Blockchain is a hot topic in nearly every industry, but few of its proponents truly understand what it is and what it can accomplish. Although blockchain was initially created to support Bitcoin and other cryptocurrencies, it has enormous potential for other finance-related applications–a fact that finance executives are just beginning to appreciate.
A Bain & Company survey reported that roughly 80% of executives at financial institutions expect to start using blockchain technology before 2020. Despite its positive qualities, blockchain has some serious flaws that make it a poor choice for certain applications and industries. It is important for finance professionals to develop a thorough understanding of blockchain in order to guide their companies to take advantage of its strengths without wasting resources on less-than-ideal use cases.
What is Blockchain?
At its most basic level, a blockchain is a decentralized database. Traditional databases (like those that store all the information for accounting software programs) exists in one place only. Similarly, each datum inside the database exists in only one location. If someone accesses a traditional database and opens a record, that record will be locked so that no one else can edit it until the first person is done with it. A blockchain, on the other hand, gives each user their own copy of the database. Everyone who has a copy of that database is a node, meaning that they’re a member of the blockchain network. Any node can access and edit any record at any time, since each one has a unique copy of the database.
All of those nodes work together to maintain the database, validating transactions and adding them to the blockchain once they’re verified. This works by a sort of majority vote system: each node reviews each transaction, and if at least 51% of the participating nodes agree that the transaction is valid, it’s added to the blockchain. That helps keep individual bad actors from forging transactions or otherwise altering the database.
Blockchain pros and cons
Blockchain’s unique structure gives it some major advantages, but it also has some equally major drawbacks.
Blockchain advantages
- Because everybody has a copy of the blockchain data, it’s a totally transparent system.
- Blockchain removes the need to have a single party control all the data.
- A distributed database is much harder to hack or illegally alter because the hacker would have to break into and alter at least 51% of the existing nodes to get his changes accepted by the blockchain.
- There is no single point of failure. The more nodes a blockchain has, the more copies of the database exist, and the less likely it is that any data would be lost.
- Once a piece of data is added to the blockchain, it can never be removed. That means it’s possible to review every transaction that’s ever occurred in the blockchain.
Blockchain disadvantages
- Having numerous copies of the same database is inefficient, particularly when the blockchain must constantly push updates to all those copies. This can make blockchain technology much more expensive to operate than traditional databases.
- Transactions can take a long time to post because each transaction has to be pushed to the blockchain, validated, posted to the blockchain, and then pushed back out to every node on the system.
- Like any database, blockchain can suffer from security issues. A blockchain with a small number of nodes is more vulnerable because a bad actor could potentially alter 51% of those nodes. And if a hacker finds a vulnerability in the blockchain protocol, he/she could potentially alter it without needing a majority consensus.
- Controlling access to the blockchain can be a challenge, since blockchain technology is public by its very nature.
- Once a piece of data is added to the blockchain, it can never be removed. This means that the blockchain can end up laden with junk data, resulting in bloated databases requiring tons of space to store on each node.
Because of these drawbacks, blockchain isn’t suited to every possible use. For example, if proprietary company data was stored using blockchain technology, competitors could simply join the blockchain, become a node, and get a complete copy of the data. It is possible to limit access to a blockchain, but it’s a challenge–and arguably not worth the effort extra when proprietary data is easier to protect in a traditional database.
Blockchain’s finance use cases
Finance, in particular, has a number of processes that fit the blockchain model quite well, though some challenges still remain to be overcome before the technology is mature enough to manage them. The below chart gives some examples of general use cases along with the challenges that are holding them back (note: DLT stands for distributed ledger technology, aka blockchain)
Here’s how the blockchain would play out in some specific use cases:
Supply chain management
Blockchain technology is well suited to track items in a supply chain, particularly high-value items or ones that are likely to be subject to fraud. For example, a vendor providing organic fruit might be tempted to substitute cheaper non-organic fruit instead. Blockchain supply chain technology could prevent such fraud by using digital tokens (virtual assets built on the blockchain, Bitcoin being the most famous example) to track each item’s provenance across the entire purchasing process. A blockchain is superior to a traditional database for this purpose because of its total transparency and resistance to tampering. Since nothing in the tracking process is confidential, there’s no need for concern about revealing sensitive information. TradeLens is one example of a blockchain-based supply chain management platform.
Ownership records
A blockchain is an excellent way to store and maintain public records of ownership. Take corporate assets such as buildings, vehicles, and machinery. If all such assets are registered with a blockchain, there will never be any questions about who holds the title for each of these items. It would also be easy for interested parties to research asset information within the ownership blockchain. For example, a bank trying to decide whether or not to make a loan could access the ownership blockchain to see the proposed collateral’s history and find out how much it’s really worth. Several governments are working with blockchain companies to put their land title information on blockchain-driven registries. The Republic of Georgia was the first nation to adopt blockchain for official records; in 2017 it moved both public and private land ownership records onto a registry created by blockchain startup Bitfury. Japan, Russia, and Sweden all ran blockchain land ownership registry test trials in 2018.
International transactions
Sending money between different nations typically involves routing the money through various middlemen before it arrives at its final destination. A blockchain could cut out most, if not all, of the intermediate steps, resulting in a much faster transaction without raising the cost. This could make it considerably easier for businesses to both purchase supplies from and sell products to other nations. The blockchain used for this purpose would most likely employ cryptocurrency for these transactions. For example, say a business in the United States needs to send $5,000 to a supplier in China. The business would purchase $5,000 worth of the blockchain’s cryptocurrency–most likely a token unique to that particular blockchain–and deposit the tokens in the supplier’s “wallet,” a special program for storing cryptocurrency. The supplier could then withdraw the tokens and exchange them for yuan. Deloitte estimates that the fees for such a transaction would be just 2%-3%, compared to the 5%-20% charged by traditional remittance programs.
Preparing for blockchain
A recent Deloitte survey on blockchain adoption found that 78% of respondents believed they needed to adopt blockchain to maintain competitive advantage, yet one-third of respondents said their ROI on blockchain technology was uncertain. Because blockchain is still an immature technology, it’s not clear just how it will develop, which means finance professionals must commit to staying informed. As the aforementioned Deloitte survey put it,
“…the only real mistake we believe organizations can make regarding blockchain right now is to do nothing. Even without a completely solid business case to implement, we believe that organizations should at the very least, keep an eye on blockchain so that they can take advantage of opportunities when they present themselves.”
A blockchain roadmap, such as the below example, can help you prepare for the day when you’re ready to implement this technology at your own company.
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