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The cryptocurrencies and their underlying blockchain technology are advertised as the next big thing after the creation of the Internet. One area in which these technologies can have a greater impact is the financial sector. Blockchain, as a form of distributed ledger technology (DLP), has the potential to transform established financial institutions and reduce costs, faster transaction execution, greater transparency, verifiability of operations and other benefits. Cryptocurrencies maintain the promise of a new class of native digital resources without a central authority.
What do these technological developments mean for the various players in the sector and end users? "The blockchains have the potential to move any business based on transactions that occur on traditional business databases, which is what underlies almost every aspect of the financial service – any financial transaction that has little transparency and limited traceability is vulnerable interruptions from blockchain applications: DLT is therefore both a great opportunity and a disruptive threat, "according to Bruce Weber, Rector of Lerner College and Professor of Business Economics, and Andrew Novocin, Professor of Electrical and Computer Engineering, both at # 39; University of Delaware.
At the beginning of this year, Weber, Novocin and Jonathan Wood conducted a review of the cryptocurrency literature and DLT for the SWIFT Institute. Based on this review, the SWIFT Institute recently released a grant to conduct new research on DLT and cryptocurrencies in the financial sector. Weber and Novocin have noted that, just as disrupters like Amazon, Google, Facebook and Uber have built software platforms and flourishing businesses thanks to the connectivity provided by Internet standards, the new generation startups will build new services and activities with blockchain. "Many experts expect that the blockchain, as a distributed technology, becomes the basis for new services and applications that have completely different rules from those running on hierarchical and controlled databases.The cryptocurrencies are a prime example, but many others will follow", they added.
Regarding cryptocurrencies, Hosanagar stressed that most of the value today is linked to speculative purchases rather than to real use cases. But having a currency without a central authority offers "some unique types of protection, especially in countries with troubled central banks". For example, the currency of Venezuela is rapidly losing value. For people who stored their savings in the crypt, there was greater protection against such rapid monetary devaluations. "Of course, cryptocurrencies have their own instability, but they are not tied to central bank actions and this is particularly relevant in countries and economies where citizens do not trust their governments and central banks," he said.
"Any financial transaction that has limited transparency and limited traceability is vulnerable to interruptions by blockchain applications." -Bruce Weber and Andrew Novocin
Hosanagar expects the first wave of applications to be implemented in "private" blockchains where a central authority as a financial institution and its partners are the only ones with permission to participate (as opposed to public blockchains, without authorization, where the participants are anonymous and there is no central authority). Applications in private blockchains, he said, will be more secure and will offer some of the benefits of decentralized ledger books, but they will not be radically different from the way things work today. However, over time, it is expected that smart contracts (self-enforcement contracts when requirements are met) are offered on public blockchain networks such as Ethereum. "When securities are traded, intermediaries provide trust and charge commissions, Blockchains can help provide such trust in a low-cost way, but securities trading is governed by securities laws. ensure compliance with the law and have great potential thanks to their ability to reduce costs while being compliant, "says Hosanagar.
According to Weber and Novocin, a & rsquo; mature area for transformation is reaching consensus on important rates and reference prices. At present, they point out, several proprietary indices are used to determine interest rates and the price of many traditional assets. Blockchain can transform it. "We think of the London Interbank Offered Rate (LIBOR) and the recent scandals involving the manipulation of benchmarks when they are controlled by a single entity that may not be able to detect false or fraudulent data, but Blockchain could provide greater transparency on the process creation of agreed target prices and allow more people to participate in the consensus process ".
Weber and Novocin expect that in some areas intermediaries will find their roles reduced because blockchain allows automation through greater transparency and traceability. In other sectors, intermediaries will be well placed to take advantage of the changing needs of their clients, as companies will need help managing the transition to new standards and the increased complexity of open and traceable blockchain infrastructures. Intermediaries in potentially disruptive areas, they said, "should be involved in projects that seek to set standards, so that they can stay informed and position themselves to profit from becoming leaders in the operations of new markets that will emerge."
Blockchain will reduce the enormous duplication of information that creates delays, conflicts and confusion in many aspects of financial services, added Werbach. For example, when a credit union union takes part in a loan, having a shared ledger means that not everyone has to keep track of it independently. International payments and registrations of corporate securities are other examples where there are huge inefficiencies due to duplicate registrations and intermediaries. "End users will not see changes in the deep plumbing of financial services, but they will allow new service providers to emerge and new products to offer," said Werbach.
Impacts along the way
Angela Walch, a law professor at St. Mary's University School of Law and a researcher at the Center for Blockchain Technologies at University College in London, offered another perspective. He said there is a lot of excitement about the blockchain as accounting technology distributed to the financial sector, because many believe it offers a better, more efficient and more resilient form of storage. However, making use of the blockchain is not as simple as simply buying new software and running it. "Blockchain technology is at the center of group registries.To get all the benefits, it is necessary that all the relevant members of the group adhere to the system.This requires collaboration with and through companies, which is a potential obstacle and it could be the obstacle that most limits adoption ".
Governance is the biggest challenge in decentralized organizations, said Weber and Novocin. Members who participate in a financial function supported by blockchain may have misaligned incentives and may end up stalled or with a chaotic result. They cite the example of the "DAO Hack", which was the first major smart contract project on the Ethereum network to suffer a major loss of funds. The Ethereum community voted to conduct a difficult fork (a radical modification of the protocol that validates previously valid blocks / transactions or vice versa) – reverse transactions after the hack and substantially repay DAO investors. This was in effect a violation of the immutability of Ethereum and left a considerable minority of the deeply dissatisfied community. This group saw the Ethereum community abandon its commitment to permanent and immutable records. They refused to recognize the hard fork and kept the original Ethereum blockchain, now known as the Ethereum Classic (while the forked version supported by the Ethereum Foundation is simply Ethereum).
"The power to eliminate intermediaries is the ability to reduce transaction costs and regain control from powerful financial intermediaries." -Kartik Hosanagar
"Distributed organizations serving an open community need to take care to design their governance systems, incentive structures and decision-making processes to build consensus without unduly slowing decision-making," Weber and Novocin said. "Scenario planning or warfare deserve to be explored at the start of blockchain projects: Early planning enables organizations to respond quickly and predictably to support stakeholders." Early publicizing these plans can also increase trust and trust of users. "
Cryptocurrency risks
Werbach has listed a variety of cryptocurrency risks and vulnerabilities: Bitcoin has shown that the fundamental security of its proof of work system is robust, but has important limitations such as limited scalability, massive use of energy and concentration of data mining pools. There was a massive theft of cryptocurrencies by the centralized brokers that most people use to keep it, and massive fraud by promoters of initial offers of coins and other schemes. Handling is widespread on slightly regulated cryptocurrency exchanges.
For example, about half of Bitcoin transactions are with Tether, a "stablecoin" which claims to be supported by US dollars, but which has never been controlled and is involved in highly suspicious behavior. Money laundering and other criminal activities are a serious problem if transactions do not require real-world identity checks. "There are great efforts to address all these risks and vulnerabilities, some are technical, some are business opportunities and some are regulatory issues, and there must be recognition among the cryptocurrency supporters that the maturing of industry will in many cases require cooperation with historical operators and regulators ", added Werbach.
Hosanagar warns that while decentralization offers significant value – and a significant number of miners / validators must verify the transaction for its validation – it is still susceptible to collusion. If one or a few companies that manage many miners / validators in a small network collude, they can affect the sanctity of the network. The big risk with cryptocurrencies, he added, is that most of today's activities are linked to speculation. It is important that cryptocurrencies quickly discover a killer app, so there is an underlying value created beyond speculation of its future value, "concludes Hosanagar.
The road ahead?
Consider all these challenges, what is the current mentality in the financial sector towards the adoption of these new technologies? And, importantly, should you push for broad acceptance and diffusion, or do you need to stabilize first?
According to Werbach, "It is neither a nor a choice". Cryptocurrencies and blockchain technology in general, he noted, are currently immature. However, there are some areas where they are already able to be implemented effectively. The best way to tackle today's problems is to "build work systems and see where the difficulties arise," Werbach said. Looking ahead, integration with law, regulation and governance will be fundamental. Blockchain and cryptocurrencies represent a new form of trust, he added. They will only succeed if they become sufficiently reliable, beyond the basic security of distributed accounting books. "Law, regulation and governance are three main mechanisms for producing reliable systems that fit society-wide adoption.We have to find ways to address the legitimate concerns of governments without unduly restricting the innovations that blockchain technology lets me be optimistic about that process over time. "
"We need to find ways to address the legitimate concerns of governments without overstretching the innovations that blockchain technology allows." -Kevin Werbach
Walch noted that while it is claimed that some consortia are putting into production "blockchain" systems, in many cases it seems that what they call blockchain has little or no resemblance to the original blockchain technology behind Bitcoin. In many cases, he said, existing shared databases are called "blockchain" for marketing purposes. "If people use something that they call DLT technology or blockchain in important financial systems, my hope is that they decide based on the real capabilities of technology rather than its widely exaggerated and generally exaggerated capabilities," Walch said. "Authorized blockchains, which are the most likely variants to be used for financial system registers, are very different from public blockchains such as Bitcoin or Ethereum.I hope a more modest and accurate understanding of the actual features of the authorized blockchain sinks before are widely adopted ".
Regarding cryptocurrencies or cryptoassets, Walch said that the interest of the financial sector is "less on record keeping and more on a new financial asset from which it can make money". He stressed that at the moment there is no clarity on how these systems work and power. The ongoing operation of cryptographic systems and the value they incorporate and support depend on the ethical competence and behavior of software developers and untrustworthy validators. "The financial sector believes it understands and is able to manage the risks of the cryptoassets, but I am less sure and worried that arrogance and greed are driving the drive to create criptoassets as a real asset class This was a bad mix in the past, "says Walch. "I think it would be more responsible to let the cryptosystems exist on their own for a while to get other nodes resolved – if they can be, I'm not sure the rulers can – rather than quickly integrate them into the financial system. as they seem to be doing. "
"I … I fear that arrogance and greed are driving the drive to create criptoassets as a real asset class". -Angela Walch
On the other hand, Weber and Novocin believe that the financial sector is cautious about the new DLT technology. According to them, to increase confidence in the new blockchain systems it is necessary to be transparent about how the processes work and what the benefits are, and to ensure adoption, they must be simple to use. "Experts have drawn parallels to the open source Linux operating system, and although only a few people use Linux directly, they run most of the servers and cloud processors around the world, and the same is likely to be the case. anticipated blockchain takes place against the background of business processes, companies should be involved now, even if it is only to experiment with concepts, and becoming familiar with these new tools will be ready as space continues to develop. "
Weber and Novocin expect that in the coming years many other companies will implement private blockchains to improve the transparency and traceability of their financial operations, supply chains, inventory management systems and other internal business systems. Clearer standards will be adopted and some high profile projects will emerge. Meanwhile, they said, R & D will continue among the many decentralized blockchain projects to invent more scalable public registries, whether it be blockchain, Tangle, Hashgraph or something new. "We need to work on better and more efficient consensus models, whether it's a new form of game testing or proof of work or something else." There are many groups, start-ups, companies and research groups. established that organizations can merge, collaborate or support to contribute to research and expand their capabilities. "
This article is part of an editorial collaboration between Knowledge @ Wharton and the SWIFT Institute.
