Banks and other financial institutions have long been derided as being technologically-stunted organisations, too reliant on outdated processes and legacy systems and slow to adapt to the changing demands of 21st century life.
This is not always fair and, when it comes to the new wave of emerging technologies such as blockchain, many banks are not just keeping pace with innovation, they are leading it.
But what is blockchain technology, and why do the banks care enough to commit an estimated $1.7bn (£1.3bn) a year on blockchain research and development projects?
What is blockchain?
We must distinguish blockchain from its most famous incarnation as the technology that underpins cryptocurrencies such as bitcoin. Blockchain as a technology is a much broader proposition.
A subset of distributed ledger technologies; blockchains make clever use of cryptography, distributed computing and consensus mechanisms.
We could be very technical here, but we will not be.
It suffices to say that a blockchain is a distributed ledger, which can be used to identify ownership and audit transactions of value.
A blockchain enables the creation and maintenance of a replicated, shared and synchronised digital dataset that can be held and maintained in a distributed fashion, crucially without the constituent parties needing to trust each other.
Value proposition of blockchain
An obvious use-case example of a replicated and synchronised dataset that is held and maintained in a distributed fashion by untrusting counterparties is personal banking.
Let us say Kevin banks at Bank A and wishes to transfer £1,000 to Rosie, who banks at Bank B. At present, this transfer requires a number of steps:
- Kevin instructs Bank A to make the transfer ;
- Bank A deducts £1,000 from its internal ledger, reflecting Kevin's reduced cash holdings and confirms the same to Bank B;
- Bank B adds £1,000 to its internal ledgers, reflecting Rosie's increased cash holdings; and
- Each bank makes corresponding adjustments to their interbank ledgers.
The ledgers of both banks (and those of a central bank, in respect of the interbank lending) all need to agree with each other in respect of this transaction.
Now consider how often such transactions happen – literally millions of times, every day. That is a lot of ledger adjustments.
Imagine then a means by which a single ledger is accessible by defined parties.
In our example above, such parties would include Kevin, Rosie, Bank A, Bank B and the central bank.
Policy may dictate that the ledger is also accessible by Kevin's other creditors, his parents (where Kevin is under the age of 18), the tax authority or credit rating agencies.
This would streamline the operation of finance, making it simpler, cheaper and less prone to error. That is a blockchain solution.
Beyond money: blockchain in financial services
The value of blockchain has not been lost on the financial services industry.
A number of large organisations have invested in blockchain-focused research and development programmes, primarily focused on the classic banking our example illustrated above, that is, the maintenance of inter- and intra-business ledgers in respect of their lending.
The Bank of Canada and the Monetary Authority of Singapore have recently announced that they have successfully completed a cross-border, cross-currency transfer using blockchain technology.
This marks the first successful trial between two central banks and, according to Sopnendu Mohanty, chief fintech officer at MAS, demonstrates that, "cross-border payment and settlement can be made simpler and more efficient".