Blockchain presents new opportunities, risks for banks

For Supernal Software, March 2016

If you’ve heard of Bitcoin by now, chances are it was not in a positive way. The central bank-eschewing, mystery-steeped “cryptocurrency” has already received plenty of press for its role in drug trafficking, funding resistance fighters in the Ukraine and as a conduit for digital ransom. With this in mind, Bitcoin, as well as the technology that makes it work, faces an uphill battle to be taken seriously in the banking world, to say the least. Yet many in the tech community are eager to sing its praises, and some even see it as the catalyst for a coming financial revolution.

It turns out, these starry-eyed entrepreneurs may not be far off. The finance world at large has lately been looking at blockchain database structure, the “secret sauce” behind Bitcoin, with fresh optimism. However, it still faces many hurdles, and presents many risks, before it can become as indispensable as some think it should be.

Blockchain, explained

Bitcoin is made possible by a newly developed database technology called blockchain. As The Wall Street Journal explained, blockchain is a way to create a digital ledger that can be shared securely between a network of computers. This ledger can be accessed by anyone within the network, but can only be used or modified by running a series of complex algorithms. The authenticity of data recorded in the blockchain is verified by these algorithms, eliminating the need for a middleman to verify the ownership of the data.

The data is validated by consensus in a network of computers, rather than a central authority like a bank or broker. The algorithms used to create, modify and distribute data across this network are incredibly complex mathematical formulas, making them virtually impossible to hack. This is why transactions made through Bitcoin are untraceable, except by the unique sender and receiver.

As the Journal explained, this elimination of the middleman in the transactions could be of use in a variety of legitimate business use cases. For example, a blockchain system could be used to buy and sell stock without the need for a broker. Logistics companies could use blockchain methods to keep a record of accounts payable and receivable without combing through each transaction. In the broader scope, as reported in The Atlantic, some think blockchain databases could be used to keep track of deeds and titles to property in third-world countries, where such records are often lost or compromised due to lax government oversight. In theory, this would allow billions of people to gain access to credit that remains off limits without a reliable way to prove land ownership and post collateral, like the deed to a house, for example.


Knowing the risks

The Journal reported that since 2015, at least 40 different financial institutions were developing some form of enterprise blockchain solution. Although it’s already been working with Bitcoin and other databases for several years, there are still a number of kinks to work out before we see a blockchain in every bank, or before businesses begin to implement the technology on a wide scale.

The most obvious is actually making it work with systems already in place. Blockchain technology represents a seismic shift in payment and database technology, so integrating it with what’s already being used would be no cakewalk. Even more complicated is getting blockchain to work within the regulatory system, which it was technically designed to work around in the first place. Finally, some question just how secure the blockchain really is. Since the rules of encryption are technically shared across a network, it’s theoretically possible that a third party could gain access to these rules and disrupt the system. Before blockchain could be implemented on a wide scale in legitimate transactions, these questions would have to be settled.

Overall, many believe blockchain technology holds great promise for financial institutions and businesses. Now the risks inherent in the system will need to be hammered out before the technology can proceed to make as big an impact as some foresee.

Financial institutions who want to remain on the cutting edge of risk management can turn to Supernal for comprehensive assessment solutions.

 

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