7 minute read

The Economics of Blockchain

New Kid On the Block    7 minute read

The Economics of Blockchain

A few years since the mysterious creation of bitcoin, the technology behind it, blockchain, has started to get attention of its own. Blockchain was one of 2015’s financial buzzwords and, despite a slower 2016, is still attracting curiosity and investments from major financial institutions.

For the last two years, blockchain has been one of FinTech industry’s main drivers, and banks and startups alike have formed consortiums to try and get the most out of the technology for their own businesses. Its enthusiasts claim that its possibilities are endless, and hold it up as the ‘next big thing’ – yet traditional institutions are still struggling to effectively use it to solve their problems and cut costs.

What Blockchain Can Do

According to the specialised news site Coin Desk, investment funds put a total of $400m into startups dedicated to digital currencies in the first half year of 2016. Several other major banks have secretly invested hefty amounts in blockchain research.

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According to Accenture, while corporate bonds, equities, and private debt instruments currently take around three days to settle, blockchain could speed up that process to a matter of hours or even minutes. For syndicated loans, the current settlement time of multiple days could be cut down to a single day.

What’s more, it functions like a database and can be shared across different sites, in much the same way as a Google Docs file works: changes made are displayed for anyone with access to the file.

There are many key areas within financial services that blockchain could potentially disrupt. It has significant capabilities for authentication and is also easily verifiable by multiple parties. It could reduce the cost of payments by cutting out the middleman and increasing transaction speeds. Auditing could also be done in real time, making it easier for regulators to dig into corporate records.

It could also dramatically decrease the need for savings accounts since it provides a reliable and safe way to store value, and its implementation could spur the development of new methods of peer-to-peer financing.

Building Blocks

In theory, blockchain could help banks cut transaction costs and enable them to process bonds and settlements faster. But of utmost importance is its aforementioned potential for cutting out middlemen which costs companies a large chunk of their annual revenue. Its secretive nature makes it attractive to big firms looking to cut costs.

$20bn is how much blockchain could save the banking sector

There are nowadays countless blockchain startups, each of them offering different services within the array of possibilities that the technology creates. Some companies focus on providing a single service like easier payment methods, while others provide the infrastructure that traditional banks lack for handling the upcoming technology.

Big banks like JP Morgan and Bank of America are just some of the many institutions that are teaming up with other companies and testing technology’s potential for replacing existing transaction methods in trade, foreign exchange, settlements, and securities. According to Santander Bank, blockchain could save the banking sector $20bn per year.

But its applications to finance go way beyond just private networks of trust between banks. Some companies specialise in using it for transferring bonds or shares, and others use it as a ‘truth machine’ by essentially adding particular data to the blockchain to give certain items proof of their identities. Its most popular use in this respect is for ‘smart contracts’, which work by programming bitcoin to become available only if certain previously agreed-upon conditions are met.

A Dark Past

Blockchain was not always a trendy word. The fact that blockchain and bitcoin are inherently interconnected has often been seen as bad for business. Bitcoin is still perceived as a murky unregulated online currency associated with money laundering and the buying and selling of illegal goods.

The technology consists in a database distributed in a list of records, usually called ‘blocks’. Each block has a digital timestamp that links it to a previous block. The interconnectedness of all these blocks forms a chain – hence the term ‘blockchain’. The data recorded into every block cannot be changed, which makes the technology essentially unhackable.

120,000 transactions in average are added to the blockchain every day

Of course, the technology has since its inception been pegged for use alongside bitcoin. All the data recorded in the blocks contains the amount and value of every bitcoin transaction ever made – this means that information on all transactions is public, transparent, and available for everyone to see. However, everything changed when financial institutions realised that they could copy the technology of the bitcoin blockchain and build their own private versions.

Copycat Currencies

As an open-source technology, blockchain can be programmed and developed by anyone in the world – but it can also be copied. In response to bitcoin, many people have tried to create their own currencies, the most popular of which is Ethereum.

Ethereum’s system is built on the same technology. Besides the payments it enables, its users can also bet on sports or pay their electricity bills through the use of smart contracts.

740+ cryptocurrencies are available online

As of June 2016’s figures, there were more than 740 cryptocurrencies available in online markets, but only 26 of them had a market capitalisation of over $10m. The most popular of these are Dogecoin, Litecoin, Peercoin and Zcash.

Disrupting Money

Blockchain could revolutionise businesses in the sense that it establishes trust between parties without relying on banks, governments or companies to act as intermediaries. The only intermediaries in this case are the software code behind the technology and the thousands of community members (typically called ‘miners’) that help keep it running.

Blockchain enthusiasts such as businessmen Dan and Alex Tapscott argue that it is the first medium for value, just like the internet was for information. It could potentially transform the current financial institutions by making services cheaper and simpler while increasing transparency and improving regulation.

More Than a Buzzword?

Bitcoin enthusiasts are not necessarily happy with how much attention blockchain has been getting from the financial industry, arguing that the technology in itself doesn’t bring anything new to the table. Without bitcoin, blockchain stands to be little more than a database, which isn’t necessarily much of a novelty.

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Perhaps what blockchain has brought forth is a new competitiveness that makes such institutions want to adapt. For instance, another argument against the separation of bitcoin and blockchain is that centralised systems like PayPal can still be faster than a blockchain, which takes some time to validate transactions. Bitcoin lovers argue that the technology wasn’t created for its transaction speed or cost-cutting advantages, but rather to have a currency free from central control.

Going Mainstream

Much of this is still hypothetical, though: the technology is still in its early days, being explored and tested for value. Big corporations are assessing what they stand to win by adopting the technology, but they haven’t yet successfully implemented it within their services.

Will blockchain ever go mainstream? Enthusiasts and moguls hope so, after the frenzy of the last two years. But the new kid on the block is still just a child – one which needs to mature before authorities allow it to become part of the financial world’s infrastructure.

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