Inaccurate Design

Bitcoin and the Blockchain in the Financial Industry

Tuesday, 23 February 2016

Bitcoin and the Blockchain is the current ‘next big thing’ in financial services. Nobody wants to be the target of a ‘disruption’, and the easiest way to avoid that is to be the disruptor!

It seems as though every other week, a financial services institution of some sort (whether it be a bank, a market, a hedge fund, or another player) announces that Bitcoin and the Blockchain are the future of the finance industry. The key piece of information that most of these announcements are missing is, “how exactly are they going to leverage Bitcoin and blockchain to do this?”

Before I go further, I just want to clarify the difference between Bitcoin, and the Blockchain. The easiest way to explain it is that Bitcoin is the currency, and the blockchain is the ledger. A ‘coin’ (of any sort) is the unit of currency that you can exchange. This is recorded in the blockchain, which is a single long line of transactions that can be traced all the way back to the inception of the blockchain. Note that for the most part, all ‘cryptocurrencies’ work in this way - including Litecoin, Dogecoin, and Coinye.

While Bitcoin works well for consumers as a deregulated currency (and a currency transfer mechanism), the blockchain is where the real technological magic will happen in the future. The thing that makes the blockchain so revolutionary is its ability to act as a public, decentralised ledger of transactions, where all transactions can be cryptographically validated, and enshrined in the ledger where they cannot be tampered with or deleted, without needed a central authority to control or manage the blockchain.

The method that these transactions are committed to the chain by is called ‘mining’, which involves people racing to find the correct solution to a complicated mathematical equation that takes a previous block, bundles it with a batch of new transactions, and publishing the result. This is where the name ‘blockchain’ comes from - each block is a link in the chain, and breaking one link will break the chain at that point.

In Satoshi Nakamoto’s original paper outlining the concept of Bitcoin, one of the core concepts that Bitcoin (and the blockchain) was developed around is the lack of reliance on a third party financial institution - that two parties could exchange funds without needing to involve a bank or payment processor. This is where we need to start thinking about how an FI could practically utilise blockchain technology in a way that makes sense, while still being the right technology choice.

Key questions that I want to answer are:

  1. In what scenarios and situations could a financial institution make use of a blockchain or digital currency?
  2. What are the key issues with a financial institutions using a blockchain or digital currency?
  3. Given the key issues identified, in what situations does it make sense for a financial institution to use a blockchain or digital currency over traditional technologies?