We all heard about Bitcoin, the digital currency that allows you to transfer and store money without having to trust any third party, but not everyone knows that the Bitcoin protocol is just the monetary application of a very powerful technology called blockchain, something that all the big players in the finance industry are looking at.
Daily transaction on the Bitcoin blockchain
The blockchain is nothing more than a distributed permissionless database, but this allows people to store in a secure way very valuable data, such as monetary transactions, and the possible applications over this technology are endless. The most interesting one that we have at the moment are the so called smart contracts, self-executing contractual states that make possible to have any kind of contract, between two or more people, executing automatically when a certain event occurs. What does it means for finance people? Well it means that it is now possible to have, for example, futures, options and swaps without a clearing house or any kind of third party involved, 2p2 insurances without counterparty risk, smart bonds without middle or back office (already experimented by UBS), decentralized crowedfundig, prediction markets and 2p2 shares distribution.
The concept of smart contract is not new at all, it was introduced for the first time back in 1994 by the famous computer scientist Nick Szabo, but in the world before Bitcoin it was impossible for a computer program to trigger a payment and since every transaction had to be manually authorised by a bank, a smart contract couldn’t exist. After Bitcoin became popular the first smart contracts platforms were launched, but there were still many limitations due to structure of the Bitcoin protocol, it is only in 2015 that the first blockchain specifically designed for smart contracts became real when in August Ethereum, what some people call Bitcoin 2.0, has been finally released. Ethereum can be seen like a big distributed computer that can’t be switched off and once you write a contract on it, and you pay the fee to the network, nobody can stop it from being executed. A platform like this opens the financial industry to an huge number of opportunities allowing more secure and better performing financial services with less intermediates involved. Indeed through the R3 CEV consortium, 11 banks including RBS, Barclays, UBS, HSBS and Credit Suisse are already experimenting new ways to connected each other using the Ethereum network, once these technologies will be implemented many back office costs will be cut, making financial products cheaper and more accessible. This means that big corporations will lose part of their competitive advantage, and much more players will have a significant market share in a world where financial services are more diversified and more efficient.
However it is important to underline that blockchain technologies are so powerful that the possible applications go far behind the finance world, for example in a recent research conducted by IBM blockchain technology is identified as the best option to support the development of Internet of Things, because it provides better security and less scalability issues compared to centralized alternatives. Therefore blockchain shouldn’t concern only finance people, but it is interest of anyone who wants to be where innovation takes place.
Federico Tenga, Co-Founder at Blockchain Education Network
This article was originally posted in January 2016
Nick Szabo, The Idea of Smart Contracts (1997)
UBS smart bonds
Ethereum, a platform for smart contracts
R3 CEV, banks consortium for blockchain development
IBM, Internet of Things report