly a radical innovation?
Secondly I would like to walk you through a few examples in my notes on how a blockchain works – and finally based on that try to summarise it all into a definition that we can all understand.

What is blockchain?
You might have come across a few articles talking about it, The Economist calls it a “Trust machine” – trust can be coded up – replacing the so called “anchors of trust” in a network, Bank of England goes one level deeper, focusing on how this technology allows for people that don’t know each other to agree and trust a shared record of events. Deloitte take it a step higher, calling it a foundation layer for something more, finance being its logical implementation but much more can be done with it.

Now at this stage we just understand that it allows trust to be coded, it allows “somehow” to reach a consensus with strangers and without an intermediary and its a foundation of a lot more… too vague.

What is Blockchain?

A blockchain is a chain of blocks that makes up a database, holding a log of transactions. This database is replicated across a distributed network using cryptography & digital signatures to determine valid transaction such that everyone agrees on the order and state of the ledger in real time (consensus algorithm or block puzzle) without having to rely on a trusted 3rd party to hold the true golden copy. This database is by design immutable and holds all events since inception which makes it the holy grail of audit trail.

Before we get on to what we can actually do with it, let’s get something out of the way.

Blockchain is not Bitcoin, Bitcoin – the currency – is email for the internet, it is not the real invention, is the first application of that invention. It is commonly brought up in these discussions being a public blockchain that handles around USD 11bln (market cap), which could also be seen as a white hacker experiment on the technology more broadly, which is in place since 2008 and has no winner yet.

Also it is important to notice that the example we saw refers to a public blockchain, we have several type of blockchain and the technology changes slightly depending on its usage case.

For instance, in a private blockchain such as a company’s private blockchain, there is no need to come up with a consensus algorithm that waste energy to acquire a “proof of work”, we know & trust each node in the network and there is no risk of a untrustworthy participants.

The promise of Blockchain

Now that we get a sense on how a blockchain works, we attempted to define it, let’s see why everybody gets excited about.
A good way to breakdown its potential implication is via “ ATOMIC” – as described by William Mougayar in “Business Blockchain” – a high level summary of the fields disrupted by this technology.

  1. Assets being the first one, creation and real time movement of digital assets
    • Digital asset is a digitalised version of a product that includes specific rights to use, and typically has a value attached to it because of it. Without rights, it is not considered to be an asset, and is just a “digital file”
    • Before blockchain, digital assets in a P2P fashion did not make sense because of the double spending (or double sending) problem, now P2P becomes a viable option.
    • Not digital native only, tokenisation: embedding data that describes a real-world asset on a digital token that lives on a Blockchain
  2. Trust: transaction that requires trust related actions, such as proof of identity, existence, purchase, location ownership
  3. Ownership: public record of real or digital asset ownership
  4. Money: it can be an alternative (as bitcoin), a pegged fiat extension to expand velocity and capabilities (micro transactions)
  5. Identity: you become the owner of your identity in the network and this could very well replace re creating an identity at each POS (multiple proprietary databases vs decentralised database) – toc toc KYC
  6. Contracts: virtually the most exciting part of blockchain as it builds on top of all of the area it disrupt to create something out of it. A contract, or smart contract, its essentially business logic with self enforcement.

This has implications across industries obviously, but we take a narrower look at our industry we can see how it could benefit it.

  • All transactions of digital assets could be facilitated, we can imaging instruments illiquid before being brought back to the radar increasing the opportunity set of our portfolio managers.
  • From an operations perspective, the big one is trust without reconciliation, functions that are employed to reconciliate transactions can be reallocated to increase value elsewhere in the value chain, complexity can be reduced, transparency implies better risk oversight, and the big is: this is the dream for a regulator, we could give a read-only to a regulator or even embedding a regulatory framework such as UCITS as a self-enforcing smart contract.
  • The technical architecture becomes more simple and robust (distributed database), secure and allows for actual step forwards in product development.

 

Conclusion

  • Blockchain is a new protocol that sits on top of the Internet, one that allows for trust to be coded up making digital tokens reliable and valuable, the missing piece of the information revolution.
  • Blockchain is more about business process reengineering than just technology.
  • It cannot be applied to existing process, it needs to be at the core of the design of new processes.

To answer the original question of this post, despite the hype, the premises and potential implications of Blockchain technology are too significant to ignore and are worth taking the risk.

To finish with a quote aimed at all the industries potentially impacted by this technology:

“When a single technology touches almost every core part of your business model, you need to pay attention, as it will be a challenging encounter” by William Mougayar.

 

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