Although the proliferation of e-commerce, social media, cloud computing and many other advances attributed to the Internet have become common place in recent years, no innovation will have as great an impact on our social and financial lives as blockchain technology.
In layman’s terms, the blockchain is a decentralized ledger of all transactions between counterparties. However, unlike most ledgers maintained within the database of a third party, such as a bank or credit card company, blockchain technology, of which bitcoin is the best known example, is a public yet highly secure and encrypted distributed ledger that allows peer-to-peer transactions to occur more efficiently and cost effectively than traditional business models.
The technical aspects of the blockchain are a little more involved than could be explained here, but if you search for “bitcoin” or “blockchain” on Google, you’ll learn that in order to ensure buyers and sellers are matched and transactions reconciled through this peer-to-peer distributed ledger technology, the network time-stamps the first transaction in which a buyer spends a specific bitcoin, rejecting subsequent spends of that same coin. It then captures the transaction permanently in the blockchain before any future transaction occurs. In the wealth-management industry — in which banks, asset managers and dealers are the arbiters of our investments — blockchain technology threatens the status quo by potentially eliminating intermediaries and putting buyers in direct contact with sellers, without a third party’s involvement.
Unlike a centralized database that records and reconciles financial transactions, the blockchain is a bit like a global spreadsheet maintained in a network of individuals’ computers around the world. Although this may sound far-fetched, blockchain technology will soon impact every facet of the financial services sector, from retail banking and investment management to insurance, accounting and regulation.
As Don Tapscott, author of Blockchain Revolution: How the technology behind bitcoin is changing money, business, and the world, points out, this is why more than 50 financial services institutions around the world, including Canada’s Big Five banks, have formed a consortium to create standards and protocols for using blockchain technology in financial services in the past year. Throughout the financial services sector, banks and other incumbents, entrepreneurial startups, commercially minded and not-for-profits are all investigating the blockchain.
The Internet has improved productivity within financial services; however, the blockchain promises warp speed innovation and efficiency, particularly in the areas of authentication, investing, lending, insuring and payments. For example, you can now buy and sell a mutual fund, stock or bond in seconds, yet it takes three days to settle the trade. Why is this settlement process so inefficient? Whereas technology enables financial services companies to reduce trade execution to nanoseconds, the post-trade settlement activities that typically involve communications between a bank, dealer, custodian, transfer agent, lawyers, accounting firms and other stakeholders can still take anywhere from three days for a stock trade to several weeks in the case of some bank loans or insurance applications.
This transference of value from one stakeholder to another is slow, costly and symptomatic of financial services infrastructures, which have not truly evolved in decades. Blockchain networks, on the other hand, on average take 10 minutes, but in some cases mere seconds to clear and settle all transactions between counterparties conducted during that period. The technology is fast, secure, transparent and inexpensive.
Although the bitcoin blockchain was designed to transact in a specific digital currency, new blockchains are being created to represent other artefacts — digital and physical — including stocks, bonds, car payments and virtually any other assets and liabilities. It will most certainly find a place in the wealth-management industry.
Investors seeking small equity stakes in companies through private placements or initial public offerings have started using crowdfunding platforms to do so; and while Canadian regulators are a little slower to embrace this model than their U.S. counterparts, crowdfunding is gaining acceptance. Blockchain technology will take this a step further by eliminating an intermediary crowdfunding platform, such as Kickstarter, and putting investors in direct contact with the companies raising the funds.
For financial transactions through banks, dealers and other intermediaries, which have traditionally been relegated to individuals with a third-party account and a credit rating, blockchain technology will allow anyone, anywhere, with a smartphone and an Internet connection to access financial markets in the new “sharing” economy. This does not necessarily mean that traditional financial players and business models will suffer, but it does mean they will evolve dramatically in the coming years.
Just as some smaller investors are starting to manage their investments through robo-advisor platforms, it is conceivable that someday investors will be able to participate directly in the capital markets through blockchain technology. So, financial advisors seeking to play a role in this new paradigm had best familiarize themselves with this burgeoning technology.