Twenty years ago, banking business involved a trip to the brick-and-mortar office to speak with a real person working at the bank. Now, customers can monitor accounts, transfer funds and deposit checks without leaving the couch. Digital technologies have become mainstream in the financial world, whether it’s mobile banking or roboadvisors.
The newest innovation, blockchain, offers a potential new era in financial services. With its global-scale, technology-driven business transformation, some experts believe it will eventually have an impact equivalent to that of the World Wide Web, or of the internet itself. Hence, blockchain is sometimes referred to as “the Internet of Money” — or in more general terms, “the Internet of Programmable Value.”
Bitcoin is a form of digital currency and blockchain is the colloquial name for the distributed ledger technology that underpins it, providing a trusted, immutable record of transactions.
Restructuring an ecosystem and displacing established players is the classic pattern of innovative disruption
The use cases for the technology in financial services include cross-border payments, smart contracts, and online identity management. However, blockchain has potential pitfalls and is still far from mainstream financial services.
“While it’s constructive to have a ‘glass half full’ outlook on the technology, it’s also necessary for financial services leaders to adopt a skeptical “glass-half-empty” perspective based on significant limitations in the current generation of technology, combined with lack of understanding by many in the industry about the radically decentralized nature of this technology,” says Ray Valdes, vice president and fellow at Gartner.
To understand the technology’s potentials as well as shortcomings, start with the fundamentals.
The core concept of blockchain technology is the distributed ledger. A ledger is an authoritative record of transactions or other events. It’s called “distributed” because the data is replicated across thousands of participants — or “nodes” — in a peer-to-peer network. Achieving this goal of recording and replicating data in a secure manner requires a complex mechanism with significant computational load (called “mining”).
The purpose of the blockchain is to allow any participant on the network to have a value-exchange interaction of natively created digital assets with any other participant, and without relying on intermediaries. This means the transactions are not recorded in a single centralized system of record, but are instead kept by the entire network. The majority of nodes on the network together define the truth of all transactions in the system. In theory, the information recorded in the ledger is immutable, tamperproof, uncensorable and therefore, trusted.
Now, more than 300 million transactions later, assets worth more than $270 billion are being managed by this distributed ledger technology.
Enabling a business ecosystem of thousands of participants who don’t know each other, don’t trust each other and perhaps don’t even know of each other, to create and exchange value across a global network is what gives blockchain technology the potential to be disruptive. This setup effectively removes the need for traditional intermediaries — lawyers, brokers, bankers — who can consume a portion of the revenue stream and add friction to business interactions. Removing intermediaries also enables new business models to emerge.
“Restructuring an ecosystem and displacing established players is the classic pattern of innovative disruption,” says Valdes.
While its decentralized design has tremendous transformative potential, blockchain technology is unlikely to have significant disruptive effects on the mainstream financial industry in the short to midterm. As it stands today, the current generation of blockchain technology does not have sufficient scalability, functional scope, performance, efficiency, flexibility, interoperability and operational manageability.
“In its current form, the potential for blockchain technology is blocked by significant technology limitations, as well as by a lack of understanding on the part of established companies on how to effectively apply this radically decentralized platform” says Valdes.
Most large established companies are successful because they have invested time and money over the years in building a robust, reliable centralized system of record. Blockchain technology is at the other extreme of decentralization. Further, most companies are successful because they have cultivated over the years a stable set of known, trusted business partners. Blockchain technology enables an entirely different kind of ecosystem that traditional organizations find difficult to grasp.
These two aspects of blockchain make it difficult to exploit this technology, but do leave an opening for a new generation of small, innovative risk-taking ventures to disrupt and transform existing industry — once the technology limitations are removed.