blockchain a disruptive technology with the power to ... · 4 smart contracts in financial...
TRANSCRIPT
March 2017
BlockchainA disruptive technology with the power to revolutionize financial services
A White Paper by EquiSoft
Table of Contents
Foreword ................................................................................. 3
What is blockchain? ......................................................4
How does blockchain work? ................................ 5
Is blockchain secure? ...................................................7
Blockchain applications in
the financial services
and insurance industries ...........................................8
The challenges ...................................................................9
Towards global standardization ...................... 10
Conclusions ........................................................................ 11
Previous white papers from EquiSoft:
Invasion of the Robo-Advisor: Is the Threat Real?, February 2016
CRM2 and its impact on the Canadian Retail Investment Industry, January 2015
ForewordBlockchain is a technology you need to be aware of.
Because of its immense potential, more than 70 of the world’s largest financial institutions
(including Barclays, J.P. Morgan, Royal Bank of Scotland, State Street and UBS to name a few)
are part of a consortium researching and developing blockchain technology. Moreover,
PwC’s Global Blockchain Team has identified more than 700 start-up companies in the space1
and blockchain technology is viewed by some as the fifth paradigm of computing following
the mainframe, the personal computer, the Internet and finally the mobile and social
network revolution2.
Not yet familiar with blockchain? You are not alone. In fact, according to a 2016 survey
of top-tier executives at some of the world’s top financial institutions, less than 20%
of respondents described themselves as “very familiar” or “extremely familiar” with the
technology. That being said, 56% of survey respondents recognize its importance3.
Why that lack of familiarity with a technology that has the potential to revolutionize
commerce as we know it? We believe that this is, in part, attributable to the fact that many
industries are still focusing their efforts on leveraging the Internet and mobile technology
to enhance client front-end experiences. The financial services and insurance industries in
particular are playing catch-up in this space. With so much attention focused on the front
office platforms, little attention has been paid to archaic back-office and mid-office systems,
where blockchain technology is most applicable. Another factor contributing to the lack of
knowledge in this space may be that people have a hard time wrapping their heads around
what amounts to a paradigm shift in how humans have always conducted business.
At EquiSoft we believe that blockchain technology and its potential implications to the
financial services and insurance sectors warrant close attention. As such, we have formed an
internal blockchain task force to better understand the technology and how it can be leveraged
by our clients. The group’s first initiative was the development of the basic introduction
to the topic contained in the following pages. We trust that our overview provides you with
some clarity and food for thought regarding this potentially game-changing technology.
Jonathan Georges, CIM, FCSI
Vice President, Wealth Management Solutions
EquiSoft
1-888-989-3141, ext. 201
1 PwC Global FinTech Survey 2016
2 Blockchain: Blueprint for a New Economy
3 PwC Global FinTech Survey 2016
/ EquiSoft / 3
Blockchain: A disruptive technology with the power to revolutionize financial services
“The first generation of the digital revolution brought us the Internet of information. The second generation — powered by blockchain technology — is bringing us the Internet of value: a new platform to reshape the world of business and transform the old order of human affairs for the better.”
Don Tapscott, CEO of the Tapscott Group and bestselling author of Wikinomics, The Digital Economy and Blockchain Revolution
What is blockchain?
Blockchain was first introduced in a 2008 white paper published under the
pseudonym Satoshi Nakamoto and is best known today as the platform behind the
Bitcoin cryptocurrency. While the terms blockchain and Bitcoin are often used
synonymously, it is important to note that Bitcoin is but one of an infinite number
of applications for blockchain technology.
Blockchain can be defined as a distributed public ledger designed to record
transactions in a trusted environment. In other words, it is a type of database for
recording transactions that is copied to all computers participating in the network.
To truly understand what this means, it is helpful to first remind ourselves of the
inefficiencies in existing transaction processes. To illustrate how a typical transaction
occurs in today’s world, let’s take an example of John, who is buying a shirt in Jane’s
store. Because John isn’t carrying enough cash with him to pay for the shirt and
John and Jane don’t know each other, a trusted third party (such as a bank or credit
card company) is required to validate John’s ability to pay for the shirt before the
transaction is complete and John can take the shirt home. So, John swipes his debit
or credit card in the terminal in Jane’s clothing store, the purchase is approved
and John leaves with his new shirt. Simple enough, right? Well, not really.
On average, five institutions need to be involved in a routine transaction like the one
between John and Jane: John’s bank, Jane’s bank, Jane’s merchant service provider,
card processors and, in some cases, the credit card company (e.g. Visa or MasterCard).
With this many players involved in the transaction, it could take up to a week
for Jane to get her money and there are many points along the way that are subject
to fraud and theft. For obvious reasons, this process is both expensive and inefficient.
What if there was a better way to execute John and Jane’s transaction? Blockchain
technology eliminates the need for the trusted third-party intermediaries and allows
John to transfer payment to Jane directly in a way that is cheaper, faster and safer.
“Blockchain is a really disruptive development, and banks have a lot of fear concerning this technology because in the pure theory of blockchain, a lot of processes within a traditional bank would be obsolete.”
Thomas F. Dapp, Research Analyst, Deutsche Bank
4 / EquiSoft /
Blockchain: A disruptive technology with the power to revolutionize financial services
How does blockchain work?
In any transaction system there must be a ledger with everyone’s balance in it. In today’s
world, these ledgers are isolated and closed to the public and, as such, trusted third parties
(e.g. governments, banks, trusts, accountants, notaries and paper money) are required to
facilitate and approve transactions.
Blockchain technology is free open-source software distributed worldwide that eliminates
the need for the trusted third parties by enabling a network of computers to maintain a
collective ledger via the Internet. This collective ledger is public and fully distributed across
a network of “nodes” that all own a full copy of the ledger or blockchain.
In a blockchain, all new transaction details are logged, time stamped and verified by
“miners” who compete in solving complex mathematical problems for the ability to post
the next block of transactions to the ledger (or chain of historical transactions). Miners
are individuals who run complex computer systems designed to solve the mathematical
problems, and they are rewarded for their efforts through some type of financial
compensation. Once the block of transactions is uploaded by the miner that solved the
calculation first, all nodes in the network automatically validate the ledger and every
transaction in it. Generally, a majority (51%) of the nodes must agree that the block is valid
for it to become part of the chain of transaction blocks or blockchain. Transaction blocks are
generally posted to the shared ledger in ten-minute intervals.
“It’s hard not to be fascinated by something so transformative.”
Carolyn Wilkins, Senior Deputy Governor of the Bank of Canada
/ EquiSoft / 5
Blockchain: A disruptive technology with the power to revolutionize financial services
In this basic example, the terms of John and Jane’s agreement for the purchase of the shirt are straightforward. However, the
type of details that can be included in the transaction details are limitless. This means that not only can a simple transaction
be efficiently executed on a blockchain, the terms of a complex contract (e.g. mortgages, options and futures, employment
contracts, insurance contracts, etc.) can also be managed through a blockchain. A “Smart Contract” on a blockchain will store
the contract terms and even automatically execute the terms of the contract through automated money flows, for example.
These smart contracts eliminate the need for intermediaries between parties, automatically ensure compliance and significantly
reduce bureaucracy. In fact, Capgemini estimates that Smart Contracts will be implemented into practical and mainstream
applications by the year 2020 and could save consumers US$ 16 billion a year (US$ 500 for the average consumer) on banking
and insurance fees4.
LET’S REVISIT OUR EXAMPLE OF JOHN AND JANE, BUT THIS TIME WE WILL USE BLOCKCHAIN
TECHNOLOGY TO PROCESS THEIR TRANSACTION.
JOHN uses a digital wallet app (like
a mobile banking app) on his smart
phone by entering Jane’s public key
obtained by scanning a QR code from
her phone or by having her email him
an encrypted payment address.
John’s transaction is grouped
with many other transactions
that are requested within
a ten-minute period and the
block of pending transactions
is submitted for verification.
When a miner solves
the mathematical
challenge, they
announce it to the
rest of the network.
All the miners around the world
compete for the right to
post the block of transactions
to the shared ledger by solving
a complex cryptographic
computation.
The miners
validate that
John has enough
money in his
wallet to make
the payment.
The winning miner is
issued a financial reward
(the buyers and sellers
in the network generally
bear these costs) and the
new block is added to the
front of the blockchain.
Within ten minutes of the initiation of
the transaction, JANE receives payment
for John’s purchase (compared to one
week in our previous example).
4 Smart Contracts in Financial Services: Getting from Hype to Reality – Capgemini’s Digital Transformation Institute
The app alerts the
“miners” around
the world that John
wishes to execute
a specific transaction
with Jane.
APP APP
6 / EquiSoft /
Blockchain: A disruptive technology with the power to revolutionize financial services
Is blockchain secure?
Given the shared and public nature of the blockchain, it is only natural to
question the security of transacting on such a network. In fact, blockchain is
much more secure than existing transaction networks.
First off, while the ledger and all its transactions are public, people participate
in the blockchain anonymously through public and private encrypted keys.
The implication is that even though everyone knows all the transactions
and account balances of everyone on the blockchain, there is no way of linking
them to a specific person.
Secondly, because every single node on the network holds an up-to-date
record of the ledger, to modify transactions on the blockchain, a hacker would
be required to hack at least 51% of the miner nodes (because without
consensus, a block of transactions cannot be added to the chain) around
the world within a ten-minute period (the frequency at which a new block of
transactions is validated and added to the chain). As such, it is estimated
that it would require 200 of the world’s largest super computers combined to
hack the system5.
5 Future Bank Today
“Blockchain trading is much more secure than the current system. The distributed nature of the network that verifies the integrity of the transactions and associated account balances makes a successful attack mathematically impossible.”
Judd Bagley, Director of Communications, Overstock.com
/ EquiSoft / 7
Blockchain: A disruptive technology with the power to revolutionize financial services
Blockchain applications in the financial services and insurance industries
The obvious and well-documented applications of blockchain technology center on the
concept of facilitating the exchange of money and the related updates to ancient legacy
transaction and settlement systems. However, there are countless other opportunities
for financial services firms and insurance companies to use blockchain to optimize
processes and improve services.
For example, preventing money laundering and the financing of terrorism is extremely
expensive for financial firms. In fact, it is estimated that the global spending on
Anti-Money Laundering compliance alone totaled $10 billion in 20146. Furthermore,
Know Your Client (KYC) requirements tend to delay transactions and entail substantial
duplication of efforts between firms. A blockchain-based registry would not only
eliminate the duplication of effort to complete KYC checks, client detail updates could
be distributed to all institutions almost in real time. Also, the distributed
ledger would provide a historical record of all documents and compliance activities
for all clients.
Likewise, in the insurance industry, smart contracts on a blockchain could provide
customers and insurers with the means to manage claims in a transparent and
efficient manner. Not only could insurance contract details be stored on a blockchain,
but the platform can be used to validate claims (thereby reducing the frequency
of fraudulent claims) and even trigger payments automatically when conditions
are met and validated. The result would be streamlined processes and a better
customer experience.
“Blockchain technology will not only change the way we do payments, it will change the whole trading and settlement topic.”
Oliver Bussmann, CIO, UBS
“Blockchain technology continues to redefine not only how the exchange sector operates, but the global financial economy as a whole.”
Bob Greifeld, CEO, NASDAQ
6 Global Anti-Money Laundering Survey 2014, KPMG, January 2014
8 / EquiSoft /
Blockchain: A disruptive technology with the power to revolutionize financial services
The challenges
While having the potential to power a paradigm shift in how the world does business, blockchain is not without its
challenges. Some of the primary challenges associated with the adoption of this young technology are outlined below.
BUY-IN Because blockchain is so unprecedented, there will be
challenges in gaining understanding and buy-in among
system developers, users and operators. In fact, because
blockchain represents a way of thinking that is so far
from how things are done today, IT skills in this area
may become hard to come by because they fall outside
the traditional IT skill set.
COST While blockchain technology could offer organizations
incredible cost savings, the high initial costs may be
a deterrent. The move from a centralized system to a
decentralized network will require significant changes
or the complete replacement of legacy infrastructure.
REGULATORY ISSUES Today’s world currencies are generally created and
regulated by national governments. Crypto currencies,
managed by blockchains, may struggle achieving
widespread adoption with existing financial institutions
if question marks surrounding their government
regulatory status are unresolved.
ENERGY CONSUMPTION Blockchain technology requires a substantial
amount of energy to maintain. Just take the Bitcoin
blockchain as an example. The network’s miners are
attempting 450 thousand trillion solutions per
second to validate transactions7! As new blockchains
are added, the computing power requirements could
grow exponentially.
STANDARDIZATION For blockchain to effectively accelerate trade processes,
improve recordkeeping, enhance fraud detection
and much more, some global standardization across
institutions is required. Unfortunately, this is easier said
than done. Country customs, regulatory regimes and
political processes often slow standardization efforts.
“It’s a wonderful technology [blockchain], and I do think it will be disruptive. I just think we’ve got a lot of work to do.”
Peter Cherecwich, President of global funds services, Northern Trust
7 Deloitte Insights, Blockchain technology: 9 benefits and 7 challenges
/ EquiSoft / 9
Blockchain: A disruptive technology with the power to revolutionize financial services
10 / EquiSoft /
Blockchain: A disruptive technology with the power to revolutionize financial services
“Distributed ledger technology has the potential to change financial services as profoundly as the Internet changed media and entertainment.”
r3cev.com
“… Ethereum is also attracting attention from giants in finance and technology, like JPMorgan Chase, Microsoft and IBM…”
The New York Times
“Not since the Web itself has a technology promised broader and more fundamental revolution than blockchain technology.”
Hyperledger.org
Towards global standardization
There are already several efforts underway to help standardize distributed ledger
technology.
R3 is a technology company leading a consortium of over 70 of the world’s largest
financial institutions in the research and development of distributed ledger technology
in the financial system. To date, their efforts have resulted in an open-source
distributed ledger platform called Corda, designed to record financial events and
execute smart contract logic.
Ethereum Foundation is a Swiss nonprofit organization that developed a
decentralized platform that runs smart contracts on a custom-built blockchain.
This platform, originally funded by an online “crowdsale” in 2014, enables developers
to create markets, store registries of debts, move funds and much more.
Interledger is an open-source, collaborative project to build a universal payment
system allowing payments between participants regardless of the medium the payee
and payer are using. The project is led by the World Wide Web Consortium (W3C),
the main international standards organization for the World Wide Web.
The Hyperledger project is an open-source collaborative effort created to advance
cross-industry blockchain technologies. This global collaboration includes leaders
in finance, banking, the Internet of things, supply chains, manufacturing and
technology. The project aims to bring together a number of different independent
efforts to develop standards by providing a framework that supports different
distributed ledger technology components for different uses.
Conclusions
Today, blockchain is an emerging technology with some important challenges ahead.
However, if properly harnessed, blockchain has the potential to completely disrupt
traditional business models and render some current industry leaders obsolete within the
next five to ten years. That is precisely why global industry leaders and start-up firms
alike are pouring billions of dollars into researching, developing and testing applications
based on the distributed ledger technology.
As such, the EquiSoft blockchain task force will continue to closely monitor developments
with this exciting technology, with the objective of guiding our clients through a potential
paradigm shift in how the world does business.
Regardless of when (or even if) blockchain technology becomes mainstream, it does warrant
your attention today. After all, weren’t the mainframe, PC, Internet and social media once
emerging technologies that had uncertain futures?
“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” Bill Gates
/ EquiSoft / 11
Blockchain: A disruptive technology with the power to revolutionize financial services
EquiSoft specializes in the design and development of digital business solutions for the financial and insurance industries. To find out more about our products, custom solutions or our expertise on demand, please visit our Website: www.EquiSoft.com.
CANADA | UNITED STATES | CHILE | SOUTH AFRICA | INDIA