Blockchain, cryptocurrencies and Banking

We’ve always loved money. Because, as the old saying goes, it does make the world go round. From the days of bartering we’ve been exchanging, and used shells, miniature replicas of bronze tools, rare metals like silver and gold, and eventually starting to standardise the modes of money into various types of coinage and currency.

And now we are evolving a new system – the ‘bitcoin’. According to Sopra Banking Bitcoins and other cryptocurrencies are based on digital technologies and utilize cryptography, through the ‘blockchain’, as the method of protection, in much the same way as we’ve used watermarks and similar methods to protect paper money. This is a natural pathway for money to go down. We are becoming an increasingly digitized society. Cryptocurrencies are part of this new era.

Before we begin, a little on what the blockchain is and how it works.

The blockchain, is as it sounds, a chain of information broken up into blocks of data. Cryptocurrencies, like bitcoin and others, use the blockchain as a conduit.  A blockchain is sort of like DNA in that each ‘gene’ (block) contains a specific piece of information. Each block of data represents a transaction of currency and you can follow the chain to build up a picture of each transaction, right through to the current one. You could take the analogy further and describe the individual units (nucleotides of the gene, i.e. ATGC) as being a simple codon, a little like the encryption in the blockchain. In the block chain, the block of data is protected using public – private key encryption and you can only access these data if you hold the private key. This is also what obfuscates the information within cryptocurrencies and therefore helps to prevent data theft.

Blockchain Banking Applications

The evolution of bitcoins mechanisms has been acknowledged by banks, and has the potential to go beyond this and be revolutionary. The Fintech sector has been exploring the use of cryptocurrencies as a new innovation to challenge some of the more legacy business models in banking that may stall progress. Many banks, including CitiBank, Santander and UBS, are starting to embrace that this disruption can exert a positive influence on future banking innovation. Because the blockchain encrypted transactions are registered in an authenticated ledger system, it allows individuals and banks to transfer assets worldwide in a secure and traceable way. Security is always paramount to finance.

Removal of intermediaries: One of the areas being explored by the financial sector is how cryptocurrency technology can remove the need for intermediaries due to its inherent cryptography based security. It offers an automated intermediary system, removing the need for the current system of centralised ledgers that act as a custodian. In the blockchain, there is no central ledger – instead it is a decentralized trust model not dependent on a single entity.  Financial market researchers the TABB Group, whilst speculating that blockchain syndicated loans can happen very soon also caution that the financial sector needs to agree standards and set up checks and balances before the blockchain technology can truly make inroads into the sector.

Voting management: Another key area that is seeing financial sector disruption via the blockchain is in ‘voting management’. Voting amongst shareholders and directors may well be crucial to the continuation of a company, mergers and acquisitions, and other crucial verdicts. Proxy voting can improve voting turnout for these fundamental decisions but can also be open to fraud and security issues.

The use of the blockchain as a proxy voting mechanism can retain the ease of electronic voting whilst simultaneously increasing security. The NASDAQ chief executive Bob Greifeld announced in October 2015 that the Estonian NASDAQ market will be using blockchain based technology to provide proxy voting at AGMs – all possible from a voter’s mobile device.

Dividends and shares: Cryptocurrency technologies are also being modified to accommodate the issuance of shares and dividends.  This year the U.S. Security and Exchange Commission (SEC) approved the use of blockchain technology to allow Internet trader to issue company shares. The fact that a block chain keeps a record of every transaction and its owner of the throughout its lifetime means it is perfectly placed to handle this sort of transaction in a very seamless and traceable manner.

The Blockchain as a Proof Chain

Pretty much any type of information can be encrypted and placed within the blockchain.  In this way, it acts like a database – a linear and traceable database. Because the transactions are verified by a community of users and not a single entity, the trust levels are increased; there is no single weak link or point of failure. Each part of the block in the chain is individually timestamped and cryptographically signed. And so any process that now requires documentation and proof of validity or certification could have those paper documents replaced by individual blocks. One example of use is identity verification, including name, date of birth, address etc. The block chain could be used to create certified and verified identities that offer a greater level of assurance when performing financial transactions. Speeding up the process and building in hardened trust models goes beyond the current centralised, single intermediary system and takes it into a whole new sphere.

Crossing the Border with a Blockchain

Seamless cross border payments is one of the real potentials of cryptocurrency technology. The current systems used for moving money across global borders are full of friction and some processes utilize many multiples of banks and within those multiples of intermediaries.  A blockchain provides a more simplified process, based on inherent accountability, assurance and verification.  It can also allow for localized transactions within the movement of currency – a bit like opening an email on a desktop; the email may have been sent from the USA but it opens in a French client. Each part of the money movement is audited through the chain for financial system compliance, and the experience should end up much more streamlined and with reduced costs.

Which blockchain has to be used?

There are different types of blockchains, broadly falling into open and private. Companies like Ripple and Etherium would like to impose their blockchain, but understandably blockchain community and banks don’t like to depend to a company to transfer their asset securely.

The Future is Blocked

Finally, cryptocurrencies and the underlying blockchain technology are being taken seriously by the banking sector. Analysts Greenwich Associates found that 94% of the surveyed financial professionals believed that technologies like the blockchain would be beneficial to institutional markets and that at least half of those were actively exploring their use. The previous concern that the obfuscation of and inability to trace transactions fuelling the criminal elements use of cryptocurrencies is being left behind. Instead the ability of the blockchain technology to create more efficient, secure and faster processing systems is proving too attractive to ignore.