Blockchain in Financial Services
By: DeWitt Gibson
Blockchain in Financial Services is here to stay.
I clearly remember when I started my career in financial services. The year was 1997 and dial up internet was all the rage. AOL CDs would arrive in my mailbox almost daily and a company called “NetZero” was offering free dial up service at a blistering baud rate of 56kps if you agreed to look at a page of paid advertising when you first logged on. My too-expensive black Nokia cellular phone only did one thing – make voice calls.
I had several conversations with my financial services managers in those early years about how I really felt we should be using e-mail to communicate to clients and how having an online portal for clients to see their account values would be a service upgrade. I was not taken seriously. I was told that real people only want to communicate face to face or at worst over the phone. Email and the Internet would never catch on in a real way. They were toys for the lazy and socially inept and would never pose any real threat to the power of in-person communication.
Fast forward to 2018……… how often do you sit down these days and have a nice face to face chat with your personal banker or stockbroker? I bet it’s a lot less often than you check your accounts online.
I am not falling for that kind of stuck in the mud thinking again!
I see Blockchain today as I saw the Internet in 1997. A new technology with huge potential to transform, among other industries, the financial services industry. There are a lot of folks jumping in with both feet this go-around. Universities like MIT[i], Stanford[ii], Harvard[iii] and the like are embracing the teaching of blockchain technology. Major start up investors like Andresen Horowitz[iv] are likewise pouring millions of dollars into the space. Consulting firms like Deloitte[v] and Accenture[vi] are defining blockchain as a major initiative.
Blockchain is, at its core, simply a data structure: a way to organize and store values. It is in a certain sense, a new kind of database storage system. Blockchain has many features that transcend being a mere database, however. Blockchain is immutable, permanent, secure, and its data is transparent and verifiable in a way that most traditional databases are not. This gives Blockchain a serious advantage in many use cases in financial services.
Major technology players embracing this space and offering a Blockchain platform are IBM[vii] and Amazon[viii]. Non-commercial players like the Linux Foundation[ix] are hosting major blockchain projects. Ethereum[x] hosts one of the most popular blockchain projects and is highly favored in certain circles due to the ease of creating tokens and smart contracts using the Solidity programming language.
One must be careful to understand that despite all this hype, not every use case is suitable for blockchain. In many instances, a traditional database is more efficient. Running a blockchain network can be computing resource and storage intensive. It can take a lot of electricity to run a network. Blockchain simply for the sake of blockchain does not make fiscal sense. To effectively use blockchain in an application, there must be a clear case that other efficiencies are being created to offset the greater resource utilization. Like every other technology before it, however, it will probably become more efficient and inexpensive over time and thus will open other use cases.
There are 3 Applications that I have identified as having a clear and unquestionable current use case for blockchain in the financial services sector:
Application 1 – Asset Ownership Tracking
The tracking of the ownership, or “chain of title”, of financial assets is a clear use case where the features of immutability, transparency, and visibility of blockchain create greater efficiencies that the resources utilized to run the networks.
In the current state of things, verifying ownership, or “clear title” to a piece of real estate can be a very inefficient, uncertain, and slow. A title professional may have to manually search through offline records held at a County office to establish clear ownership rights. Even then you can’t be sure and will need to purchase a title insurance policy as protection. A blockchain based real estate title application could very quickly verify ownership and transfer ownership in a secure and transparent manner. The same could be said for other titles like automobiles, boats, aircraft, etc. If the assets were subject to financing, you could attach smart contracts to these blockchains which would act like a lien against the title of the asset and update the lien each time a payment is made and release the lien when the payments are made in full.
For exchange traded assets like stocks, bonds, notes, etc. settlement of trades could be near instantaneous without the need for a lengthy settlement period. The immutability and transparency of the blockchain would allow for more accurate reporting of things like cost basis and buy and sell dates.
Asset Ownership tracking and verifying is a use case where Blockchain offers clear advantages and efficiency in financial services.
Application 2 – Alternative Currencies and Payment Systems
Foreign Exchange is inefficient. Cross border financial transactions are mired in red tape and bank fees are crazy. Having an acceptable currency that is not tied to government control and available anywhere the Internet can be found is an undeniable game-changer. Anyone who has ever dealt with money in a real way though knows that banks and governments don’t take their control of the money system lightly. They call it by many names: Anti-Money laundering, currency controls. Patriot Act, etc. but the result is the same – if you skirt their system, they don’t want you to exist. For this reason, I believe this aspect of blockchain and cryptocurrency is going to have a long road ahead.
Even local transactions can be a challenge. Centralized bank clearing houses, merchant fees, and bank account fees all add up for everyone involved. Cryptocurrencies offer an alternative to these systems. For the same reasons as international transactions, I think even local transactions will be slow to progress. Blockchain and cryptocurrencies have their own challenges too: high electrical uses, slow transaction times, network unavailability, and other technical issues abound to provide challenges to this new way of processing payments.
Utility Tokens and ICOs (Initial Coin Offerings) are another spinoff of the Blockchain brainchild. This is an interesting area of blockchain in financial services, and one that is entirely unclear now (at least to me). Here you have a hybrid of paying for a service, buying a security, and simply buying a commodity. It will be something to see how the ICO space plays out. For now, the regulators are all over the map and as such it is likely to be a highly volatile aspect of blockchain in finance for some time to come. While this application holds great potential, it is facing the greatest regulatory headwind and will likely be turbulent for some time moving forward.
Application 3 – Financial Accounting
Financial accounting, bookkeeping, and reporting using blockchain technology is by far one of the most interesting use cases in financial services to me. One of the big benefits of blockchain is immutability. The idea that once a record gets committed to the blockchain or to the ledger, it’s there permanently. With each transaction linked to the transaction before it, blockchain provides a permanent and quickly verifiable financial ledger. This could essentially replace the need for the reconciliation of books and audits. It could reduce fraud, or at least make fraud much more difficult to achieve.
The move from double entry accounting to infinite accounting is going to truly revolutionize the accounting and financial services industries. It’s so big I can barely even get my head around it. This is the aspect of blockchain for financial services that gets me the most excited! This is an area I feel I will be hearing more about for years and decades into the future!
Having studied blockchain’s evolution and potential applications in financial services to this point, I believe that its application in financial accounting and bookkeeping to hold the best immediate use case. The advantages and efficiencies in this space are clear. Private companies could implement a blockchain accounting system very rapidly and without much red tape. Public companies could lobby for the regulatory permission to use one as well. These systems could be shared throughout the entire supply chain and with customers as well. This would create exponential efficiencies and reduce audit expenses.
Not every application is enhanced by blockchain, but the these application cases and more will bring massive transformation, disruption, and opportunity. Just like the internet before it, blockchain will be bringing massive transformation to the world of financial services in ways yet to be imagined. Those who are in denial or disregard today will be playing catch up tomorrow.
About the Author
DeWitt Gibson graduated cum laude from the University of Massachusetts Isenberg School of Business. He has worked in various sides of the financial services profession since 1997 and is a lifelong software and technology enthusiast. DeWitt took his first BASIC software writing course in 1982 on an Apple II+. He still has the programs he wrote saved on 5 ¼” floppy disks and printed out in dot matrix.
[iv] Andreessen Horowitz https://dealbook.nytimes.com/2014/01/21/why-bitcoin-matters/