IBSI Announces Subscription Flexibility !

IBS Journal now starts at £9 per issue, and custom Reports at 40% off

With its advantages of carrying out tamperproof, decentralised and transparent transactions in a decentralized manner, blockchain has applications across many industries, but its most popular use remains the one it was originally designed for payments

Blockchain has significantly evolved since it came to the fore as the technology architecture behind bitcoin. Blockchain technology is currently powering solutions that are used for varied applications such as trading of surplus energy among utilities, secured decentralised file storage, identity management, and smart supply chains, to name a few. The technology was developed to enable trading of the first and most popular cryptocurrency – the Bitcoin. Many other cryptocurrencies have been introduced since then – such as Ether, Litecoin, and Peercoin – and more are under development.

At its core, blockchain is a distributed digital ledger. Each unit of currency (or a coin) acts as a node in the chain. Every user transaction creates a block, which is added to the chain of previously completed transactions. The ledger is stored in a decentralised manner, and even the process of authentication is computed over multiple computers, thus eliminating the need for a central server, or agency. Since the processing is distributed over a network, it eliminates the possibility of the data being manipulated or hacked, making it “immutable”.

The availability of a network of processing resources allows near real-time processing of transactions, without the need for a centralised infrastructure, delivering high speeds at lower costs. Also, the ledgers are transparent and visible to all participants in the blockchain ecosystem, making all transactions traceable.

Originally, the blockchain was designed as an open network, also known as “permissionless blockchains”, where anyone could start “mining” Bitcoins in exchange for providing computing power to authenticate other transactions. However, such open networks are not very practical to power international payment systems, as they could be used for any purpose, including scams and money laundering; and are difficult to update protocols, as that would require a consensus of 51% of the network participants.

This led to the evolution of “permissioned” or private blockchains, where users need permission to access, and each participant has been vetted to some extent. Most permissioned blockchains are created and operated by consortia of banks or organisations, who give others permission to use it. These blockchains address some of the risks involved in public blockchains, such as the ability to blacklist misusing participants (such as scammers or terrorists), restricting use for specific purposes as agreed upon by consortia members, and most importantly, the ability to easily update protocols – users who choose not to agree to updated protocols lose their access.

Since permissioned blockchains allow more control and can be adapted to existing and upcoming regulations, they are expected to be the foundation on which banks, regulators, and other players will operate and power a plethora of services including payments, recordkeeping, and possibly even exchanges.

With an increasing demand of digital payments, blockchain is receiving a lot of attention from both banks and start-ups. Blockchain appears to be a threat to banks, offering an entire payments ecosystem that could render banks redundant.

However, banks are actually looking to leverage the benefits of blockchain to reduce costs, improve efficiency, and support cryptocurrency payments.

Many banks, either standalone or acting as part of a consortium, are working to explore use-cases for blockchain. The Bank of England recently unveiled its own cryptocurrency called RSCoin, which allows encryption and speeds up international payments at the same time, reducing their cost. On the other hand, some of the largest global banks have formed or joined consortiums such as R3, CLS, or Utility Settlement Coin (USC), where they can work together to develop industry standards for blockchain-based implementations as well as a unified platform with common services for the participants.

  • More than 250 banks have announced initiatives in blockchain feasibility since 2015
  • 15% banks are now preparing rollouts of full-scale products by 2017

Realising the potential of blockchain

The disruptive potential of blockchain has also induced many start-ups to dip their toes in the water. Owing to their specialised focus, many of the startups such as Ripple and B2Bpay, have rapidly gained capabilities and have shot to fame within the industry.

Many of these startups have gained strong clienteles, Ripple was selected by a consortium of 47 Japanese banks – representing 30% of the banking market in Japan – to implement a cloud-based payment system called RC Cloud. This system will enable the consortium members to make real-time money transfers both in and outside Japan at a significantly lower cost. According to Ripple, distributed ledger technology could potentially bring down transaction costs for retail remittances and corporate payments by 60% and 50% respectively.

Other start-ups form very good investment opportunities for banks and PE firms, and end up attracting massive amounts of funding and support, or getting acquired by large players in financial services. Notable examples include 21 Inc., which raised $121m in venture funding before even launching its product; and Bitnet, a bitcoin wallet startup, was acquired by Rakuten, a Japanese e-tailer, a year after it started accepting bitcoin as a payment method.

  • Venture capital investments up from $230m in 2014 to $462m in 2015
  • Blockchain has attracted $ 1.4bn in investments in 2016.

The role of Blockchain in financial transactions

The Bank Spending on blockchain is expected to cross over $300m by 2018. According to a joint study by Infosys and Let’s Talk Payments (LTP), over 80% of bankers surveyed expect to see commercial adoption of the technology by 2020, with nearly half of the financial institutions already investing or planning to invest during 2017. The top use-case expected to go to production was quoted as cross border payments.

In another study by IBM, 65% of banks are expected to begin production on blockchain solutions within the next three years. Early adopters expect the benefits from blockchain technology to impact several business areas, including reference data (83%), retail payments (80%) and consumer lending (79%).

While blockchain holds a lot of potential, its success will depend on collaboration between banks, regulators, and fintech companies. Banks need to continue to identify feasibility of more use-cases, test proof concepts, and plan for implementation while being aware of security implications. Governments must determine the regulatory frameworks and responsibilities for managing and implementing blockchain infrastructure. Fintech companies need to innovate for better integration and efficiency, and develop solutions conforming to regulatory requirements.

One key challenge in the global-scale adoption of blockchain is processing requirements. Very high volumes of payment transactions would require massive computing power, which may not be available to many, except some of the largest corporations.

Blockchain is expected to find its way into mainstream applications by 2020. If deployed on a large scale, blockchain is expected to result in savings of $12bn on switching to cryptocurrency and blockchain technology, for both banks and companies. Instant payments will become the norm, and will strengthen the global e-commerce initiatives by firms. This will help small businesses improve short-term liquidity, and provide large businesses visibility of their cash flows in the short term.

While it is hard to comment on the future of cryptocurrencies, and whether they would replace physical currencies, one thing is certain – Blockchain is here to stay.

Devansh Patel

Lead analyst, IBS Intelligence

This article first appeared in IBS Journal October 2017

by Bill Boyle
IBS Intelligence Senior Editor