Fung Institute for Engineering Leadership

Op-Ed: Why we need to talk about the applications of blockchain technology on the financial market

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By Michael Brenndoerfer, edited by Maya Rector

Photo by Andre Francois on Unsplash
Michael Brenndoerfer is a current UC Berkeley Master of Engineering student in the class of 2018. He is in the Electrical Engineering and Computer Science (EECS) department, and his concentration area is Data Science & Systems. Most of his work at Berkeley revolves around Deep Learning, Systems and Crypto. After graduating, he plans on expanding his cryptocurrency related startup. In his free time, he loves to travel and is no stranger to living out of a suitcase. Disclaimer: This piece was written in August of 2017. Certain data, especially market capitalization, has changed since then. Furthermore, over the last few months cryptocurrencies and Blockchain technology have seen a vast rise in mainstream awareness and acceptance.

What is Blockchain?

Blockchain technology is popular in the context of cryptocurrencies. People know of Bitcoin and Ethereum, but Blockchain technology can be used for extensive applications beyond just cryptocurrencies. Blockchain is a technology that allows for multiple parties’ parallel access to a commonly shared, but distributed, ledger. Its major distinguishing feature is its unprecedented level of data integrity (Treat, Brodersen, Blain, & Kurbanov, 2017), while being decentralized. More precisely, a Blockchain can be imagined as a distributed and decentralized (and that’s the important point) database, which, put simply, is always in a state of integrity. This is achieved through a network of random participants that try to solve a cryptographic function. This process is called proof-of-work (also known as mining) and is the pillar upon which the initial Blockchain technology is based. The process of successfully mining transactions leads to a constant validation through the network, forming consent, so that nobody can tamper with the data. Once a transaction becomes persistent, there is basically no way to undo the history. This allows for absolute trust in the data, in its consistency and integrity. (Crosby et al., 2015).
Photo by Vladimir Solomyani on Unsplash

Potential applications of Blockchain technology

Almost every financial institution is currently exploring and evaluating its possibilities. A heavily investigated application is the reduction of legacy IT and back-office processes by moving them on the Blockchain. Estimates based on test environments show potential savings of more than 50% (Treat et al., 2017). In order to enable these changes, regulatory rules need to be adopted for the Blockchain. The BBVA Blockchain in financial services working paper, by Cermeño (2016), suggests several approaches towards regulation, such as “supra-regulators” on a global level, or regional regulators, which themselves report to a higher organization. This approach allows them to split the organization up into smaller, more granular consortia. Recent joint research between the European Central Bank and Bank of Japan (2017) aimed to identify possibilities to move today’s financial transactions on distributed ledgers. The result of the research was that Blockchain based technologies might be able to meet today’s standards of Real-Time Gross Settlement (RTGS) systems, the backbone of gross transactions of securities and assets between banks (Committee on Payment and Settlement Systems of the central banks, 1997). However, a performance impact was noticed when increasing the number of transactions, and when increasing the distance between the participants in the network. Nevertheless, as shown by the European Central Bank and Bank of Japan (2017), distributed ledgers have the potential to further increase today’s security and reliability, in terms of availability, quality of service, and data safety.
“Since 2016, the usage of Cash has been heavily in decline in Sweden and many stores do not even accept it anymore.”
Further research by Bech and Garratt (2017) at the Bank of international settlements and UC Santa Barbara, investigated the applicability of central bank based cryptocurrencies. They scrutinized what a centrally-issued crypto currency would need to look like, and what use cases it would need to cover. An interesting development in that regard is, that since 2016 the usage of Cash has been heavily in decline in Sweden, and many stores do not even accept it anymore (Cermeño, 2016). Additionally, Bech and Garratt (2017) explained how such a trend makes the adoption of cryptocurrencies more likely.
“Every aspect indicates that the interest and demand in Blockchain is going to increase further.”
With its first appearance in 2013, Blockchain is still a comparatively a young technology. However, according to CoinMarketCap.com (2017), at present all cryptocurrencies combined yield a market capitalization bigger than $150B USD and basically every bank is investigating use cases. Every aspect indicates that the interest and demand in Blockchain is going to increase further. [Update: Since writing this piece, in December 2017 Bitcoin reached its highest market cap at almost $330B USD, before falling again to around $140B USD in mid-February 2018.] Learn more about Michael and his cryptocurrency startup here.

References

Op-Ed: Why we need to talk about the applications of blockchain technology on the financial market was originally published in Berkeley Master of Engineering on Medium, where people are continuing the conversation by highlighting and responding to this story.