Market Views: Fixed Income
What is Blockchain and why will it revolutionise business?
Cryptocurrencies like Bitcoin get all the attention (and notoriety), but it is the underlying Blockchain technology that will revolutionise global business. In our view, it has the potential to be as significant for industry in general as the internet was for society.
So what exactly is Blockchain?
The fundamental principle of Blockchain is decentralised accounting, whereby network participants approve, validate and record transactions, rather than placing the onus on a single entity, such as a bank or trustee. The network participants, also known as miners, collectively time-stamp and validate entries, which prohibits unapproved changes to records.
As the name Blockchain suggests, transaction data is stored in blocks or data segments. Blocks are a set number of transaction records which are validated in a batch, then chained or tied together with other approved transactions. Blocks store, record and time-stamp transactions and then log them into the overall Blockchain. As the number of assets or transactions in a business network grows, the degree of trust and confidence in the ledger increases. Assets that could be tracked using this technology include tangibles like houses, cars, and land, or intangibles like patents, copyrights, and brands.
A disruptive feature of Blockchain is that the technology facilitates peer-to-peer transfers or transactions without intermediaries like a bank or a governing body. In contrast to today’s intermediary-based transaction model, Blockchain technology requires validation via consensus among miners. This is commonly known as a proof-of-work consensus protocol. Miners must apply significant computing power to cryptographically synchronise and validate the database in real-time and, in return, earn fees or tokens from the underlying Blockchain.
Blockchain’s five attributes
Blockchain has five attributes that create a sustainable network:
- Distributed ledger: The ledger is shared; it is not owned or controlled by any single entity. The longevity, veracity and security of a distributed ledger doesn’t depend on any single entity. Rather, a distributed ledger or database requires public consensus among accounting participants.
- Security and privacy: Security is maintained by network consensus and the continued reconciliation and connection to prior verified transactions. Blockchain values, in the form of tokens, are assigned to the electronic wallets of network participants. The network wallet has a unique identifier and is updated according to new transactions. While transactions and wallet electronic addresses are publically available, corresponding names and details of the owner remains private, unless the wallet exist on a regulated exchange that enacts “know-your-customer” procedures.
- Transparency and auditability: The concept of an open or shared ledger allows participants to validate transactions and verify ownership without intermediaries. At the same time, transactions are time-stamped and verified in real time without the need of third party audit.
- Consensus algorithm: Through the use of consensus algorithms, all network participants must agree that a transaction is valid. Transactions that do not meet the consensus protocol are dismissed as non-valid transactions.
- Flexibility: In addition to value and transaction accounting, Blockchain tokens can include customised rules such as contract terms and conditions. For example, a“smart lease contract” token would include information regarding lease terms such as initiation, termination as well as repossession. As business rules and protocols can be embedded into the network, Blockchain networks can adapt and evolve to support a wide range of activities.
Leveraging these attributes, Blockchain has the following benefits over traditional networks:
- Faster transaction settlement: Current transfer intermediaries, such as banks and trust companies, can take days or even weeks to confirm, verify and clear transactions and ownership changes.
- Lower cost: Peer-to-peer verification eliminates costs related to audit oversight and duplication of records.
- Enhanced security: Blockchain’s distributed architecture and consensus protocols prevent tampering. As the chain grows, it becomes more secure.
- Improved auditability: A shared ledger serves as a single open book of record to monitor and audit transactions.
Each block of information contains a digital signature called a hash. A hash is time-stamped and connected to recent transactions and the hash of the previous block. A hash is issued by a verifiable trusted agency otherwise known as a miner. Miners are allocated blocks to validate and provide identifying information that is forgery resistant.
Because the previous block’s hash is linked to the next new block it prevents any block from being changed or a block being added between two existing blocks. As each subsequent block is added, it strengthens the verification requirements of the previous block and therefore strengthens the security of the entire Blockchain. As the ledger grows it becomes more tamper-resistant.
How revolutionary can Blockchain be for industry?
In light of the explosive growth of e-commerce, online banking, and the proliferation of mobile transactions globally, businesses need transaction processing networks that are fast, secure, transparent and efficient. Despite the advancement in technology, in traditional networks and databases recording and auditing functions remains expensive, inefficient and vulnerable to security breaches.
Transactions in traditional business grow more expensive with increased complexity. Each new intermediary charges fees for their services and the transaction incurs larger administrative costs. For example, in the insurance industry, there are administrative costs associated with policy underwriting as well as costs related to claims adjudication. The cost layers of these functions could be reduced or eliminated by a Blockchain-based smart contract.
Inefficiencies in the current business environment often arise due to duplication. For example, in loan documentation or bond trading, multiple parties track documentation, ownership and trading. This type of duplicated effort could be reduced by a Blockchain solution which inherently requires all versions of the database to synchronised.
Traditional database centralisation is inherently more risky than a distributed ledger. With a centralised system of control, a single weak point could, if compromised, place the entire business network at risk. Decentralised Blockchain can, therefore, significantly increase accounting and transaction security.
What next for Blockchain?
While the applications for Blockchain have historically been restricted to cryptocurrencies – which initially were used mainly for nefarious dark-web payments – we believe that the Blockchain technology itself will revolutionise legitimate asset accounting and payments.
Like the internet, we predict it will transform industries that have benefited from a lack of transparency in commerce. Blockchain has the potential to reduce accounting and transaction costs, improve security and increase efficiency and efficacy of personal and commercial transactions. At the same time, a consequence of Blockchain’s success will be that intermediaries who are currently reliant on inefficiencies as part of their business model will be disintermediated.
Although industries ranging from healthcare to intellectual property will benefit, the banking and brokerage industries could be transformed by the implementation of Blockchain networks. While this transformation will offer opportunities for incumbents and new entrants, this technology is a threat to the status quo. Incumbents must be willing to navigate and embrace new technology as well as overcome scalability hurdles.
 Consensus algorithms are a highly complex series of computer science programming systems that seek to ensure correctness, agreement, and utility of a given chain ledger application.