Old Dog, New Tricks: How buzzy cryptocurrency technology is changing the game for finance
Is blockchain poised to change the world of banking and finance?
According to most industry experts, the answer is yes – but with a caveat. In all likelihood, blockchain technology will eventually bring huge changes to the banking industry. How long it takes to reach that eventuality, though, is the bigger question.
“Banking technologies do change, but sometimes, the adoption of them takes a long time,” said Zachary
Hegg, a commercial lender with Chemical Bank in Traverse City. “When we adopted electronic payments with the automated clearing house (ACH) system, I think all those rules had initially been set in place in the 1970s but didn’t see mass adoption until after 9/11. It was 30 or 40 years before people said, ‘Yes, let’s do this, because our economy grinds to a halt if checks can’t go up in the air and fly to the reserve bank to be cleared.’”
Certainly, blockchain faces hurdles such as ignorance and misconceptions; most people assume that blockchain is synonymous with bitcoin and cryptocurrencies.
In reality, blockchain is merely the data ledger by which cryptocurrency transactions are tracked (see Blockchain for Blockheads below). And while cryptocurrencies continue to face criticism for being unstable and risky – bitcoin is worth about $3,350 right now, compared to a near-$20,000 peak at the end of 2017 – blockchain as a technology has big potential to change the way many industries operate, banking included.
In banking, one major area that blockchain could revolutionize is overseas payments. Working through a bank, sending a payment internationally takes time and involves steep fees. You pay a wire transfer fee, and then you pay a fee to your bank, and then you pay a fee to the receiving bank, and then you can send money.
An appealing facet of cryptocurrencies like Bitcoin is that they are sent on public blockchains. Since no one owns these blockchains, no one gets a cut of the money as it travels from point A to point B. The result, in the case of cross-border payments, is a faster transaction without the fees. Bitcoin transactions can take as little as 30 minutes and as long as 15 or 16 hours. Working through the traditional banking structure, international transfers typically take a week or more.
The reason for the slow transfer process is the infrastructure of the bank system. When sending funds from one bank to another, it’s not as if the money just leaves one bank and appears instantaneously in the vault of another. The balances for each bank – and for the involved accounts – need to be reconciled with one another. This process is made more complicated by the fact that not all banks have existing financial relationships – again, especially in the case of international transactions. In situations where banks don’t have that direct relationship, transactions need to go through an intermediary bank, or an “interbank.” Interbanks are banks that have existing relationships with both banks involved in a transaction.
During a transfer, the interbank plays a middleman role, settling the transaction for the banks on either side. There is even a whole organization – the Society for Worldwide Interbank Financial Communication – that connects banks with intermediaries and then sends payment orders to initiate the processing of transactions. Not only does this process add fees for each intermediary involved in a transaction, but it also slows down the transaction and increases the risk for transfer failure.
According to Hegg, one of the big perks of blockchain is its potential to trim all these middlemen out of the equation.
“With blockchain, banking could be a more seamless process with fewer people handling the transaction,” Hegg said. “Every time you can have fewer people handling the transaction, you reduce cost.”
Just how much cost reduction might be possible? Feasibly, blockchain could take all the fees associated with the interbank process and wipe them out. Because blockchain is a distributed public ledger, all the data it processes is 1) stored on countless machines around the world, and 2) available for everyone to view. As such, a blockchain could play the interbank role for financial institutions, keeping track of payments in a transparent and uncorruptible way. By settling transactions on the blockchain rather than through intermediary banks, financial institutions could deliver no-fee processing services to customers and provide faster transactions. At this point, banks estimate that the savings could be worth $20 billion.
Blockchain has other possibilities, too. Some experts see it as a new way to transfer stocks and keep track of commodity ownership. Others, Hegg included, are enticed by smart contracts – contracts that exist as code on the blockchain and self-execute once terms and conditions are met.
At this point, most of these ideas are little more than theoretical. The vast majority banks have yet to wade into the world of blockchain in any fashion. Right now, it looks like the earliest adopter will be JP Morgan Chase. Last summer, CEO Jamie Dimon told the Harvard Business Review that JP Morgan Chase was testing blockchain and would eventually “use it for a whole lot of things.”
Locally, meanwhile, Hegg doesn’t expect to see the effects of blockchain in banking for quite some time.
“Blockchain is eventually going to be a disruptor for banking and it’s going to change my world,” Hegg said. “But I think we’re many years, if not a decade out from seeing this rolled out to small banks and players in our region. As a small town banker, I just need to be open to adopting this if and when it will make my clients’ lives better.”
Blockchain for Blockheads
Writing on blockchain for the Harvard Business Review in 2017, Marco Iansiti and Karim R. Lakhani defined the technology as “an open, distributed ledger that can record transactions between two parties in a verifiable and permanent way.” The technology was first developed in 2008 by someone with the alias of “Satoshi Nakamoto” – also the inventor of Bitcoin. Blockchain was used initially to track Bitcoin transactions.
Because of its status as a “distributed ledger,” blockchain meant that Bitcoin transactions would not be stored, controlled or regulated by one entity or machine. Instead, all Bitcoin transactions are replicated and “distributed” throughout an entire network of computers. Said another way, the entire history of Bitcoin transactions is stored identically across millions of computers around the world. This decentralized structure allows each party to verify transaction records independently and makes it impossible for the data to be altered or faked. For cryptocurrencies, blockchain is a 100 percent traceable and verifiable record of who owns what, who they bought it from and who they might sell it to.
Blockchain is so named because it is a constantly growing collection of records. Each time a new transaction takes place through the blockchain, another “block” is added. These “blocks” are organized chronologically and cannot be deleted or reversed, hence the term “blockchain.” Each block is public and viewable to anyone with access to the system.
Beyond Bitcoin, the core power of blockchain is in its ability to store a public record of any transaction, contractual agreement, task or process. Because blockchain is a peer-to-peer system, there is no need for one central entity to maintain the database of records or provide access to it. Since it cannot be hacked or tampered with, it is immune to fraud. And because blockchain can be used to trace or verify interactions between different users, it can drive assurance and accountability for transactions and other agreements. Collectively, these features make blockchain a potential game-changer for how we transfer money, how we buy things and sell things, how we enforce contracts and much more.
Information partially sourced from hbr.org; “The Truth About Blockchain” by Iansiti, Marco and Lakhani, Karim R.; January-February 2017.