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Earlier this year, three topics dominated the 48th World Economic Forum in Davos, Switzerland: tax laws, inequality in the workplace and blockchain. Of the three, blockchain, a nascent distributed ledger technology, is likely to have the biggest impact on commerce and finance. That’s because, at its most basic level, blockchain is a technology that promises to automate trust.
Can you put a price on trust? Here's a sobering fact: we do it all the time. When we use or accept a credit card swipe as payment, we trust that the funds will somehow clear, and we pay a bank for that assurance. When we hand over a deposit for a house to an estate agent, who in turn lodges the funds with the conveyancing attorney, we trust that the money will be transferred to the seller in return for the front-door key.
A large part of what we pay to intermediaries in these sorts of transactions is, in effect, a fee for trust: trust that the other party will live up to its obligations, or the comfort of recourse if they don't. But what if there was a way of securing this trust without needing to pay a middleman?
Well, it would seem that there is, and the solution goes by the name 'blockchain'.
What is blockchain?
Invented in 2008 to serve as a public or open transaction ledger for bitcoin, blockchain’s purpose was to record transactions between two parties efficiently, in a verifiable and permanent way. But unlike a traditional ledger, the blockchain is replicated simultaneously across thousands of computers, each one of which must verify any change in order for the change to take effect. So, once data has been recorded in any block, it cannot be altered or removed without altering all subsequent blocks, which in turn requires the consensus of the network.
When a transaction is recorded in the blockchain, all details of the transaction – such as price, the nature of the asset and ownership – are captured, verified and settled almost instantaneously.
Picture an Excel spreadsheet. Now visualise multiple copies of this spreadsheet and any copy is the most updated copy. That's blockchain.
Nasreen Saunders, founder of Cape Town-based Umphakathi weAfrika, a decentralised marketplace that connects Africa's blockchain and crypto enthusiasts, explains it simply: "Picture an Excel spreadsheet. Now visualise multiple copies of this spreadsheet, and any copy is the most updated copy. That's blockchain. It’s an open, distributed ledger that is immutable and decentralised. The one difference between it and something like Google Docs is that the latter is centralised. Somebody owns that, whereas blockchain technology is decentralised. Nobody owns it."
To understand why such a ledger is so important, consider the centrality of trust in commercial transactions. Take the simple example of buying a used car. Has the car been in a serious accident? When last was it serviced? Is the person you're buying it from the rightful owner?
Currently, we pay trusted intermediaries like insurance companies and banks to perform the due diligence and give us peace of mind. But imagine if the entire life cycle of a vehicle could be recorded in one central, transparent database that tells you everything, from its previous owners and their outstanding fines to the car's accident history? That's where blockchain comes in.
Closing the 'trust gap'
The internet heralded a new era in the global exchange of information, making it a lot easier for anyone, anywhere in the world, to transact and do business. But, in and of itself, the internet did little to address the trust gap between transacting parties. So, we simply continued using the same old intermediaries to close that gap for us.
Because of its immutability, blockchain holds out the promise of verifying that no party to any transaction can misrepresent itself to the other. The most famous application of this feature is in cryptocurrencies. Blockchain ensures that I can only spend cryptocoins that I actually have, and that I can only spend each coin once. But this is by no means the only application. Blockchain can also be used to store digital records, exchange digital assets and execute smart contracts – all without the need for an intermediary.
The New York Times had this tremendous network of consumers buying newspapers every day. The internet democratised the creation and distribution of content. Now, blockchain technology is doing the same thing to financial services.
How blockchain will disrupt financial services
According to Chris Becker, blockchain lead for Investec, to understand how blockchain will disrupt financial services, think of what the Internet did to publishers. "The New York Times had this tremendous network of consumers buying newspapers every day. The internet democratised the creation and distribution of content. Now, blockchain technology is doing the same thing to financial services."
The hallmark of what Singularity University's website regards as "exponential technologies", is that they go from a "deceptively slow pace of development to a disruptively fast pace". (Singularity University is a Silicon Valley corporation which offers educational programmes and a business incubator.) People generally disregard these so-called exponential technologies at first, until they start changing the way we do things. The internet, digital cameras and smartphones are all cases in point.
Becker regards blockchain as such a technology. "Blockchain will disintermediate financial services companies across the world and will democratise access to, and the creation of, financial services products – because you don't need to work for a bank in order to build financial services products anymore."
But Becker is also quick to note that many large financial services companies are still dismissive of blockchain technology because the use cases for it – such as share trading, identity management and smart contracts – are not yet well developed. John Haynes, head of research at Investec Wealth & Investment UK and chairperson of the Global Investment Strategy Group in London, concurs. "The killer app for blockchain has yet to be invented," says Haynes. "But I am sure it is out there. It will be the plumbing that runs a large part of the financial systems at some point in the future, because it will take a lot of cost out of the system and that will be good for consumers."
The end of banking?
But while blockchain may inject new efficiencies into the workings of banks, it is hardly a death knell for financial services. Rather, it may result in lower costs for banks, which will be passed on to clients in the form of lower fees and enhanced services. Potential uses include cross-border transactions, securities trades, syndicated lending, trade finance, swaps, derivatives or any other financial instrument where counterparty risk arises.
In fact, according to a recent paper published by Santander Bank, ledger technologies could save banks
$15bn to $20bn a year by 2022, just by reducing the infrastructural costs of cross-border payments, securities trading and regulatory compliance. In addition to reducing the costs of transactions and speeding them up, the greater transparency and traceability offered by blockchain transactions is very appealing to regulators. No wonder, then, that the SA Reserve Bank undertook a recent blockchain experiment with eight banks, including Investec.
Project Khokha, a proof-of-concept settlement platform based on distributed ledger technology, built a system that handles gross settlements in real time. It was also able to process the entire daily transaction volume of all South African financial institutions within two hours, without the need for the Reserve Bank to check and approve all the transactions. Instead, banks were able to approve the transactions on the network themselves.
The killer app for blockchain has yet to be invented, but I am sure it will be the plumbing that runs a large part of the financial systems at some point in the future.
Blockchain in Africa
Blockchain is also being used in the registry of title deeds. Nathana Sharma, principal of the faculty in blockchain, law and governance at Singularity University, points out that in Africa two-thirds of land ownership is insecure.
"When you can't prove that you own your land, it gets really hard to borrow money based on that land. But, if you can prove it, you can go ahead and buy capital needed to improve your farm, for example. This is a key aspect of taking people out of poverty. What blockchain technology does is that it … supports cooperation among parties that no longer trust, or never trusted, each other."
Sharma references the start-up Bitland, which is helping towns in Ghana to put land records on a blockchain database. "This is really important because once the land records are on a blockchain database, when new people come to power they cannot just change or alter the database. The blockchain records are secure."
In addition to tracking precious metals and minerals, Sharma says that blockchain is also being used effectively to track fake pharmaceuticals – a scourge that kills 100 000 people a year, according to World Health Organisation estimates.
Five to 10 years before we truly feel the impact
It seems clear that blockchain is a foundational technology that will disrupt several industries, including financial services, within the next five to 10 years. But, disruptive as these changes will be, the technology itself may remain largely invisible to those who use and benefit from the new technologies.
"I suspect we'll see a diminished usage of traditional bank ledgering systems," says Becker. "What I think will also happen is that people will not necessarily know that they are using blockchain; they will bank with a company that uses the blockchain in their back-end."
Like the internet, which underpins so many of the services we use today, blockchain seems likely to become the invisible spark behind a host of services that will one day be as indispensable as email or online news. And, like the internet, this invisibility will come to be a hallmark of its ubiquity.