Today’s transactions are besieged with attacks from cybercriminals, but a distributed digital ledger technology called blockchain is changing the future of the financial services industry. Trillions of dollars circulate through the global financial system every day in transactions that impact billions of people. In January 2018, an average of $1.8 trillion was traded daily in the foreign exchange market alone. These transactions are an attractive target for fraud and theft. Forty-five percent of financial intermediaries, including stock exchanges, money transfer services and payment networks report being the victim of an economic crime. Blockchain addresses these vulnerabilities through a peer-to-peer transaction process driven by distributed networks.
Leveraging networks to power commerce
The technology that enables entities to directly transact value without a trusted third party was originally developed to support bitcoin. A blockchain is a shared, distributed ledger that records transactions through a secure, verifiable process that does not flow through an intermediary. By leveraging the combined computing power of a distributed network, it manages all of the verifying, contracting, settling and record-keeping tasks that are the basis of all forms of commerce. For the first time in modern history, two or more parties can build or exchange value independent of institutions like banks, government bureaucracies and rating agencies. Though initially utilized to trade cryptocurrencies, blockchain can record the transaction of anything that has been assigned value.
Blockchain exists as a shared database distributed across a public or private network of computers. A network uses its combined computing power to continuously reconcile data so that the shared ledger of transactions is updated and audited frequently. Secure, direct exchanges make blockchain ideal for trusted transactions. Individuals or businesses can utilize it to transfer intangible values such as equities, currencies, votes, patents or copyrights, as well as tangible property such as gold, real estate, pharmaceuticals or commodities.
Reshaping business models
Emerging network-based business models are poised to transform the financial services industry. For example, consider the process for trading an equity on blockchain. The buyer initiates an order to purchase shares of stock at a particular price. This transaction is grouped with other transactions and represented digitally as a “block” that is broadcast to every user on the network. The network utilizes known algorithms to validate the data in that block, including verifying the buyer’s status and the trade. Then the block transfers the title of the securities from the seller to the buyer. Once the transaction has been validated, it is added to the blockchain, and the updated blockchain is distributed to the network and utilized for future verifications.
These same principles also apply to larger transactions such as how companies access growth capital. When companies seek investment through traditional channels, they initially pursue angel investors, then target venture capital and may ultimately issue an initial public offering (IPO). These stages rely on multiple intermediaries, including exchange operators, investment bankers and lawyers. Blockchain upends this process by enabling companies of any size to raise money through a peer-to-peer global distributed share offering. Many companies have already utilized this new funding mechanism, called an initial coin offering (ICO). In 2017 start-ups raised $5.6 billion in ICOs and nearly a third of that funding was generated for blockchain infrastructure projects.
Revolutionizing financial services
Executing trades via blockchain disrupts today’s exchanges by making transactions faster, more secure and less costly for clients. Many of these advantages can be attributed to the transparent, self-auditing transaction process that eliminates the need for middle men like clearing agencies and custodians. Streamlined trade validation enables a near real-time transfer of assets.
Network-based business models also offer strategic benefits for brokers. With the ability to establish and implement identity verification rules, blockchain facilitates compliance with know-your-client regulations. Blockchain technology increases efficiency by enabling the coding of simple contracts that automatically execute when the conditions are met. Perhaps most importantly, utilizing a distributed ledger reduces vulnerability to cybercrime.
Many firms recognize these solutions as an opportunity to reduce friction and costs and are investing accordingly. According to a 2017 PwC survey, 36 percent of financial services firms plan to make a substantial investment in blockchain technology in the next three years. The digital revolution has already begun, and blockchain is shaping a new landscape in the financial services industry.
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This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.