Blockchain and the currency of data

It is surprising how passionate some people are about the definition of blockchain. To some crypto-currency enthusiasts there is but one true blockchain and that is the one that supports bitcoin. Bitcoin is the crypto-currency that can be used to transfer value over the internet without the need for banks or central authorities.

The currency attracted lurid headlines when it was found to be the currency of choice on the silk road dark website where drugs and other illegal goods were being sold. However, it is also accepted by many mainstream companies and between $150m and $250m by value of bitcoin transactions happen daily across the globe.

Bitcoin is not the only crypto-currency, but it is the largest; however, it is likely to remain a niche application with the underlying technology, blockchain being seen as the real transformational opportunity.

There are numerous alternative blockchain platforms that have been (and are being) developed. The key common attributes can be summarised as:

•    Data is distributed between multiple parties with each participant in the network having their own copy of the data, which remains in line with every other copy as updates occur. This distribution of information explains the alternative terminology preferred by some: distributed ledger technology (DLT).

•    Participants communicate through peer-to-peer protocols without the need for a single central authority. This makes the barriers to extending the network low as new participants can be added as 'nodes'.

•    Updates to information are validated through a distributed mechanism so that updates can be trusted and malicious changes avoided.

•    Each update that is accepted is recorded as a new block of information thus forming a chain of events so that a complete transaction history is maintained and a tamper-proof audit history is created.

Some blockchain technologies (Ethereum is the best known) also allow the creation of 'smart contracts', which allow participants to embed behaviour as well as data in a transaction. For example, smart contracts have been demonstrated for corporate bonds that automatically trigger interest payments based on a commonly held view of rate of interest, interest periodicity and currency. Not only do all parties see the same data, but the bond also behaves the same way for all parties.

Why is this interesting firms and what applications are being explored?

The ability to have common views of information shared by all participants without a central authority is one of the key transformational opportunities that financial institutions are exploring. Today in capital markets trading environments each party keeps their own view of the ledger of assets and exchanges messages back and forth between each other and the many intermediary securities depositories, clearing houses, custodians and sub-custodians that exist.

Creating a common consistent shared view offers the possibility to reduce delays, remove disputes and eliminate duplication of data entry and the need for reconciliation. In their Fintech 2.0 report Santander estimated the savings in securities and FX settlement that could arise from this technology to be $15bn to $20bn per annum globally.

This has led to numerous initiatives and announcements with infrastructure firms such as DTCC and the Australian Stock Exchange announcing plans to launch applications. Banks have also launched initiatives and announced their plans to develop a 'settlement utility coin'.

The ability to manage updates to information in a highly secure manner and create a tamper-proof history of a transaction has led banks to explore possibilities in trade finance. By using a blockchain ledger to manage the creation and authorisation of a letter of credit, Barclays was recently able to execute on a trade finance deal in four hours instead of the normal five to seven-day timeframe. The technology offers not just efficiency gains, but also the secure management of the authorisation. The authentication process will also help fight fraud.

The technology has uses beyond banking in wider financial services. Smart contract technology was used by Allianz in a successful experiment to trial the issuance of a catastrophe bond that captured all of the key contractual information and could be triggered to pay out by conditions being met. Overall insurance could be a rich area for other business uses, Z/Yen identified 14 potential areas that could benefit from the technology in a recent survey and report. Among these the placement process, know your customer/anti-money laundering, claims management and settlement were all highlighted by survey respondents.

Blockchain’s potential uses are not restricted to financial services. The government chief scientific adviser’s report, Distributed Ledger Technology: Beyond Blockchain, identifies numerous other applications including the potential to help governments collect taxes, deliver benefits, issue passports, record land registries and assure the supply chain. One of these, payment of benefits is currently being trialled by the Department for Works and Pensions.

What are some of the challenges that will need to be overcome ?

 Delivering on the promise of blockchain is not without its challenges, including: 

•    Scalability. The bitcoin application has known scalability limits and currently can handle only approximately seven transactions per second. This will not be close to enough for wholesale markets applications. This limitation is being overcome with different (proof of stake) consensus mechanisms and the reduced complexity of private “permissioned” blockchains.

•    Confidentiality of data. On the bitcoin blockchain all participants see each transaction. On a commercial chain there may need to be greater confidentiality with certain parts of the data being restricted to the relevant parties. Different solutions to this issue are being explored, but there is more to do.

•    Regulatory concerns. Partly because of the negative connotations associated with bitcoin, regulators have in the past been concerned about blockchain. In the past 18 months there has been a noticeable change with central banks notably the Bank of England and regulators such as ESMA looking to understand the technology and encourage dialogue on how to deploy it.

•    Legal frameworks. For high value professional uses, the legal framework will need to recognise and support the new technology. Work may be needed in some jurisdictions to ensure that ownership represented in a shared ledger can be perfected, but in general problems appear to be surmountable.

•    Co-operation and standards. Probably the most complex issue o solve comes from the way the technology will deliver benefit. In most cases the real benefit will be attained though making the interaction between multiple parties more efficient. Blockchain is not a game that is fun to play alone. To deliver change therefore requires that firms need to work together with customers, suppliers and peers (competitors) to agree business practice and technical standards. To that end consortia such as R3 and Post Trade Digital Ledger Group (PTDLG) have formed to drive progress, but consortia development is complex and there is much to be agreed.

Despite these challenges the potential benefits and the size of the prize will dictate that progress will be made. With $1.4 bn now invested in the major blockchain technology firms and with technology giants such as IBM and Microsoft investing heavily, it seems certain that progress will continue to be made.

Where 2016 was a year for proof of concept and pilot applications, I expect 2017 will see more early live pilot applications with a significant uptick in use of the technology as we move into 2018.

Steve Webb is Blockchain leader and partner at PwC 

Key points

The technology causing the most excitement in financial services at present is blockchain.

Some blockchain technologies allow the creation of 'smart contracts', which allow participants to embed behaviour as well as data in a transaction.

Blockchain’s potential uses are not restricted to financial services.