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Why are Banks using Blockchain?

Posted on Posted in Finance, Other, Startups

The B words – Bitcoin, Blockchain and the BANKS

Background – Bitcoin Overview

Bitcoin concept was introduced in 2008, for one major reason – To get away from a centralized system where financial institutions, state and regulators were not trusted. Remember, the first whitepaper on Bitcoin appeared in November 2008, after the Lehman Brothers bankruptcy in Sep 2008, and several other financial institutions did not honor their commitments.

Bitcoin has been a major disruption of the 21st century. Who would have imagined in 2009, that people would be giving away their real hard earned money ($900 for 1 digital coin), to get a digital currency which nobody owns, no central bank guarantees, is not backed by any gold or any other asset, is not even accepted for most real world products and services and can be lost if you lose your digital access.

Fun Fact – A programmer used 10,000 BTC for two Papa John’s pizzas, in 2010. Back then – when the technology was just over a year old – that equated to roughly $25, but is $9m by today’s Bitcoing exchange rate.

In the absence of Bitcoin, the financial currency world looked like this. With regulators, Government, financial institutions, legal system, enabling a stable currency.

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With Blockchain, the financial world for currency became decentralized, self-regulating, immutable, borderless and digital.

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Blockchain Overview

Bitcoin is driven by underlying technology called Blockchain, that helps build trust among people, while creating and transferring unique value, without any central institution or regulator. All blockchain transactions are transparent and immutable. Blockchain has the potential to become Internet 2.0, with no central company like Google, Facebook etc. owning and selling user data. As user privacy continues to be understood and valued more, Blockchain may offer interesting alternatives to various Internet platforms.

Blockchain relies on cryptography driven mining, to build the trust using collaborative transparent technology process.

As a side note and a challenge, Bitcoin mining is computing intensive process. 300,000 Bitcoin transactions daily need more than 10 times the computing power of Google (doing 3.5bn searches daily).

Blockchain promises lot of value for various auditable, immutable transaction platforms for any assets including money (Bitcoin), user information (KYC platforms), assets registry (property), digital documents issuance (certificates), finance (trade finance) etc.

If Blockchain powers decentralization, why are so many Banks involved in Blockchain

In principal, Blockchains are meant to decentralize; hence with applications like Bitcoins, they undermine the need for the bank or any central financial institution. So why do Banks want to cannibalize their own business model? (It’s like Walmart in 2000 trying to become Amazon)

Most Banks globally are trying to be involved in Blockchain due to some of the following reasons,

  • They want to learn about blockchain. The best way to learn about a new technology is by implementing it in some use case. Hence, all the standard banks’ use cases around transactions, finance, KYC etc. These use cases are less likely to go forward into full implementation. Blockchain’s nature of immutable digital information sharing is considered valuable for several Banks’ legacy processes.
  • Consortiums of Banks are being formed to run proprietary (in due course open source) Blockchain platforms, to help Banks transact better with each other. Banks have legacy, expensive, and slow infrastructure at the back end. For several back office systems, banks are still using decades old Mainframe systems.

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Since banks (for inter-bank transactions) do not need to decentralize or build trust for transacting with each other (given they know the other banks they are transacting with and have comprehensive legal agreements between them), Blockchain’s core value is not being fully utilized. The same functions can in principal be achieved by shared database technologies too, which are much more mature, cheaper and easier to implement.

But Blockchain technology adoption acts as an opportunity for banks to improve their post transaction infrastructure in a collaborative way, by overcoming the organizational challenges towards change.

In such scenarios, Banks shall be using private / permissioned blockchain, which can only be used by approved and pre-agreed banks, and not by any general public. This keep’s the blockchain platform (relatively) safer (compared to Public blockchains like Bitcoin that are open for anyone to join the network, start mining, and even record the transactions by becoming a node)          

  • PR value Banks need to show their stakeholders their engagement into latest and the greatest technologies. Hence the race to the PR for the first new use-case etc.

Caution – Banks (being banks) have (wrongly) gone ahead in order to patent their use case(s). There are 2 challenges with such approach,

  • Use-cases of blockchain being patented by banks are so basic and unimaginative in nature that there is no innovation to protect.
  • Banks are unlikely to run any public blockchain platforms. In that case (of private blockchain), it should not matter whether the workflow or technology is patented or not. It’s unlikely that any bank will make money from a patented permissioned blockchain by selling it. In fact, more open the technology, more likely it will have greater usage and more stable it may become. (Classic Linux versus Windows example).

 

 

 

 

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