Most have heard of the rise of blockchain and its potential for disruption to the existing central banking structures and hierarchies, removing the need for costly and slow intermediaries in between parties executing transactions. It has gained international prominence (and some say notoriety) via cryptocurrencies. But future applications for blockchain technology and distributed ledgers are far wider than just virtual currencies. The FinTech industry has keen interest in its potential benefits of reducing unnecessary transactional frictions, providing a tamper-proof immutable record trail and allowing identities of parties to be validated, even in markets currently underserved by traditional financial institutions. As the FinTech industry embraces adoption of technological advances to provide competitive advantage and superior customer service, blockchain can be seen as a major enabler to digitisation, combined with IoT and advances in AI.
What Is Blockchain?
The simple answer is blockchain is a specific type of distributed ledger, but not as often portrayed as simply for recording currency transactions like Bitcoin. The blockchain network consists of nodes, i.e., distributed servers, or shared databases. All the participating nodes accept a transaction after getting proof of work validation, in real time, and are encrypted and stored as records added to blocks.
Each time a block gets filled and completed, a new block is generated. Blocks are linked to each other (like a chain) in linear, chronological order with every block containing a hash of the previous block, and once the block is completed it goes into the blockchain as a permanent record in the shared databases. The encryption and storage of post-execution data for each transaction links with precedent and subsequent transactions to form a chain, which means that to change any saved record in a block would mean changing all linked records made after the entry, across all shared databases, simultaneously. The computing power required to change even a single data element of a record in the blockchain would be immense, described as being of ‘Bond villain’ magnitude! Let’s hope the bad guy doesn’t resolve current problems with subatomic particles and qubits for quantum computing… It’s this ‘linked and shared’ aspect which means the data is both accessible by users to access or inspect, but it can’t be altered or deleted, making it tamper-proof or “immutable”.
Is Distributed Ledger Technology (DLT) the Same Thing as Blockchain?
A distributed ledger is a type of database spread across multiple sites, regions, or participants, which can be private or public. A private distributed ledger runs on servers within only the platform owner and selected participants to have read or write access to create records, while a public one is where anyone can access and create new transactions, providing they can receive proof of work validation for the entries generated. While blockchain stores data across distributed ledgers after validation using proof of work in a series of blocks as a chain, a distributed ledger does not need to record records in this way. The validation and processing of new transactions stored simultaneously in multiple databases in real time forms the integrity check. Records are only ever authenticated and stored in the ledger with a cryptographic security stamp when consensus across parties been reached, not requiring another party to validate the source and recipient transaction.
Ethereum vs Hyperledger
There are many blockchain platforms available, but two of the most widely known are Ethereum and Hyperledger. They both use blockchain technology but have key differences which determine their suitability as to their use cases and applications.
Ethereum is an open source platform running on a public network which uses the concept of Smart Contracts (written in language Solidity) running on the Ethereum Virtual Machine (EVM). Smart contracts are basically programs (decentralised applications or ‘dapps’) that can govern states or rules governing consensus and execution over transactions. All the nodes (network participants) are required to reach consensus over all the transactions using mining based on the Proof of Work (PoW) concept. Transactions must have an associated cost to fuel the costs of processing PoW algorithms, so Ethereum has its own built-in cryptocurrency called Ether or ‘gas’.
Hyperledger is an open source banner project hosted by the Linux Foundation, and could be said to be more applicable to businesses that want to utilise blockchain technology whilst retaining control over a ‘permission blockchain’ using a private network. Smart contracts are called ‘chain codes’ which can be written in Golang or Node.js. The publicly-mined PoW consensus mechanism for public blockchains is not used, the default setup uses a no consensus algorithm (No-op) as it relies on granted permissions, but custom agreement protocols can be set between the permissioned parties, for example the Practical Byzantine Fault Tolerance (PBFT).
Is Blockchain and DLT a Solution Looking for a Problem?
We can see from the previous overview that blockchain uses a radically different approach to the traditional methods employed by enterprises of accessing, storing and securing transactional data. Using the model of a single database has all the cybersecurity, storage, fraud and disaster recovery costs and risks as a single point of failure. But blockchain technology is not applicable for all IT needs of an enterprise; the following areas currently present issues in wider adoption:
• Public blockchains have storage limitations, in terms of the space allocated per block which may not be enough for the kind of transactions generated by businesses. Latency (time to validate and confirm transactions) can be slow and run into hours, and the openness of the data on the public network to competitors and malicious parties (albeit encrypted) should be considered a risk.
• The immutable nature of records stored can be considered an advantage where data being tamper-proof is necessary, but this inability to update or add to a stored transaction later can also make it unsuitable for certain uses.
• The technical framework and standards for blockchain offered by different platform providers can vary resulting in frictions and a loss of transparency across platforms. There are currently consortiums looking to standardise industry-wide blockchain standards to benefit development eg. https://dlt.mobi/.
• There is an environmental cost to the processing power used by the algorithms to reach consensus and encrypt data. A statistic given about one of the giant bitcoin mining farms racked with powerful computers is that the electricity consumed is the same as the amount a city with a population of 100,000 people would use.
• Whilst secure, there have been cases where a blockchain has been hacked with stolen cryptocurrency or sensitive data, and losses running into millions
Where Can Blockchain Provide Benefit?
The private blockchain (as in Hyperledger Fabric) is more aimed at the needs of enterprises. Many test projects and PoCs are currently being undertaken by businesses to gauge the benefits and risks associated with using blockchain before large-scale implementation. Most companies are keen to adopt bleeding edge technology to reduce costs and/or improve the customer experience, and blockchain is gaining prominence in many areas of commerce. According to a study published in 2016 by Statista about the Blockchain usage opportunities worldwide among financial institutions, the most prevalent was for international money transfers, which was about 60%. Other areas include customer identification and anti-money laundering (AML), asset and collateral transfers, and opening up smartphone-based banking services to those who are not currently served by the traditional banking models. The list of uses and potential applications is developing constantly, but currently the main areas of interest in the Financial Services sector are:
• Data Security: One of the issues that the e-commerce industry faces today is data storage. The data is stored on centralised networks which are prone to error, theft, corruption, fraud, cyber-attacks etc. Storage on a blockchain network resolves many of these issues.
• Money transfers: current payment methods, particularly international transfers, incur proportionately high processing fees paid by the user. To highlight this, the following chart shows average transaction fees using traditional methods versus digital currency. The figures are from the World Bank and BitInfoCharts:
• Digital identity and Know Your Customer (KYC): current regulations place a strong emphasis on a business knowing its new customers and their ongoing sources of funds or destination of payments. Client on-boarding is an administratively burdensome and slow process for an enterprise and also needs to be repeated by the customer at each new financial service institution, using different forms and processes. Blockchain could improve this area by an individual creating a single one-time verified digital identity which could be tied to a token on a blockchain, for which only the creator would hold a key. The token would be created once and then used to log in to apps, open new accounts, digitally sign any type of document such as claims and transactions, apply for jobs or verify emails or social-media messages are genuine. This would reduce identity related fraud and allow individuals to securely manage their personal identity data and reputation.
• Corporate compliance and auditing: as storing records in an immutable way assures auditors that those records haven’t been tampered with post-execution.
• Providing banking services to the unbanked or underbanked: DLT can provide the opportunity to the people who are unable or unwilling to use traditional bank accounts, with money transfer services (including low transactional value transactions eg. for micro-credit facilities) provided at low cost via their smartphones. It is estimated about 2.5 billion adults have no access to banking services, which is almost equal to half the adult population of the world. These neglected customers include:
- people living in remote or rural areas;
- the disabled or those with mobility problems;
- people with who do not pass traditional criteria to open a current or savings account (the unbanked);
- people who only require infrequent use of traditional banking services and thus have no or limited credit history;
- Millennials who may have grown up using smartphone apps for handling their money and do not see any need in having a traditional bank current or savings account
• Smart loyalty programs: with blockchain, companies have access to create a wide range of low-cost loyalty programs which can handle low-value transactions securely, cheaply and track spending patterns for their target customer groups. An interesting development is for customers to provide useful data via blockchain eg traffic, for which they can then be rewarded via cryptocurrency rewards which they can use for paying for tolls, parking or coffee, for example Jaguar Land Rover. Also, Hyundai are piloting using blockchain to securely store customers preferences for tailoring the settings on their vehicles.
• Micropayments to facilitate subscription-based or streaming services: blockchain technology will aid the nascent business model of customers being able to make low value but very frequent purchases from apps or using subscription or streaming services, eg. films and games, with paid for premium content. The resulting micropayments must have low transaction cost to make the business model viable. Digital currencies will further support ease of making fast, secure and cheap micropayments from digital wallets.
• Automation and connected devices: the low friction and security of blockchain can enable high volume transfers of data from connected assets such as cars, consumer goods, industrial machinery etc to both infrastructure providers, service providers and finance providers who may ultimately own the assets. Lessors and asset funders have a vested collateral and final residual value interest in their assets; regular data collected from the assets themselves (without possibility of human tampering) on servicing, repairs and maintenance, usage, consumption or mileage, geolocation history and other operating data can be used to assist with ensuring maintenance and usage terms are being adhered to by the lessee and also estimating current and future market values, potential further secondary leasing opportunities, upgrades and refurbishment. A later article will explore the potential of blockchain in the leasing and asset finance domain .
The interest in the advantages Blockchain can offer businesses is increasing, reflected in the current growth in demand of skilled resources to enable exploratory projects. Whilst developing technical standards, regulatory issues and cross-platform interoperability are causing some current issues in releasing large-scale applications, blockchain is being cited as being at the cusp of the digital revolution. Wider scale adoption is predicted over the next 10 years or so which will alter delivery of business services in the areas of cryptocurrencies and tokens, identity management, B2B and B2C supply chain, logistics and trade and connected devices as well as opening up entirely new consumer markets to the digital economy.
Blockchain could be a powerful tool, but organisations must have an aligned, clear vision of their future technology strategy. Blockchain has the potential to reshape the way business operates and challenges organisations to reimagine their business processes and customer experience. It presents an excellent opportunity to start building a more efficient, secure and sustainable operating model that will enable the adoption of innovative technology.
In the next article, I will explore areas of development for blockchain and DLT in the FinTech and Financial Services industry, one of the main areas of interest and growth in utilising the technology.
About the Author
Financial Application Consultant and Project Manager with 20 years experience of consulting and delivery of financial and accounting transformation initiatives across sectors such as Retail and Investment Banking, Leasing and Asset Finance and other Financial Services. Peter has executed lead roles on numerous ERP and finance systems transformation programmes. His excellent client facing communication skills add to core strengths in project management, business process analysis, system selection and implementation, accounting design, data migration and reconciliation.
VIP Apps Consulting provide business process management and technology consulting services. We develop and implement unique solutions to enable organisations to address their challenges and become high-performance businesses, creating value through innovation and process optimisation.
We operate in the intersection of technology and business, combining deep business and industry insight with the understanding of how technology and innovation impact the industry and business models.
Get more insight like this
in your inbox
Subscribe to our mailing list and get industry and technology insights and updates to your email inbox.
Thank you for subscribing.
Something went wrong.