By Matei Apolzan, Alumnus of The Young Investment Banker Programme 2016
$US200 million are to be raised this year by R3 CEV, a consortium of 42 global banks and asset management companies, with the specific purpose of identifying and implementing the uses of blockchain technology in the financial services industry. I believe such a magnificent display of force proves not only that blockchain is an innovative solution to many intricacies present in financial markets, but that it has the potential to redefine the concept of a transaction.
As esoteric as the concept of the distributed ledger may sound, the way it works appeals to common sense. In short, while traditional businesses each track their own transactions, the blockchain introduces a unique ledger, a copy of which is available to all users of the network. The ledger is continuously updated through advanced mathematics built in for security purposes, providing a single source of truth for all past activities. The need for a centralised hub of all transactions is foregone.
When first proposed, the immediate application of the technology took the form of cryptocurrency, unregulated digital currencies, Bitcoin being the most salient example. Yet, trading cryptocurrencies had never been an objective of big financial institutions. Expanding the scope of the technology backing the Bitcoin, however, started to uncover lucrative uses within the finance sector.
This is where it gets interesting. The “transaction” in the blockchain model can assume the form of any exchange of information. While Bitcoin facilitates solely monetary exchanges, new developments such as the Ethereum platform allow the user to embed “smart contracts”, a set of rules programmed through the platform, creating “smart assets”. This is groundbreaking. Bitcoin, infamous once for facilitating the payment of executions and drug deals, is now creating a digital revolution in finance itself.
Presently, services such as smartcontracts.com offer clients the possibility of preprogramming contracts to perform payouts between parties when certain criteria have been met. Moreover, given its flexibility, blockchain applications are now researched in fields such as public utilities , the Internet of Things , and even military communications !
What should an investment banker make out of the imminent shift in the status quo? The R3 Giants, among which Goldman Sachs, JP Morgan, HSBC and Bank of America believe implementing the blockchain full-scale system can save billions in operating costs for the big banks, primarily through bypassing slow, expensive payment networks. Thus, the blockchain brings about greater efficiency and less bureaucracy for the entire financial system; good news for bankers, no doubt.
Yet cost savings are not the sole reason for the blockchain hype. Santander Innoventure asserts that the derivative market is certain to benefit from “smart contacts”, given that the contracts supporting them will be in the hands of analytics. Enticing as ever to traders and financiers, “smart assets” will push the frontiers of financial markets.
It is my belief that the blockchain is here to stay. Are we psychologically prepared to deal with this level of complexity?