Blockchain technology is fast gaining traction as the premier method for faster payment services, automating contract negotiations, and securely storing and transferring data.
Often associated with the trading of cryptocurrency, blockchain is now emerging as a powerful tool for automation with the use of “smart contracts.” It has the potential to revolutionize the way we look at data management and has many use cases, including big data, AI, tracking intellectual property ownership rights such as music and art, limitless data storage, and the immutable audit aspects that come from using a blockchain.
Although blockchain technology has varying levels of adoption across industries and governments, it will soon become the infrastructure of choice to support the processing of the world’s data—especially in finance, where automation, transparency, and security are particularly beneficial for managing changes in financial products.
Users will need to be educated on what a blockchain is, how it works, and how it helps to improve transparency and efficiency in financial products to take full advantage of the new future.
Why use blockchain for finance?
Currently, financial systems rely on networks of middlemen and intermediaries that are connected through a concept of trust. These trusted parties work together to facilitate holding, securing, investing, and transferring your funds.
Take the idea of sending a friend in another country $100. To do this a person must go to their bank or online app and complete a funds transfer request. Even with today’s technological advances this still relies on timelines under which these banking payment rails are open (Monday to Friday, 9 to 5). This means that an international payment may take up to 4 days to reach its destination.
While this system has worked well in the past, there is always room to leverage technological advancements to drive more efficiency in global markets. Some opportunities for optimization include:
- Speed: Banks are not open 24×7 and it can take days to transfer money between individuals.
- Security: Banks serve as trusted intermediaries, but they are still able to go bankrupt. Many banks went under during the last financial crisis. Additionally, outdated mainframe systems have left them vulnerable to cyberattacks. Hackers have successfully breached the systems of many of the major banks.
- Privacy: When customers use intermediaries, these companies collect valuable data about users and their financial habits and could resell this data to sales companies to maximize their profits.
- Cost: Intermediaries profit from their current position as the trusted solution for financial services, often at the expense of users.
- Accessibility: According to the World Bank, an estimated 1.7 billion adults lack an account at a financial institution or through a mobile money provider. Traditional financial institutions have many barriers including location, age, wealth, or simply product choice that may make it difficult for people to access the financial services they need.
Blockchain removes these barriers and makes it easier to access funds, arrange financing, or simply transfer and store digital assets in a more transparent and democratic way while maintaining the same or greater level of trust than exists in traditional finance today.
What is blockchain?
A blockchain is formed when a group of computers (each called a node) are linked together to create a network to store and transfer data under a software protocol that uses cryptographic security to ensure the data cannot be attacked. The result is a database that is distributed throughout the network, with no single computer having a consolidated view of the entire data store.
This process is also known as a “distributed ledger” of information that can be used to send information, payments, track the real-time status of digital assets in the network, and facilitate automated transactions between parties using rules on the network. Digital assets and transactions on one distributed ledger framework can be published and duplicated across other blockchains, creating speed and easy adoption.
Blockchain creates additional security by breaking down messages to be sent through the network into small, bite-sized “blocks” of data. These data blocks are each given a sequence number that links the previous block and the following block, and they are then sent through the network. Each node may have connections to many different nodes in its region, which means that each block (part of the message) can be duplicated many times over.
Once a message is broken down into blocks and sent on the blockchain, it is very difficult to change the overall message because the information in that block only represents part of the message and contains links to subsequent blocks in the chain. To change the message sent on a blockchain, a hacker would need to not only tamper with one block but also alter all the preceding and following blocks in the chain.
At the destination, the message is recomposed by sequencing the blocks in order. Once a sequence of blocks is received, the message can be validated for tampering as there will be duplicate versions all containing the same information. Some blockchains will only confirm the message as irrefutable after multiple duplicate blocks have been received.
Most blockchains use “public” nodes (public chains) to send messages through, and some only allow nodes that have been prescreened or permissioned to comply with a defined set of rules. Permissioned nodes are called “private” networks or “private chains.”
Anyone can use their computer to join a network, which means that the data blocks are publicly accessible to all users of this network, adding a layer of transparency. Whenever someone joins, they will be required to download an app or software specific to a chain to allow their computer to act as a node on the network. Once connected, they will form part of the distributed ledger and data blocks may be sent to their computers to run calculations or act as part of a payment chain to assist in peer-to-peer payments (P2P).
Trading on blockchain
The benefits of trading on blockchain include:
- Built-in compliance: Security tokens in the blockchain can verify that a transaction follows the applicable regulation(s).
- Increased liquidity: Because tokenization permits less than one whole unit of a security to be bought or sold, investors can enter the market at a lower cost, thus making these digital assets more liquid.
- Greater geographic diversity: Blockchain cuts down on the cumbersome process that limits global securities trading.
- Reduced costs: Securities trading requires a lot of human intervention for steps like settling, allocating, and closing the transaction, which costs resources. Blockchains can complete these tasks quickly with built-in “smart contracts,” computer codes that automatically execute if certain conditions are met.
Given these reasons, it’s no surprise that blockchain is increasingly being used for trading. NASDAQ made its first securities transaction using a blockchain in 2015.
Blockchain is known for its inherent security, but when it comes to settlement of securities its speed is an advantage. Instead of waiting days, transactions can be finalized in minutes, lowering risk and overhead costs.
Blockchain can also streamline many complex processes involved in trading, including proof of payment, stock transfers, and calculating stock prices in real time by using “smart contracts” to check for compliance (e.g., buyers must be over 18).
Both financial institutions and investors benefit from the transition to a blockchain-based system for securities trading. Blockchain provides a faster and more secure infrastructure for asset trading that will make it easier to maximize investments.