The blockchain — the technology that underpins bitcoin — has been called “the future for financial services infrastructure”. Now banks, clearing houses and exchanges are becoming increasingly excited at the prospect of blockchain fundamentally transforming their business models.
Last week Nasdaq said it would use blockchain technology from US start-up Chain to underpin its new private share-trading market, in one of its most high profile applications to date. Former New York Stock Exchange chief Duncan Niederauer and JPMorgan banker Blythe Masters have also lent their support to start-ups exploring its use.
“Blockchain technology continues to redefine not only how the exchange sector operates, but the global financial economy as a whole,” says Bob Greifeld, chief executive of Nasdaq.
To its supporters, it marries the major preoccupations of Wall Street and Silicon Valley: tougher post-crisis regulations and cost-cutting on one side, community-agreed technology and new peer-to-peer structures to move money around the financial system on the other.
This model, however, is fundamentally different to the financial industry’s current approach of using overlapping centralised ledgers. Settling trades can take days, is often expensive and, for many banks, is partly done by humans.
The blockchain and the bitcoin assets it tracks set out a way to create an unforgeable, unchangeable ledger of asset ownership.
Transactions between bitcoin users are broadcast to a network of computers. The latter, known as “miners”, gather together blocks of transactions and compete to verify them and receive monetary incentives in return for being “first”. The blocks are secured by cryptography and other computers can verify the work. The “cost” of running the network is borne by the anonymous owners of servers. The open source code means it can be widely distributed, making it highly decentralised and difficult to change.
Banks and exchanges see a ledger updated in minutes as saving millions in collateral and settlement costs to third parties. New post-financial crisis rules have forced more over-the-counter derivatives to be processed through centralised clearing houses. That has increased demand for collateral to be sent around the financial system rapidly in order to be used as insurance for cleared derivatives trades.
A recent report by Santander InnoVentures, Anthemis and Oliver Wyman estimated distributed ledger technology could cut $15bn-$20bn from banks’ costs for cross-border payments, securities trading and regulatory compliance by 2022.
Banks are developing other ideas, such as programming “smart contracts” that can verify and execute commercial agreements.
As with any new technology, experimentation abounds. For a start, enthusiasts debate whether the blockchain even needs a digital token like bitcoin. For some, it is an article of faith that ensures miners are incentivised to do the work.
Some start-ups, such as Ripple and Chain, are trying to create distributed ledgers with identifiable owners of assets and settlement finality. They argue an authoritative and unforgeable ledger for securities and derivatives is impossible, since legal enforcement of contracts requires people to prove ownership.