Insight

Block Chain, The Real Gold Behind Bitcoin

I got into Bitcoin very early on and actually own a couple of Bitcoin from when I was messing around with it to understand how it works. So when I read about mainstream attention being given to the cryptocurrency I take note.

There are increasing reports in the media around Bitcoin being considered by major banks, in July Deutsche economist Thomas Dapp called bitcoin “one of the first truly disruptive ideas from the fintech sector”.

Last year Bank of America Merrill Lynch filed a patent to use the blockchain to power wire transfers, using the cryptocurrency on that chain as the exchange mechanism.*

But there is also resistance, Jamie Dimon (JP Morgan CEO) has been openly dismissive of bitcoin and HSBC cut ties with Jersey-based hedge fund Global Advisors, the world’s first regulated bitcoin fund, over fears around “money laundering risk” **

There have been several high profile Bitcoin exchanges (ie. Cash to Bitcoin) closed down recently by the US, and a pretty much wholesale rejection of Bitcoin by the Banks and businesses in Australia after 13 of its 17 cryptocurrency exchanges were closed down recently.

In my opinion, regulatory constraints (it allows bypass of KYC/AML regulations that governments require) and its anonymous nature will prevent Bitcoin from going mainstream.

Plus, exciting as Bitcoin seems, it is effectively just another “thing”, not massively interesting in the long term, however the technology that underpins it, Blockchain, is very interesting.

I see two separate discussions around this –

  • Use of Bitcoin Blockchain to trade other resources (ie. Securities) – The current Bitcoin Blockchain has a weakness that an attacker with enough computing power can create a new alternate Blockchain. This is very expensive and the amount of transactions on Bitcoin does not incentive people, however start putting billions of pounds of transactions a day through it and the equation would change. I read a great article around this by Robert Sams***which I recommend as further reading.
  • Use of Blockchain itself – This is the most interesting use case and the one I think has the best chance to go somewhere. Using Blockchain technology to provide a distributed, decentralised, real time ledger for various transaction types has the potential to speed up settlement and maybe even eliminate the clearing houses to provide cheaper payment processing for the banks.

Just a day after an IT glitch delayed 600,000 payments RBS announced a POC trial with Ripple, a startup that uses blockchain technology for the settlement of transactions using traditional currencies.

Goldman Sachs have recently taken part in a $50m investment in Circle, a US startup trying to use the blockchain to improve consumer payments.

It has been reported that Santander have identified 20-25 uses for the technology, and have co-authored a report that estimates Blockchain could save banks $20bn a year by 2020 through application in payments and other areas.

Barclays are way ahead with over 45 experiments currently underway using Blockchain.

In fact, you know it is serious when 22 major banks get together to create a set of global standards for the use of distributed ledger technology in financial markets!****

The two key benefits as I see them are –

De-centralisation of the system
Trust of the system without needing trust of any users of the system
But are these two alone enough to invest huge sums in migrating existing systems to a new solution based on blockchain? What is the real business need?

Trust is great, but what is the actual cost of human error? How would de-centralisation and trust reduce costs, increase profits or grow sales to drive banks to move to a blockchain solution?

  • De-centralisation could be the key here, but the tipping point may only occur when the banks assess scalability.
  • De-centralisation really comes into its own when you consider large scale growth projects, perhaps business integrations or even just seasonal peaks in demand.

Banks tend to have a small number of systems running core banking functionality and scale vertically, so catering for short term peaks in demand is very expensive as the infrastructure is costly and complex to upgrade. But the decentralised architecture of Blockchain allows horizontal scaling so an organisation could easily tap into cloud based resources for scalability.

I see this as an absolute no brainer for new projects or new start ups. The challenge will arise in asking the financial organisations to tackle the legacy of their current infrastructure and make a switch.