It isn’t all about Bitcoin: Concerning blockchain and disruptive FinTech

By Zoheb Sirguroh

As a digital currency, Bitcoin attracts both attention and controversy. However, the most potent innovation is not bitcoin itself. Rather, it’s the distributed-ledger technology that powers bitcoin. Known as the blockchain, it facilitates payments to flow through an economy in an entirely decentralized way – without banks or other intermediaries. It has the potential to change the financial system as well as reduce the cost and increase the speed and accuracy of financial transactions; it can be a true disruptor in the banking business. Or perhaps, can it fizzle out? Nevertheless, already blockchain is raising a host of policy questions such as financial stability, protection of consumers, elimination of terrorists’ finances, and ironing out tensions between established and upstart financial institutions and between regulatory agencies. This article from the fortnightly cryptocurrency series discusses the future of distributed ledger technology. Special emphasis is laid on the innovation’s impact on financial services and policymaking.

The word bitcoin is a kind of a general description of a concept similar to Kleenex and Xerox. There are more than 600 different digital currencies and a plethora of protocols. Bitcoin can be defined as three things: bitcoin is a currency or it’s a store of value, bitcoin is a financial rail on which money can move around the world, and bitcoin is a ledger on which information can be stored, ownership information as an example. It matters because if one thinks about the opportunities for bitcoin as a currency from a global perspective in emerging markets, the ability for people to store their wealth in something other than a currency that is being devalued or debased year after year, that has some level of appeal. Kind of like a digital version of gold. Use case number two, a financial rail. Those who have sent money to a person cross border, certainly cross-currency, can appreciate the friction of the costs associated. Bitcoin has the potential to make those types of movements of money frictionless and basically free. And that’s quite transformative. And then thirdly, the ledger system. If one is involved in the financial markets, s/he knows how inefficient it is to move an asset from a seller to a buyer. There are opportunities in both the financial markets as well as outside to use this decentralized ledger to hold ownership information. This will essentially disintermediate or eliminate any of the middlemen that are currently being paid for playing the role of a trusted authority on ownership.

Nevertheless, there can be scepticism regarding the first of the three uses. However, we can be quite encouraged about the potential for the underlying blockchain technology and distributed ledgers. So, the system for transferring the money and the way of accounting for it as being quite possibly extremely significant for the way that we send money and account for things in lots of parts of our economy. This could really be quite transformative.

One upside is the reduction in the cost and an increase in efficiency and speed of systems for sending money. To some extent, there is an outdated system globally for sending money. And we spend lots of money sending money, money that we could spend doing other productive things in our economy. So, changes that are in this technology is to ring some of the inefficiency out of the system and to be able to send money more cheaply and more quickly. That can also have implications for social policies. If we can, for example, send money more quickly and more cheaply we can reduce the costs of sending remittances overseas. Hence, if one is a worker in the United States and wants to send money home to his/her family, it’s still extremely expensive to do that in the payment system we have in this world and the technology that’s available with distributed ledgers and blockchains can dramatically reduce the costs of doing that and the security of doing that.

A second potential implication is reducing for consumers the incidence of overdraft. As of 2016, consumers spent $32 billion a year in overdraft fees. If one has instantaneous trusted transactions, one can eliminate that kind of risk and cost. Another probable implication is on the way we use our mobile devices, phones or the internet. We all basically give away our privacy to very large companies in exchange for being able to use the internet. If we can reduce the costs of transactions sufficiently, we might be able to give consumers the choice of keeping their own privacy, having ownership of their own information, and paying very small fractions of a penny for transactions. It’s not really possible in the current payment system, but if we squeeze down that cost efficiently, we might gain more ownership of our own financial lives and of our own privacy, which would be all for the good. We might be able to improve security. There are downside risks like terrorist financing and money laundering, but there are also upside potentials of using this technology. We can do a much better job at catching the bad guys at a much lower regulatory burden on the financial system.

Blockchain can be used to improve financial stability. So, one problem in the financial crisis was that it was very hard for both regulators and market participants to understand who owed what to whom and when, what collateral was where, what transactions had been engaged in that exposed one part of the system to risk. And with this kind of technology on a distributed ledger, it could be deployed to make it easier for the whole market to see exactly what is going on in the financial system. And that could be significantly enhancing the networks of trust that undergird our financial system, a way of building that trust because the information is all fully exposed and open.

Another potential upside implication is for corporate governance. So, if we have used this technology of a trusted architecture and open ledgers, we could significantly improve the ability of investors to see what is actually going on in the balance sheet of firms and to have more trust in the accounting of firms and a reduction in fraud and restatements at firms if we have that ledger that describes exactly the sequence of events that leads to a balance sheet. We could improve corporate governance and have a longer-term view if we use this kind of system to have firms reveal their balance sheet every single day to the public instead of managing for quarterly earnings. This could significantly improve long-term corporate governance with the help of daily kinds of disclosure. All of these are examples of potential upside and are just ideas.

What are some of the potential downsides? One of the potential downsides is not fully understanding the implications of a combination of factors in technology. We have heard of high-frequency trading or AI in finance. There are aspects of this underlying blockchain technology that share three features with that, scalability, automaticity — meaning a machine does the work — and immediacy, the transaction is instantaneous. That has lots of benefits in terms of the speed and efficiency as described, but it may also introduce new risks into the system that we don’t really understand. And we don’t really understand what the machine is doing and how it will react in particular moments. If we have a self-executing contract that changes, for example, from debt to equity in certain circumstances, we might be able to use that to improve the strength of the financial system, but what if it triggers in ways that we don’t expect in unanticipated circumstances. So, there may be new risks.

There are certainly money laundering and terrorist financing risks with this technology in the same ways or in different ways, but in similar sorts of ways to the ways there are with other forms of payments systems. And we need to be cognizant as this system is developing that they’re important regulatory oversights in place so it’s not used for wrongful or harmful or scary purposes. There are risks that the system itself could be vulnerable because of cybersecurity attacks, operation risk, weak governance, so-called mining pools that try and take over the bitcoin system, or other attacks, hacking attacks on the integrity of this distributed payment system. And there are potential consumer and investment protection problems with consumers being able to understand, investors being able to understand exactly what’s going on in transactions and to have those transactions protected in a sufficient way.

And lastly, there is a public policy risk that all of this legitimate concern about these various issues just raised leads policymakers to take steps that thwart the old ways of doing things, the dominance of banks, and outmoded ways of sending funds. If we kind of create a regulatory system that advantages the dinosaurs we’re going to lose out on that potential innovation. So that kind of balance between openness to change and the risk of the innovations is one that is going to be an ongoing challenge.

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