Blockchain Technology

Blockchain was born in connection with Bitcoin, a virtual currency.[1] It is essentially a database for recording transactions in a secure way.[2] Blockchain is a distributed database, able to generate a public ledger of all the transactions, not entirely stored at a single physical location, but rather dispersed over a network of interconnected computers.[3]

Blockchain is a decentralized solution. For instance, all participants of a P2P network have a copy of the full set of records. Consequently, there is no central authority. Each participant of the network can manipulate the ledger without causing security issues by means of cryptography and digital signatures. Through these digital tools, a real-life identity (not visible) ties with a cryptographic identity. This is useful to verify and validate transactions. Blockchain and related disruptive technologies have drawn close attention in the financial industry. Blockchain is relatively secure, transparent, and unmodifiable.

Blockchain has much greater potential than digital currency alone, even if the concept was born in connection with Bitcoin (Ngai et al. 2016). It enables point-to-point transactions without a clearing intermediary. In this way, it reduces substantially transaction time, quality, and costs. When combined with smart contracts, blockchain makes it possible to issue automatically digital securities and trade financial derivatives. For instance, the insurance sector will also provide new opportunities for the application of blockchain.

In a distributed ledger, there are two types of records[4]:

  • • Transactions
  • • Blocks

Transactions are at the core of the entire process. In the case of the blockchain used for the virtual currency Bitcoin, a transaction is the transfer of a Bitcoin value between users. Blocks contain the correct amount and order of valid transactions—indelibly added to the database. A generated transaction is not immediately added to the blockchain. It needs to be validated, giving rise to the so-called consensus approach. Blockchain technology makes use of its network to reach consensus: when the majority of participants agree on the validity of a block of pending transactions, then it is added to the blockchain.

Consensus protocols are essential in order to protect the public ledger from unauthorized changes. The consensus is also the object of differentiation between those companies that are leveraging on blockchain technologies in their business.

Bitcoin, for instance, relies on proof-of-work mining to secure consensus. A network of miners competes for rewards by validating blocks. According to some researchers,[5] this mining, or proof-of-work, comes with a substantial cost. At today’s Bitcoin prices and reward schedule, miners receive about $1 million a day to secure the blockchain. Electricity for the data center is a significant portion of that money. Proof-of-work-based consensus protocols are also slow, requiring up to an hour to confirm, in a secure way, a payment to prevent double spending.

Due to this time and cost issues, other protocols have been proposed. Tendermint, ARBC (Asynchronous Randomized Business Consensus), BAR (Byzantine, Altruistic, Rational), SCP (Secure Copy Protocol), and so on.[6] From a theoretical perspective, the ideal protocol is an incentive-compatible Nash equilibrium such that deviating from the protocol does not result in a net gain (Kroll et al. 2013). Specialized publications can provide more technical and functional details.[7]

Nowadays, protocols are far from being ideal. They show multiple complicating factors. This is the reason why different scholars and practitioners are still directing their efforts in improving this interesting and high-potential area.

Blockchain technology has interesting potential in several fields and especially in the financial services industry.

Blockchain offers trust and provenance. These are critical aspects of the financial services industry. Still, like all technologies, it can be subject to fraud. US regulators expressed concerns that “bitcoin-like” systems were vulnerable to fraud through user collusion. In 2016, there was a big incident in Hong Kong, resulting in the stealing of $65 million.[8] This incident has shown that theft through hacking is also a risk. The more so, since there are multiple institutions operating different levels of security and providing multiple entry points. Even Bitfinex’s multisignatory system, in which transaction permission was required from two of three users, proved insufficiency robust.[9] Bitfinex heist or no, trust-based blockchain security needs to improve to be fully trusted.

  • [1] There is a debate if what is Bitcoin from a taxation point of view. EU considers it a currency, SECa security and the USA IRS a commodity (hence subject to tax). See also http://blogs.wsj.com/digits/2015/10/22/eu-rules-bitcoin-is-a-currency-not-a-commodity-virtually/, Accessed 04 August2016.
  • [2] https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/Innovation/deloitte-uk-what-is-blockchain-2016.pdf, Accessed 27 July 2016.
  • [3] Public domain material, General Services Administration (http://www.its.bldrdoc.gov/fs-1037/fs-1037c.htm).
  • [4] https://www.icbpi.it/block-chain-come-la-tecnologia-al-cuore-di-bitcoin-puo-cambiare-la-banca-e-non-solo/, Accessed 13 August 2016.
  • [5] Kwon, J. (2014), TenderMint: Consensus without Mining, http://tendermint.com/docs/tender-mint.pdf, Accessed 31 July 2016.
  • [6] http://www.slideshare.net/lablogga/blockchain-consensus-protocols, Accessed 31 July 2016.
  • [7] https://cointelegraph.com/news/five-books-on-blockchain-and-bitcoin-you-may-need-right-now, Accessed 27 July 2016.
  • [8] http://www.bloomberg.com/news/articles/2016-08-03/bitcoin-plunges-after-hackers-breach-h-k-exchange-steal-coins, Accessed 08 August 2016.
  • [9] Financial Times, 6 August (2016).
 
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