Banks beware of Blockchain, Bitcoin brigade

Last month, the European Commission announced the launch of its Blockchain4EU Project enlarging its scope to embrace more than Fintech applications.

This shows how the EU is taking steps to become one of the leading economic blocks in the blockchain race. European Commission’s Joint Research Centre (JRC), together with The Directorate-General for Internal Market, Industry, Entrepreneurship, and SMEs, has announced the launching of the Blockchain for Industrial Transformations initiative to develop industrial use. Such an ambitious project will run until February 2018. Last year the European Commission adopted a proposal for legislation to amend the fourth Anti-Money Laundering Directive that will bring virtual currency exchanges and wallet providers into the EU’s anti-money laundering framework.

Virtual currency to virtual currency exchanges are not covered, which means that only those wallet providers offering custodial services “of credentials necessary to access virtual currencies” are to be included in the legislation. But what exactly is blockchain and how does it affect (if any) the daily operation of commercial banks. In simple terms, this technology may sound like science fiction but in truth, it is a database technology for managing and recording Bitcoin transactions without the intervention of central banks or clearinghouses. These ledgers are centralised (there is a middleman, trusted by all users, who has total con- trol over the system and mediates every transaction) and protected (the functioning of the ledger and its data are not fully visible to its users).

Digitisation has made these ledgers faster and easier to use, but they remain centralised. Blockchain offers the same record-keeping functionality but without a centralised architecture. The question is: how can it be certain that a transaction is legitimate when there is no central authority to check it. Blockchains solve this problem by decentralising the ledger, so that each user holds a copy of it. Anyone can request that a transaction be added to the blockchain, but transactions are only accepted if all the users agree that it is legitimate, e.g. that the request comes from the authorised person, that the house seller has not already sold the house, and the buyer has not already spent the money. This checking is done reliably and automatically on behalf of each user, creating a very fast and secure ledger system that is remarkably tamperproof.

It is a fact that Bitcoin as a digital currency is growing at a fast rate, and in China users faced fluctuations on major Chinese Bitcoin exchanges in Beijing and Shanghai such as BTCC, OKCoin and Huobi. It came as no surprise that the BTCC announced that it would be suspending digital currency withdrawals for a short term whereas OKCoin and Huobi did the same thing to give them time to comply with antimoney laundering (AML) and regulatory requirements enforced by the Central bank.

Bitcoin’s online verification is handled through algorithms and consensus among multiple computers so that the system is presumed immune to tampering, fraud, or political control. It is designed to protect against domination of the network by any single computer or group of computers. Bitcoin is by far the largest blockchain-based currency, although several oth- ers exist with slightly different technical features. Differences are often found in the mining process, which can require substantial computing resources. For example, some currencies use less resource-intensive algorithms than Bitcoin.

These currencies are already at the vanguard of blockchain development, which could lead to a major techno-social upheaval. If they fulfil their potential, they could spearhead a process of decentralisation among the institutions that traditionally govern. Moreover, because every core transaction is processed just once, that is in one shared electronic ledger, blockchain reduces the redundancy and delays that plague today’s banking system.

As can be expected, banks tend to see it as anathema to their traditional functions. Undoubtedly, the jargon is complex to comprehend and, as can be expected, it is prone to rapid change that it’s difficult to predict what form future technologies will ultimately take. So far, change in banking circles is fiercely resisted and bitcoin has been given all sort of negative titles. Banks call it the devil incarnate and pour scorn on abuses by operators who ride roughshod over the currency highway. A case of the pot calling the kettle black. Contemplate the mystery associated with the bitcoin protocol’s creator, Satoshi Nakamoto. It is widely assumed that this is a pseudonym, as a number of attempts to detect his or her real identity have proved inconclusive.

On a positive note, there are major advantages that using a blockchain can bring to the financial sector. It offers many benefits and it seems likely to be a technology that is here to stay. As it moves into the mainstream, it will be important to actively manage the risks that arise from its use. It is possible to register different kinds of activities on a blockchain but the most common is the settlement of financial transactions. Prime Minister Muscat recently announced his government’s promise to introduce the technology in the registry of the Lands Department and to regularise medical records. When put in place such activities can be monitored in real time by market participants, increasing its unique transparency. Simply put, it is an encrypted, distributed database shared across multiple computers or nodes that are part of a community or system.

Blockchain can best be described as the technology that enables cryptocurrencies to trade. It is built on the principles drawn from cryptography, game theory and peer-to-peer networking. What makes it one of the most exciting technologies is its ability to reduce the possibility of security breaches even by its own operators. Beyond its use in the financial sector, it has other uses such as in the media and telecommunication industries.

Media sector applications include supporting low-cost micro-transactions that can be processed cheaply without the fees that existing payment networks require. To start with, a blockchain ledger in telecommunications may be a reliable and secure way and in the process, the digital block’s programmability makes it possible to enforce usage rights.

A major private bank in India has launched its inaugural accelerator program for Fintech start-ups with 12 chosen candidates from an international screening process. The 12 startups stand to gain access to funding of up to $1 million through Venture Capital partners associated with the program, without any commitment to upfront equity for capital. Two Indian start-ups named Signzy and R Imo are leveraging blockchain technology.

More countries are slowly warming up to digitization and considering cryptocurrency schemes. The president of Germany’s Central Bank Dr Jens Weidmann said at a G20 conference that digital finance and financial technology was a priority in Germany. He went as far as saying that it would bring a competitive threat to the current banking industry, introducing innovation which can open the doors for new financial services, blockchain and crowd funding.

Some forecast that Fintech is currently posing a threat to the profit margins earned by traditional banks, yet its reform to the system is expected to have a “positive impact on overall welfare”. Who can deny that we are living in exciting times?