Can distributed-ledger technology restore confidence in financial services or is the house destined to come crumbling down?
The British public has some trust issues. Thanks to a slew of high-profile hacks, corporate scandals and broken promises from politicians, there’s an unmistakable scepticism surrounding the people who make our laws, sell us things and handle our money or data. Financial services companies have it particularly bad and are still suffering from the blowback from the 2008 crisis, which revealed just how little we knew about what they were up to. In fact, a study in 2016 by Accenture, the management consultancy, found that just 29% of respondents thought banks were trustworthy. But perhaps instead of trusting banks, people might be willing to place their faith in code instead. Blockchain has been around for some time now but it’s only relatively recently that people have started to speak of it as a sort of truth serum for the way transactions are recorded. If things keep progressing as they are, it could seriously disrupt financial services companies – or perhaps even restore people’s confidence in them.
At the heart of the technology is a shared and decentralised ledger that allows people to stack entries on top of older ones and view others. But once data has been added, history can’t be rewritten and edits can only be made when the majority agrees to it. There’s no one controller who wields more editing power than others. This means that for any given exchange, you’re able to see exactly who’s had ownership and every stage is automatically logged – no middleman necessary.
And this is leading many in the industry to get very excited. “Blockchain-inspired distributed-ledger technology has the potential to transform the financial services industry,” says Charley Cooper, managing director of R3, the distributed-ledger technology firm. “It will allow financial agreements to be recorded and automatically managed without errors. Duplications, reconciliations, failed matches and breaks will be things of the past. Isolated islands of asset representations will be no more. This is a huge opportunity to improve the way the financial sector does business.”
It’s still early days for blockchain but we’re already starting to see some creative applications from startups. Maecenas is promising to transform the art-buying market and make it virtually impossible to falsify a painting while GovCoin is exploring how blockchain can be applied to the benefits payments process in partnership with the Department of Work and Pensions.
Many of these innovations were inspired by a frustration with the status quo: Nuggets, a service that allows people to make payments or log in without having their data stored, was born out of founder Alastair Johnson’s discomfort with the way personal information was traditionally being handled by brands. “I had a bad experience with my credit card details being used fraudulently and developed an appreciation of just how open my data was to being used and abused,” he says. “You wouldn’t leave your credit card details in the shop round the corner so why do it online? I was sure there had to be a better way.” Johnson’s better way came in the form of a blockchain-based solution that allows people to use a single biometric tool online. And it was the immutable ledger in particular that he refers to as “an epiphany that opened up a whole new realm of possibilities”.
For the banks and traditional financial service providers, it must be tough working out whether to be excited by the technology’s potential or terrified that it will make them extinct. Many are using outdated legacy systems that are inefficient and at the stage when they’re ready to be replaced. In fact, Santander has estimated that blockchain could save banks up to $20bn each year in administrative costs. However, it could also herald the start of a peer-to-peer lending regime that’s cheaper and more appealing to consumers. “Financial services companies are interested in blockchain because it has the power to do away with them entirely,” says Simon Carlino, founder of Regent Street Strategies, the consultancy specialising in blockchain. But necessity is often the mother of invention. “It’s no accident a multitude of blockchain startups can be found at the Level39 accelerator in the heart of the City: financial services companies are working with incubators, accelerators and startups in the hope that they’ll get some useful, value-added products out of it.” For instance, banks that develop a private blockchain could offer it to high-end customers. “It’s a fascinating balancing act for the banks,” Carlino adds.
But with things moving so fast, the regulators have taken a cautious, wait-and-see approach so far. In the UK, the Financial Conduct Authority (FCA) is considering blockchain-specific regulation because not all aspects of it fit into the current framework. More regulation is by no means a bad thing of course but for Marieke Flament, managing director at Circle, the payments company, it’s important that blockchain’s massive potential isn’t stifled so early on in its story. “The thing is to regulate the services, not the technology,” she advises. “Thankfully, the FCA has been forward-thinking and is looking at all the services around blockchain and engaging fintech startups in a dialogue.” Organisations like R3 also believe it’s crucial that the FCA continues to have these conversations to allow early-stage startups to innovate and come of age in the right regulatory environment. “The most effective regulations are born of real-world experimentation and consultation,” says Cooper. R3, for its part, invites regulators, trade associations and government to observe the ways in which its members are trialling the technology in a bid to boost mutual understanding.
And as these conversations take place, cybersecurity continues to be one of the hottest topics: if blockchain proves to be not quite as tamper-proof as some are claiming, any trust it gains will vanish quickly. Theoretically, blockchain transactions are prohibitively difficult to hack because of the sheer amount of computing power needed to alter each and every block. But it’s certainly not an impossible task, as Ethereum, the blockchain application platform, discovered when it was compromised in 2016. “Blockchain is trustworthy to an extent but nothing is hack-proof,” warns Carlino. There’s also a nervousness surrounding quantum computing’s potential in the future to be able to tamper with ledgers on a massive scale. “Right now it would cost way more to hack a blockchain than you’d receive in return but with computers capable of carrying out billions of calculations per second, it could become a problem,” he adds.
That being said, it’s just as likely that an intrepid entrepreneur will figure out a solution before it becomes something to worry about. Russian scientists have already experimented with using quantum mechanics to secure blockchains and developers across the world are continually pushing the boundaries of what’s possible. Flament likens where we are now to the very early days of the internet, though the pace of change is much faster. “Even compared to a year ago, things are changing very quickly,” she says. “Using Ethereum, new types of products are being built all the time in different shapes and forms. It will be interesting to see what sticks and what’s scaleable. But I can say that the ideas that have been emerging so far are very encouraging.”