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01 February 2018

The blockchain, the future of Financial Services… or is it?

Blockchain technology, and Bitcoin in particular, was the hot topic in Financial Services in 2017. However, putting the “Bitcoin hype” aside, the underlying blockchain technology appears to have been met with public scepticism amongst some conventional financial institutions.

We were delighted to host the Centre for the Study of Financial Innovation in January, for a round table discussing the realistic practicalities of blockchain technology within Financial Services, both now and in the coming years.

The debate was lively, with welcome interventions from the audience, all of who were keen to understand what 'the blockchain' can actually do to solve problems within the Financial Services industry. What came out of the discussion was that blockchain technology is often widely misunderstood by proponents and critics alike. "Blockchain" is not simply a holistic technological solution that can be thrown at issues with data and business logic; the distributed ledger technology (DLT) behind it has a potential to be used for many different purposes and businesses must assess the individuality of the issues they face, and whether DLT is even the best solution at all.

In fact critics of the technology point to most of the problems that exist within Financial Services, such as the accuracy of data, as being largely driven by human error rather than by technological restraint. Indeed, critics point out that there is nothing in particular about DLT that makes it faster, or cheaper than existing settlement programmes – in some cases it might even be the complete opposite.

That being said, DLT undoubtedly has benefits, and in many other sectors beyond Financial Services. For example within pharmaceuticals, the blockchain theoretically has the potential to reduce the spread of counterfeit drugs. Drugs can be coded and logged in a decentralised system and tracked from source, to retailer, to user – all updated by decentralised 'nodes'. Similar use can be seen within the jewellery industry. Everledger has enabled the tracking of diamonds from rough cut to the retailer, by inscribing miniscule codes into the diamond, and tracking it in the blockchain, with the aim of ensuring responsible sourcing and accurate ownership, reducing risks of fraud.

For the [blockchain] technology to succeed it will take significant leadership from government, regulators and central banks

The blockchain will only ever allow for one record of ownership; where banks and other financial institutions have their own systems for data collection, replicating several versions of proof of ownership, the blockchain offers a clean and immutable record, with decentralised access to an ever updating system. The problem for banks is that immutable ledgers may not be what they want – for banks, ledgers may make up more than a proof of ownership.

The smart contract is a useful tool, particularly between parties who may possess an inherent distrust of each other. Though technology already exists that can enable the automatic settlement of a contract, where the risk, or at least the perceived risk, for manipulating or providing inaccurate data is high, the decentralised system ensures that data is authenticated by several sources before the coding allowing the contract settlement is activated.

Another key criticism that stigmatises blockchain is the perceived lack of regulation, exacerbated by crypto currency, dishonest ICOs and noted media stories of 'Ponzi schemes'. Legislation is usually not as innovative and responsive as the technology it governs. Our legal team are often required to consider innovative solutions within the existing legal framework to ensure our clients are sufficiently compliant. The law is forever dealing with yesterday’s problems and legal teams are ever juggling with the wide-scale differing attitudes towards regulation of the space worldwide.

The event highlighted that blockchain technology is in its infancy, is not a panacea and in some cases its relevance to the problems stalking some financial institutions is not necessarily clear cut. Whilst there might be opportunities for the blockchain to be effective, for the technology to succeed it will take significant leadership from government, regulators and central banks to make its way to the mainstream within Financial Services.

Is it the future of Financial Services? Perhaps only time will tell.