Crypto-fueled disintermediation: A Primer on Block Chain

We are fast heading into a World where vending machines can automatically pre-order and pay for the delivery of soft drinks before they run dry.  Musicians may be able to record and publish rules on how they want their music to be used instead of depending on platforms like iTunes to reach their fan base.  When you read an article on The New York Times, the free version allows you to read 10 articles a month and requires subscription to read the rest. Readers may soon be able to just pay a few cents to read one more article or half an article that they read from the free option. A digital bond can pay coupons and redeem the principal to the address that is holding the digital bond, eliminating the need for a custodian. We are talking about block chain, the centralized distributed ledger.

Set to reinvent traditional banking and payments, with many leading banks participating in the exploration of what it can do, some call it the Napster of finance.  A report released earlier this year by Santander InnoVentures in collaboration with Oliver Wyman and Anthemis Group said that distributed ledger technology can reduce banks' infrastructural costs by between $US15 billion and $US20 billion a year by 2022. 

A range of applications being developed with block chain span from proof of ownership for digital content storage and delivery to modules in app development to prove digital identity. Decentralized prediction platforms for market shares and politics, points-based value transfer for ride sharing, ownership and transfer of digital security trading to home automation. The range is wide and far flung.

Creating new, secure, decentralized services and markets and extending the reach of today’s internet and its capabilities, the block chain innovation, heralds the entry of digital rights management systems, smart e-contracts, disrupting banks and distributing finance.  Start-ups today are involved in creating “side chains” and other forms of crypto-fuel (read: Ethereum that runs on, well, Ether! and the popular Ripple). In a dramatic move, The Philippines is soon planning to integrate the Peso with the block chain.

A distributed ledger of immutable transactions

So what is block chain especially when viewed from its standalone existence, minus Bitcoin or any tech cryptographic jargon? Block chain or the distributed ledger technology allows anyone to hold and make transactions as strangers but in a completely transparent manner. With no mediators in between the two people making the transaction, the entire process becomes easier and cheaper. It is called block chain because this distributed ledger is made of blocks and each block is made of a group of transactions recorded in chronological order. Once a group of transactions is verified and securely recorded through cryptographic tools, the block is closed and added to the chain in a linear order.

Openness and hyper efficiency

Providing a novel architecture for business, it is a foundation for building new generation transactional applications establishing trust and transparency while also streamlining processes. It acts like a financial DNA, a forgeable record of the history of transactions, turning the entire Internet network into a source of truth.  

When valuable digital information and assets need to be transferred (art work, contracts, books, music), it can help establish authenticity and uniqueness, thereby, helping its users collectively to define value. Even more, users can create their own digital currency, enabling programmable money.

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 Sidebar: How does a block chain transaction work?

This is how one of the experts define it: “Block chain is the “rail to Bitcoin’s wagon”. To use conventional banking as an analogy, the block chain is like a full history of banking transactions. Blocks are like individual bank statements. A single block records all recent transactions and when it is completed, it moves into a chain of blocks, and each block contains a hash of the previous block. A block chain has a record of every bitcoin transaction it ever executed, thereby providing insights about how much value belongs to a particular address at any point of time.

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Democratizing payments

Block chain’s key characteristics are automation and decentralization, geared towards removing the middleman and enabling a direct contractual interface between the two parties involved in any transaction. In short, it can democratize payments, making any exchange of value faster, safer and cost-effective.

It can create integrated, cross-country payment chains using a private block chain network, converge payments via the Internet of Things/wearable technology with card networks and support crowd-based peer-to-peer funding.. By eliminating intermediaries in the remittances space, it can help cut down costs by USD 16 BN a year (from current estimates) and enhance spending power of recipients. By connecting the unbanked directly with agencies and individuals willing to provide funds, block chain could make those fees more equitable. More importantly, it can migrate commercial cards to enable the final disappearance/displacement of cash.

Facebook credits, TwitterPay have not shown high adoption rates due to lack of trust and confidence among consumers. Block chain can make social media payments cheaper and strengthen the existing bond between parties.

Ripple, the second largest cryptocurrency, has signed a deal with payments vendor, D + H to integrate its Global Payplus solution with distributed ledger technology and CGI that offers payments hubs, financial messaging and watch list filtering. NASDAQ is building a new trading platform called Linq for pre-IPO trading in its private market segment. Visa has invested in Ephiphyte, a SWIFT Innotribe winner that offers block chain services via Software-as-a-Service.

New block chains on the financial services horizon

R3 CEV is a block chain project backed by 30 of the world’s largest banks and focused on an open-sourced, shared ledger that will help banks reduce reconciliation costs. Member banks are testing this platform for trade financing, processing syndicated loans, the settlement and clearing of OTC derivatives, and marketplace lending.

Barclays Bank is exploring block chain technologies with Safello, a bitcoin spending platform and Atlas, which provides mobile banking for the developing world; and Everledger, an immutable ledger for identifying and tracking diamonds. Everledger marks and tracks the life of a diamond on the block chain.

Commonwealth Bank of Australia (CBA) has put together five 1-gigabyte computer boxes each representing a "node" in the dummy block chain. These nodes replace the central party and validate all transactions. CBA intends to use this technology across international payments and trade finance.  Goldman Sachs recently filed a patent for a settlement system for stocks and bonds using block chain technology

Public and Private Block chains

Public block chains allow anyone to show proof of work once they read or write on the platform, for e.g., Ethereum, which helps run smart contracts and publish applications. A private block chain, on the other hand, allows only the owner to have the rights on any changes that have to be done. Of great interest to financial institutions, the owner will have power to change the rules, revert transactions. For example, Blockstack that provides FIs with clearing and settlement operations on a private block chain, Chain Inc, a provider of block chain APIs, among others.  NASDAQ has chosen Chain to run a pilot around block chain technology on the NASDAQ Private Market.

Many developers have begun looking at the creation of other different block chains, called side chains, as they do not believe on depending on a single block chain. These parallel chains can improve scale and independence, allowing for more innovation.

Block chain and the start-up world – A natural synergy

Many startups are building their businesses around block chain technology. Coinometrics gather data and research on qualitative and quantitative behaviors on block chains, while companies like BTCJam provide bitcoin-based loans. A number of other startups built around block chain technology include BlockCypher, BitPay and BitPagos. 

Ranging from establishing proof of ownership for apps and digital content, securities trading, transfer of contracts, ownership and governance rights to home automation and decentralized storage, this decentralized Internet is touted to cover every home and business soon. It can provide a digital identity to protect consumer privacy, custodian services for the gaming, loan servicing and e-commerce space, counter fraud, manage user reputation, predict share market moves and election results, establishing all of this with a stamp of authenticity, transparency and security.

In Conclusion…

Today’s Internet does not allow a way to establish credible identities, except through social networks like Facebook and others, who do this for you in return for your personal information. Block chains eliminate the middle-man of the Internet—the central servers.  Whether or not its potential is ever fully realized will depend more on the willingness of key stakeholders to adopt the model than on the limitations of the technology itself. To survive, block chain will need government buy-in and focus on reducing complexity.