The problems of the current financial system
The existing financial system is based on trusted intermediaries and corresponds to financial contracts (for deposits, bonds, shares, derivative financial instruments, etc.) that separately exist in the databases of each bank or exchange in a digital forms. Such contracts are confirmed by a signature, telephone call, e-mail and other systems of user identification. As a result, we have the interdependence in the financial market from the successive transactions in each of them; therefore, it may take several days for one transaction and the bank charges the client for such expenses. Thus, the costs of back-office operations of world banks reach $800 billion a year.
Supporters of the blockchain technology propose to change the situation as follows:
- Firstly, to confirm any transaction with a cryptographic signature - it will indicate the transaction validity without a centralized institution;
- Secondly, to introduce a decentralized system of settlements (the so-called distributed registers) – in other words, transaction information will be immediately available to many users who are not connected to each other; each of them stores a copy of the general blockchain ledger. Blockchain focuses on an encoded or distributed database (the ‘distributed’ part of distributed ledger technology) which acts as a ledger, on account of which it keeps all the records.
Such innovations will help to process real-time interbank payments flows using highly standardized smart contracts that will be concluded without interruption, censorship, fraud or third-party interference.
Last year the Swiss bank UBS already reported about working on smart bonds based on blockchain showing that risk-free interest rates and payment flows are fully automated; to put it differently, they created a tool with a self-payment function. Commonwealth Bank of Australia, in turn, began testing the decentralized payments protocol from Ripple Labs to transfer funds between its subsidiaries. And the first representative of the banking sector, integrating the protocol Ripple, was the German digital bank Fidor. Many large market players, such as UBS, Citigroup and State Street, create their own laboratories for blockchain research and JP Morgan even developed its own digital currency.
It should be noted that the blockchain database can be public, private or work as a consortium. In the first case, all users have access to the data, in the second case - one owner, in the third - a certain group (for example, several banks). Meaning, banks can create their own network for making transactions – they do not have to expose all the data even in an encrypted form.
Difficulties in implementing blockchain
The financial system cannot be changed in one day. Current transactions involving blockchain are minimal compared to the volume of transactions that daily occur in the world so banks will have to develop special protocols, algorithms and software that can cope with such a load. Also, regardless the fact that processing transactions with blockchain is much faster than in traditional banking, it requires very powerful computers.
The question of financial regulation remains open - European and American financial managers are still expressing optimistic views about the potential of blockchain but still might not fully understand how to work with this technology and where its weaknesses are. Experts suggest that to begin with, financial managers may issue separate licenses for the use of blockchain in certain transactions.