Blockchain is well known as the technology that has made possible the introduction of Bitcoin, Ether and thousands of other cryptocurrencies, making it one of the most important innovations in finance today. It has however also created the misconception that cryptocurrency and blockchain must always co-exist, although this is simply not the case. Several banks and insurance companies, such as JP Morgan and MetLife, are using their own private blockchains, without cryptocurrencies, to simplify, streamline and verify transactions and contracts.
What is a private blockchain?
Fundamentally, blockchain technology delivers a distributed database that provides a single time-stamped version of the truth. It then uses mathematics and cryptography to provide trust and security – rather than through third parties – and relies on an accessible and open user structure to confirm all is well. A private blockchain is a type of database where a single authority or organisation ultimately retains control and no one can enter this type of network without proper authentication. Private blockchains are, by definition, ‘permissioned’ and are more suited to enterprises for reasons of performance, accountability and cost. For many enterprises, using private blockchains is the preferred option to safeguard the company’s sensitive information and they are used for reasons of privacy, where it is not appropriate to allow every participant full access to the entire contents of the database.
The objective of a private blockchain is to empower and support the business rather than the individual users, retaining some overall control to improve privacy and eliminate any of the illicit activities often associated with public blockchains and cryptocurrencies. Enterprises need to demonstrate full accountability on the running and operation of their systems and processes and private blockchains provide a greater degree of oversight and regulation, determined and set by external administrators in line with their industry’s regulatory codes.
Importantly, private blockchains do not need to use cryptocurrencies or native tokens to process transactions and any association with cryptocurrencies, good or bad, is not a required part of the private solution.
Blockchain for financial services
First and foremost, Blockchain is a database, comparable to a general ledger used by accountants to record transactions and payments. In blockchain every transaction is recorded chronologically and can digitally log the entire life cycle of money. Recording this automatically means blockchain technology vastly improves the efficiency of the process, reducing the time and cost needed to keep accurate records.
Blockchains are decentralised, which means each transaction, or multiple transactions in a block, is recorded via independent nodes at the same time. Nodes can be on a smartphone, computer or a server, providing a complete financial record of every transaction and offering significant protection from fraud.
Blockchains are also immutable, meaning the blocks cannot be altered in any way and no single node has control of the chain. Any changes that are attempted are immediately seen and corrected using a consensus mechanism across all the other nodes. Hacking the chain is not mathematically impossible but it is essentially economically unfeasible to change more than half the blocks to achieve the required 51% attack.
The improved security and automated implementation offered by blockchain means the use of third-party intermediaries to validate transactions can be reduced or even eliminated altogether. Every financial transaction requires validation from simple merchant shopping to investment banking and they all need paying for ‘touching’ the transaction. This is the area where many of the disruptors and innovators in fintech believe huge cost and time savings can be made.
Payments is an area of finance for which blockchain technology is ideally suited – tracking and verifying account payables/receivables, using smart contracts to automate processes and remove third parties, whilst practically eliminating duplications and errors. However, early trials on public blockchains involved cryptocurrencies, which proved to be too slow and volatile for any practical solution. The increasing value of Bitcoin for example has meant the transaction fee – payable in coins – has almost become prohibitive. Merchants and their banks were also very concerned about value swings during the transaction processing as well as the privacy and transparency needed for fraud and money laundering prevention required for B2B transactions.
The conclusion was that fiat currency or credit were still the better solutions for these transactions. However, a permissioned blockchain solution without any tokens but with its significantly higher transactions per second (TPS) speed, privacy and adherence to regulatory frameworks can provide the ideal solution. Essentially, blockchain provides immutable verification that the transaction has taken place and confirmed by each party. For merchants and banks, the technology makes it safer, quicker and cheaper whilst leveraging the best elements of existing systems and processes and upgrading areas where step change improvements can be made.
With distributed, immutable features providing improved privacy, accuracy and security, it would be difficult to find a use case in financial services that would not benefit from adopting blockchain. Banking, lending, insurance, trade finance and asset management would all benefit from using the technology, which the finance sector acknowledges will save billions of Euros for banks and major financial institutions over the next decade.