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Financial services get ready for blockchain, but is blockchain ready?

September 01st, 2016 - Posted by Sam Hemmant in Anti-Money Laundering

A report issued by Deloitte and the World Economic Forum, 'Disruptive Innovation in Financial Services' looked at the impact of implementing distributed ledger technology – the same blockchain technology underlying Bitcoin and other cryptocurrencies – across nine sectors of financial services and found that it has the potential to 'reshape financial services".

In addition to stating that blockchain technology has the potential to 'reshape financial services', a recent Deloitte and World Economic Forum report suggested that this will require "careful collaboration with other emerging technologies, regulators, incumbents and additional stakeholders" if it is to be implemented successfully.

The report found that blockchain technology has the potential to drive simplicity and efficiency for the financial services industry by establishing new infrastructure and streamlined processes, as well as working in conjunction with existing technologies. The report estimates that 80 per cent of banks globally could implement blockchain technology by 2017.

Giancarlo Bruno, Head of Financial Services Industries at the World Economic Forum, explained: "Rather than to stay at the margins of the finance industry blockchain will become the beating heart of it".

Is blockchain ready for financial services?

A blockchain ledger is not maintained centrally by a single government, regulator or institution, instead it is distributed between a network of global users.  This maintains the integrity of the ledger and offers a more secure, visible and transparent way to monitor transactions.

To date the blockchain has yet to make a significant impact outside of Bitcoin and other virtual currencies including Ethereum.  The leading cryptocurrencies have also faced ongoing security concerns.  Hong Kong-based Bitcoin exchange Bitfinex announced at the beginning of August that hackers had stolen 119,756 bitcoins – equivalent to $72 million – from accounts at the exchange.

Ethereum – the second most popular cryptocurrency after bitcoin – suffered a similar attack which targeted an organisation with huge holdings of the currency.  While developers have proposed a fix, the attack has yet to be rectified and the value of the digital currency dropped dramatically as a consequence.

Experts argue that the problem is not with blockchain technology, but with the security vulnerabilities of the exchanges storing the code that determines ownership.  The combination of these vulnerabilities and ledger decentralisation – which has been essential to the value proposition of cryptocurrencies until now – is still proving to be a significant obstacle to wider adoption.

Is Ethereum the future of underlying blockchain technology for financial services?

Ethereum is built to allow for decentralised organisations to be built on top of its blockchain and for smart contracts to execute themselves automatically when certain conditions are met.

Continued development of the Ethereum platform is supported by its 22-year old founder, Vitalik Buterin, as well as co-founders including Toronto Stock Exchange Chief Digital Officer Anthony Di Lorio, and a board of special advisors and technical experts.

Swiss-based bank UBS has announced that it is building a smart bonds platform using Ethereum, and Bank of America, HSBC and R3 have also succeeded in developing a way to significantly reduce international trade costs using blockchain technology.

The key to the potential success of Ethereum for financial services lays in its potential to offer sub-second confirmation times.  This speed will enable the technology to be applied to asset trading and financial derivatives.

What, if any, regulations apply?

The risks of money laundering, terrorist financing and tax fraud have the potential to be increased if it becomes more difficult to trace the identity of those using blockchain technology.  Despite this, nine of the largest financial institutions in the world – including Goldman Sachs, Barclays, RBS and JP Morgan – are already working on a joint project to create a framework for using blockchain technology in financial markets.

While the question of specific regulation remains unanswered, as with any business operating on the internet, existing regulations will continue to apply.  The European Parliament Committee on Economic and Monetary Affairs has confirmed this, noting that existing EU legislation is likely to apply, irrespective of the use of certain underlying technology.

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