Introduction to Blockchain Technology

How Blockchain Works And Possible Applications In Financial Services

Banking Blockchain FinTech

Is Blockchain technology really going to change the world? Simply put, I believe it will offer a more secure mechanism to transact business in a less centralized way. A growing community of developers moving to open source code and the adoption by several tech giants is really making it possible for us to contemplate living in a decentralized world. Add to that the billion dollar venture capital investments in fintech startups, government support and advancements in technology create a sustainable and innovative ecosystem. Blockchain is still in an early development stage with many potential applications.

So how does it actually work? Well, a general understanding of blockchain tells us it is a shared, distributed database of transactions among different parties. It is designed to increase security, transparency and efficiency of the transactions. It makes use of cryptography to allow users to manipulate the data in a secure way without the need for a central authority. The database is replicated across multiple locations and nodes with the transactions of various parties. These transactions are split into blocks with each block containing the details of each transaction such the seller, the buyer, the price, the contract terms, and other relevant details. When a transaction request occurs, it is verified by the entire network via encryption to determine the authenticity of the request.

The network algorithms verify the unique signature of both parties involved in the transaction. If the transaction matches the blockchain history then the transaction is valid, it is therefore approved and a new block added to the chain of prior transaction. If the block is invalid a ‘consensus’ of nodes will correct the result in the non-conforming node. The blockchain ledgers are distributed across multiple locations and each maintains its copy which is updated based on a new transaction data.

Blockchain systems can be either public or private. The distributed ledger used in bitcoin application is public and can be accessed by anyone who wishes to transact. Yet many high commercial transactions ie securities transcation or capital market that might benefit from blockchain system require a level of privacy. These may be ideally served by private blockchains. Private or ‘permissioned’ blockchains behave in the same way as the public blockchain, except that the identity of anyone who attempts to access the blockchain must be validated against a list of pre-validated market IDs.

The blockchain ecosystem has various advantages over other centralized systems. Firstly, blockchain is very secure. It relies on encryption to validate transactions by verifying the identities of parties involved in a transaction. This ensures that a “false” transaction cannot be added to the blockchain without the consent of the parties involved. The use of hashing algorithm guarantees the authenticity of data transacted, identities of parties involved and counter checks result of previous transactions to ensures that malicious actors cannot alter past transactions.

In many cases real word example, multiple parties already maintain duplicate databases containing information about the same transactions. In many of these cases data pertaining to the same transaction is usually in conflict. This results in the need of costly, time consuming reconciliation procedures between organizations. The use of a distributed system such as blockchain can substantially reduce the need for manual reconciliation, thus driving considerable savings across organizations.

Also, transparency is a key component of blockchain architecture. Since it is a distributed database that is maintained and synchronized among multiple nodes, transactional data must be consistent between parties in order to be added to the blockchain. This means that multiple parties can access the same data thus increasing the level of transparency. This is a huge contrast to other conventional systems where databases are behind firewalls and are not visible outside a single organization.

There are many possible applications for blockchain technology and the potential impact it could have is still yet to be determined. However, several proof of concepts are underway with fintech investment leading the way.

Some other applications include:

  • Reducing the total clearing cost for equities, repurchase, and capital markets.
  • Property titles that require a labor-intensive clearing process thereby simplifying verification and reducing premiums.
  • Providing secure identity and reputation management.
  • Improve quality of data and reduce false positives.

Hence, there is expected to be huge uptake in blockchain projects in the near future. The banking and financial industry have taken a proactive stance in funding billions into research and fintech startups. We are already seeing an impact on balance sheets, lower revenues and falling profit margins. Financial business models are now in a risky position where innovation is a key driver moving forward and sitting idly is not an option.