WTF is blockchain
This post is part a series of articles that explain, in plain English, new technology tools and platforms that are changing the face of finance. Check out other articles in this series here.
What is a blockchain?
A blockchain, or distributed ledger, is a list of transactions shared and updated by a network of unrelated computers. The information on blockchains is stored as blocks of information that are linked together by a chain of information (thus the name of the technology). In contrast to a traditional database that is stored and administered on a central server, every computer participating in the chain holds a complete copy of the ledger, and every copy of the ledger is updated automatically whenever a member of the network makes a transaction.
The technology streamlines transactions that previously required brokers or middle men to verify identities and information about parties to a transaction or exchange. In principle, the technology could eliminate the need for traditional finance institutions such as banks, insurance companies, stock exchanges and payment processors by allowing the public to streamline, validate and secure their financial transactions, often at a lower cost than traditional industry services.
The most well known existing example of blockchain technology is bitcoin, a cryptocurrency not issued by any state or bank.
What are the benefits of blockchain?
The biggest benefit of blockchains is transparency. All information and all transactions are visible and verifiable to all members of the network at all times.
In addition, the transparent nature of blockchain, combined with the highly-complicated technical demands of the system make it virtually fool-proof: A dishonest agent would need to deceive thousands of otherwise unrelated computers to verify a false piece of data at a given moment in time, and then to convince all other members of the chain that the fraudulent information was, in fact, legitimate.
What are blockchains used for?
Anything requiring a third-party to serve as a middle man to verify a transaction between two or more parties can use a blockchain. Today, the technology is mainly used to create, track and monitor bitcoins. Banks are also testing blockchain applications for securities lending, stock and bond trading, underwriting, and payments.
In the future, however, the technology can be used to ensure regulatory compliance, streamline consumer and bank payments, facilitate property transfers and escrow services, and validate legal contracts.
Why should finance professionals care about blockchain?
Because the technology stands to democratize finance in a way that few, if any, technologies, have done before. For example, take the stock market: Traditionally, stock trades required brokers to verify information on both sides of a trade and then three days to settle a transaction. Blockchain would enable buyers and sellers to trade between each other without a middleman. Blockchain will reorganize parts of capital markets as various intermediaries are rendered obsolete.
Are there any downsides to blockchain?
One of the best things about blockchain technology is also one of the biggest drawbacks: Anonymity. Blockchains allow internet and mobile transactions to remain nameless, and this also potentially makes the technology useful to criminals moving large amounts of money far from the eyes of governments and law enforcement agencies.
And there are jobs. As mentioned above, one of blockchain’s selling points is the ability to cut middlemen out of the industry. That means that a whole industry of bankers, brokers, notaries, lawyers and others could soon find themselves looking for work.
Lastly, speed: Because every transaction must be approved by the blockchain and recorded on every ledger on the chain, the approval process can be lengthy for a digital transaction. Some technology has improved upon this, but still, transaction speed is an issue the industry is working to solve.
Is blockchain secure?
In theory, yes. Blockchain data is stored on computers along the chain, meaning a computer crash or hack in one location will not affect data for the rest of the network.
In addition, experts say the decentralized, open nature of the system, as well as the complexity of updating the blockchain renders the technology fraud-proof because data blocks cannot be tampered with retroactively once they have been admitted to the blockchain. Dishonest agents trying to defraud the system would a) have to alter data at each location simultaneously in order to perpetrate a fraud, and b) convince other members of the chain that the amended data is accurate.
On the other hand, industry professionals are certainly maintaining a healthy dose of skepticism about the technology. It pays to remember, however, that almost by definition, technology is vulnerable to hackers. Industry professionals describe the system as “virtually impenetrable” or “nearly impossible to invert or undo.”
Can blockchain technology be regulated?
Ultimately, however, it would appear that the technology itself cannot be regulated, anymore than the internet or voiceover internet protocol can be regulated. In other words, federal regulators are likely to address applications of blockchain technology (like virtual currencies and bank transactions), but the technology itself cannot be regulated.