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Blockchain technology: How it could change the future of financial services

24 March 2016 in Investing Insights

Key Takeaways

  • Blockchain is the cryptography technology behind the decentralized currency bitcoin.
  • More financial firms are adopting blockchain technology for improving money flow, reducing transaction costs and expediting settlement time.
  • Recently, NASDAQ used blockchain for issuing private securities and proxy voting. In addition, 40 large banks including Goldman Sachs have tested fixed income trading using blockchain.

Since blockchain is the technology behind bitcoin, before we dive into how it could affect the future of investing, it helps to get a solid grasp of bitcoin. You’ve probably already heard of bitcoin, but perhaps brushed it off as hype from years past. Since bitcoin is now the most prevalent form of blockchain technology, it is worth understanding how it works.

Bitcoin is a type of digital currency that is created, held and exchanged electronically. In other words, it is a type of money that can be used to place transactions though you can’t physically touch it. Also referred to as a crypto currency, mobile currency, or virtual currency, it was created to enable fast, low-cost and secure online payments without a central bank. Essentially, it is a peer-to-peer system that doesn’t rely on a third party or government.

While bitcoin first surfaced in 2009, still unknown is the identity of its creator who goes by the pseudonym “Satoshi Nakamoto.” Either way, bitcoin gained popularity in 2013 when its value crossed the $1,000 mark in November from under $15 at the beginning of the year. Its time above $1,000 was short lived, however. Interest began to fizzle out as concerns grew over its instability, lack of regulation and limited acceptance among merchants. Many people still have reservations about its security and an absence of transaction insurance.1

Source: Statista, Bitcoin Price Index
Source: Statista, Bitcoin Price Index

Blockchain Gains Momentum

What’s interesting is that blockchain, the technology behind bitcoin, is gaining traction. More financial services businesses and Silicon Valley leaders are signaling that they believe the technology has more potential than previously thought.

The reason? Blockchain technology is not just for bitcoin. A growing number of people believe it could be used for other purposes such as managing trading settlements, improving data management, optimizing internal processes and enhancing security practices.

How does blockchain technology work? In regards to bitcoin, it functions like an enormous public ledger that continuously keeps track of who owns how much bitcoin now and since inception.

Data centers around the world known as “miners” keep everything running and earn newly minted bitcoins for authenticating transactions. In other words, there are a bunch of computers dedicated to stringing together “blocks” of transactions. If you have fears that one day computers will run the world, you may find blockchain a terrifying thought.

To get a grasp of how blockchain functions, it helps to visualize a chain being formed one link at a time. Each link represents a group of transactions and the chain gets longer and longer as more transactions take place. Historical data is also preserved and accessible at any time.

Source: The Economist
Source: The Economist

Even with a public bitcoin ledger, the identities of bitcoin holders are protected and kept anonymous by blockchain’s unique cryptography. This is one of the reasons bitcoin and other crypto currencies are often used in black market activities.

Blockchain’s Advantages

Some advantages of chaining blocks together in sequence is that it helps prevent multiple parties from spending the same bitcoin and offers protection from any single party altering the system. Since miners have to reach a consensus on the latest version of the blockchain, there’s no need for a middleman such as a central bank to verify or control anything.

If blockchain technology can also be used to significantly improve the flow of money, banking fees could be reduced and the speed at which transactions take place may also see improvement. This decentralization, for instance, could allow banks in different countries to interact directly with each other without having to transfer money through correspondent banks. In addition, some proponents visualize a world in which blockchain would end credit card fees and foreign transaction charges.2

It is also possible that blockchain technology could be applied to other areas; it be applied to sending messages, tracking the ownership of assets, notarizing information, tracking land registries or enforcing contracts. Other potential uses include creating audit trails for marriage licenses, lawsuits, voting and health records while maintaining privacy.

While blockchain’s potential may be limited only by our collective imagination, for now, it seems to be gathering the most momentum in financial services and investing.

Recent Trends

Many large financial firms want to harness blockchain technology to lower costs and speed up capital market transactions and payment systems.

NASDAQ announced in December that issuer Chain.com successfully used its NASDAQ Linq blockchain ledger technology to complete and record a private securities transaction. It said blockchain has the potential to reduce trade clearing and settlement for equities from three days to as fast as ten minutes. As a result, systemic and settlement risks could be reduced.3

Bob Greifeld, CEO of NASDAQ called this transaction a “seminal moment” in deploying the blockchain technology, and believes it will jumpstart a process that could “revolutionize” the infrastructure of capital markets.4

In addition, administrative tasks can be streamlined with fewer manual and multi-step processes. NASDAQ has also been exploring ways to utilize blockchain for proxy voting in Estonia. Estonian residents recently voted in shareholder meetings using blockchain technology.5 Notably, most of Estonia’s banking infrastructure is secured by blockchain, which is believed to have contributed the country’s claim to having the lowest rate of credit card fraud in the euro zone.6

In January 2016, U.K. chief scientific advisor, Sir Mark Walport, asked the government to start using blockchain technology for issuing passports, tax collection and other public services. Not much later, the consulting firm PwC announced it was assembling a team of 15 technology specialists to focus specifically on blockchain technology development.7

In March, 40 major banks tested blockchain technology with fintech firm R3 CEV to trade fixed income securities, with participants including Barclays and Goldman Sachs.8 The ability to securely settle large volumes of trades within minutes or even seconds would be automatic and a significant improvement to current processes.

Keep On Learning

Things happen fast in the stock market and blockchain technology could accelerate the pace even more. The more knowledge you have, the more you can be more empowered to make informed investing decisions. Get insights and learn about emerging trends in the investing insights area of our blog.

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  1. Statista, “Bitcoin Price Index from July 2013 to February 2016 (In U.S. Dollars),” Statista, 2016.
  2. The Economist, “Blockchain: The Next Big Thing. Or Is It?” The Economist, May 9, 2015.
  3. NASDAQ, Inc., “NASDAQ Linq Enables First-Ever Private Securities Issuance Documented With Blockchain Technology,” GlobeNewswire, December 30, 2015.
  4. NASDAQ, Inc., “NASDAQ Linq Enables First-Ever Private Securities Issuance Documented With Blockchain Technology,” GlobeNewswire, December 30, 2015.
  5. Kharpal, Arjun, “40 Banks Test Bitcoin Tech For Trading Bonds,” CNBC, March 3, 2016.
  6. Gault, Mike, “Forget Bitcoin – What Is The Blockchain And Why Should You Care?” Re/code, July 5, 2015.
  7. PwC, “PwC Launches New Global Technology Team To Harness Bitcoin Technology,” PwC, January 21, 2016.
  8. Kharpal, Arjun, “40 Banks Test Bitcoin Tech For Trading Bonds,” CNBC, March 3, 2016.
Tags: bitcoin
  1. Brian
    24 Mar at 12:57 pm

    Wow this is so fascinating. This is the first I’ve heard of blockchain. I’d heard of bitcoin before but never really understood it before. Thanks for making it so easy to understand.

    Reply
  2. Alex
    26 Mar at 10:27 am

    I had a friend who tried to mine bitcoins in college. I had no idea what he was talking about at the time. Now I wish I got a piece of the action. Blockchain sounds promising so I’m excited to see where it leads. I’m really digging these insights posts, keep em coming.

    Reply

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