TURNING TRADITIONAL BANKING ON ITS HEAD
The introduction of Bitcoin initially instilled fear within financial institutions, afraid of being forced to innovate. But lately, banks have been slowly warming to the technology behind the virtual currency system — called blockchain, explains Barbara S
Banks were supposed to be frightened of Bitcoin. Last year, in a commentary for Fortune called “Why banks fear Bitcoin,” MIT business professor Trond Undheim wrote that “banks are afraid of Bitcoin because it would force them to innovate.”
The mysterious inventor of Bitcoin, Satoshi Nakamoto, specifically challenged the idea of trusting banks as one of his justifications for creating the currency. “Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve,” he wrote in 2009. “We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.” In some countries, banks even banned any transactions connected to Bitcoin.
But lately, banks have been warming to the technology behind Bitcoin, called blockchain — using it to innovate, in fact — having recognized the advantages of the lightning-fast, decentralized transaction verification system as having broad applications for transactions involving everything from stock trades to money and property transfers.
“The concept is a network that guarantees the validity of a transaction,” said John Jason, a lawyer at Norton Rose Fulbright Canada LLP, who testified at recent hearings by the Senate committee on banking, trade and commerce on digital currencies.
Bitcoin merely served as “proof ” of that concept, he said. Now, it is being recognized that anything that plays a “trusted intermediary role” in today’s world “could be replaced by blockchain technology.”
That’s why Victor Dodig, chief executive of Canadian Imperial Bank of Commerce, talked about blockchain during a recent speech in Toronto on the future of banking.
The banking business is largely based on trusted transactions between individuals, institutions and even governments. It’s a system that is built on banks as the trusted authorities required to verify and record them.
But blockchain has the potential to upset this with its “distributed ledger” approach that shares and quickly verifies transactions across a network of de-centralized computers. No middleman, such as a bank, is needed.
With Bitcoin, computer code stored entirely by computers verifies every transaction within minutes across the network on a public ledger, and prevents the currency from being spent more than once.
A Senate report last month stemming from the banking committee hearings compared the system to a tree falling in the forest and being recorded by millions of independent computers with cameras.
As a result of the permanent and unalterable record of multiple recordings of the same event, “we can trust that it fell,” the report said.
“Anything that currently has a centralized database of records is potentially made redundant by the distributed ledger approach,” said Sviatoslav Rosov, an analyst in the capital markets policy group at CFA Institute.
This potential disruptive force has driven a handful of global banks including Barclays, Goldman Sachs, and UBS to experiment with how they can use the technology and stay ahead of competitors.
In some cases, this involves launching their own blockchains internally for testing purposes.
What’s the point of the NYSE if you can trade equities on the blockchain?
Nasdaq also has blockchain projects under way and reports last week suggested the U.S. stock exchange is preparing to expand on them.
Rosov said such experimentation could dull the disruptive impact of the new technology.
“Typically, disruption is allowed to happen by incumbents ignoring developments,” he said.
Global banks and large exchanges, at least, “appear to be relatively on top of events” in this case, he said, adding he expects the first place the technology will be used by traditional financial institutions is in international transfers between accounts within the same banking group.
Despite these developments, however, Rosov said there is a view incumbents could be rendering themselves unnecessary.
If Barclays, for example, “is just using a blockchain to run its banking services, why does Barclays exist in the first place? Or what’s the point of the NYSE if you can trade equities on the blockchain?” he said to illustrate the point being made by those who view blockchain as lethal to the status quo.
Clearing and settlement and auditing are among traditional banking functions that are seen as vulnerable to blockchain’s approach, he said.
A more likely form of disruption in Rosov’s view would be the use of blockchain or a similar technology to target the billions of people in the developing world that are “unbanked” because they can’t establish the creditworthiness required by traditional financial institutions.
Blockchain, with a distributed ledger verifying successful transactions between two parties, has creditworthiness built in to the system. Rosov said it could therefore be used for transactions as involved as an equity issue for a local village restaurant, which would automatically be audited. Dividends could be distributed via blockchain.
“Most commentators would probably agree this is the most disruptive aspect of blockchains,” he said.
But it is not only traditional bank functions that stand to benefit or become vulnerable to the technology.
“There are potentially many applications. For example, you could use the technology to replace the land registry system,” said Jason, the Norton Rose lawyer.
While cautioning he is not a real estate expert, he said it appears it would be possible to have a property sale broadcast across the network, with the network verifying for the buyer that it was a valid transfer of title.
Last month’s Senate report said there is “vast potential” in the technology behind crypto currencies such as Bitcoin and urged the Canadian government to explore it.
The report also urged officials to “tread carefully” when contemplating any regulations that could restrict or stifle its use and development.
“Blockchain technology shows great promise in extending beyond the realm of just currency,” the report said.
Blockchain technology shows great promise in extending beyond the realm of just currency.