Bitcoin’s revolutionary contribution was to create a means of building trusting relationships between participants in an open, “permission-free” environment. Anyone can join the Bitcoin network and become a Bitcoin miner to compete for a reward in the BTC, and contribute to the registry by providing proof of the completed “proof of work”.
However, currently many projects, especially in the financial sector, are considering the possibility of using blockchain technology in closed “permitted” environments and without proof of work and related internal protocols.
The term “distributed ledger technology” (DLT) is often used to describe this area in a more general way. However, it is obvious that the success of Bitcoin has become a motivation for later “unresolved” cryptocurrencies, which are listed on Coinmarketrate.com. In addition, DLT uses the concept of smart contracts, with which the technology can be adapted to many applications.
A simplified way to understand the DLT mechanism is to use it as a secure registry in the cloud that multiple parties can edit together. Although several users can access and edit data at the same time, each transaction remains absolutely protected from forgery. This is due to the fact that cryptography provides authentication for each transaction, and guarantees the preservation of data integrity. In addition, the data has a control log, so anyone can check it at any time.
Advantages of blockchain on the example of banks
The use of blockchain technology offers a number of advantages over other traditional technologies, which can be well illustrated by the example of banking and finance:
- Fast cross-border transactions: Assets in the blockchain network are moved using DLT records, which makes transactions almost instantaneous. Without appropriate solutions, the verification and processing of bank transfers may take several days. New technologies can speed up the process so that it no longer takes a few hours, but only takes a few minutes.
- Better data quality: blockchain can store any type of information and provide access to it, following certain rules and procedures. The technology uses smart contracts to automatically view and complete transactions. This improves the quality of the data and makes it resistant to external attacks.
- Cost reduction: Distributed financial transactions involve various entities that charge for their services. When using blockchain, some intermediate stages are omitted, so the processes are not only simplified, but also the total costs and associated infrastructure costs can be significantly reduced. Smart contracts also help to minimize maintenance and execution costs.
- Traceability and Verifiability: Another advantage of using blockchain in the financial sector is that institutions can better prevent the misuse of their products and all types of fraud. Blockchain makes transactions traceable and easily viewable, so banks can process and track transactions more efficiently.
- Better integrity Protection: With blockchain, financial institutions can optimize security. Hackers have less time to access transaction data or redirect payments when transactions are executed quickly, which significantly improves the protection of funds and the integrity of transactions.
- Fraud reduction: blockchain protects very well from DDoS and hacker attacks, as well as from other types of fraud, so the number of fraud cases in financial institutions and banks is minimized. In turn, less fraud leads to lower costs and improved financial transactions.
Opportunities in the banking sector
Banking systems around the world work with billions of dollars and billions of people every day. If the system is error-prone and slow, delays can lead to costs, excessive and burdensome documentation creates friction, and the likelihood of becoming a victim of crime increases.
Some of the benefits mentioned above can be used to improve currency transaction processing, credit processing, derivatives clearing, cross-border payments and identity management among many other applications. As a result, blockchain can increase efficiency not only for banks, but also for companies from other industries in the value chain. Each of the participants benefits from access to a common data set that facilitates the performance of the functions they need. These advantages have already led to large-scale investments in blockchain startups in the financial industry in recent years.
DLT has a huge potential to change the world, especially the business world.
Barriers to widespread adoption
The problems on the way to the widespread use of blockchain-based solutions are diverse and are not only technical in nature. The transition from existing business models to new ones based on agreements made possible by smart contracts is also hindered by commercial obstacles.
Many companies in the financial sector are trying to master the new technology through pilot tests and POC, but have not yet used any blockchain solutions in their core business processes. Among other things, the following reasons contribute to this:
- Performance: The performance, scalability and efficiency of blockchain technology are currently limited. Despite the fact that many improvements are already built into various implementations, most existing blockchain solutions are limited due to their design, complexity and associated delays that limit transaction throughput. For example, in payment transactions, Bitcoin can process from seven to ten transactions per second, and Ethereum can process about twenty transactions per second. By comparison, the Visa network surpasses blockchain technology with 24,000 transactions per second.
- Security and data protection: In general, blockchains are resistant to attacks, but there have been many reports of hacks in other areas and at other levels of the crypto ecosystem, where management was partially delegated to other participants.
In addition, financial institutions are concerned about privacy and security, which creates contradictory problems. Privacy protection is not strong enough because distributed registries are designed with transparency in mind so that all participants can see and verify every transaction.
- Interaction: There are still problems related to the interaction of blockchain applications. The success of most use cases depends on how you can connect with legacy infrastructures, databases and technologies and how you can coordinate the transfer of assets and information from legacy systems to the blockchain.
- Regulation: In addition, blockchain tools and products should be more comprehensively integrated into the existing regulatory framework. Rules protecting investors are just as important for blockchain-based decentralized financial products as they are for established financial instruments. The requirement to align innovations with regulatory objectives provides social and economic benefits. Unregulated financial products will almost certainly reduce public confidence in these markets over time, and increase the economic inefficiency of financial markets.
Despite many problems related to technical performance, scalability, data protection, security and interaction that currently hinder the implementation of blockchain technology, there is reason to believe that many of these problems will be solved over time. Previous waves of Internet innovation have overcome similar constraints, helped by continuous software improvements, increased basic computing power, and investments in communication networks.
Given that thousands of developers around the world are working on open source projects aimed at improving blockchain protocols and applications, there is reason to hope that technical problems will be fixed in the near future.