Blockchain: Everything You Need to Know About How It’s Impacting the Front Office

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Written by: Liqueo

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Dominic Madden, Senior Consultant

What Is Blockchain?

Blockchain at its core is a distributed and decentralised network providing security, transparency, immutability, and privacy. By the nature of blockchain there is no central authority to validate and verify transactions – but despite this every transaction can be assumed to be completely secure and valid. This is because of the concept of consensus (which we’ll go on to talk about later), whereby peers of the blockchain network reach an agreement on the validity of each and every transaction. Only once this has been achieved is it possible to add a transaction to the blockchain, making the blockchain the one and only source of truth.

What Applications Does Blockchain Have in the Front Office?

Trade Settlement and Clearing

Post trade flows are ones in which the blockchain can excel. The chain itself is the history of all transactions and can contain much more information such as contract terms, which can take the form of payment for the exchanges.

Since the Blockchain is updated in real time then it will provide a live view of all transactions. Once these transactions are on the blockchain then they can be guaranteed because of the way the chain validates the transactions across the nodes. The results mean reduced settlement times and clearing costs.

Payments

For much the same reason as settlement then transactions for payments are instant. Leveraging one of the stablecoins will help to facilitate these payments in real time.

Tokenisation of Assets

Physical assets can be tokenised on the blockchain. Because of the guaranteed state of the blockchain we can then track ownership, transfers, and sales – even fractional ownership, meaning physical assets can be securely traded. This is also very useful for illiquid assets. A good example of this is real estate such as a commercial building. This is quite illiquid, but if it is converted into a number of digital tokens then these can be stored on a blockchain and then traded fractionally.

It is possible for financial institutions to create digital assets on the blockchain too, and in fact a huge asset manager has recently launched a tokenised fund – BUIDL from BlackRock.

Identity Management

As identity information is stored in a decentralised ledger then the consistency of this data cannot be questioned and therefore identities guaranteed. This can be used in many ways, from Anti Money Laundering (AML) and Know Your Client (KYC) functions, as people who have passed these safeguards can then be stored and immediately be trusted.

What Are the Potential Benefits of Blockchain’s Use in The Front Office?

Increased Efficiency

By automating manual processes and reducing settlement times this will result in significant savings for financial institutions.

Transparency & Auditability

Because the entire transaction history is on the blockchain in real time then it is possible to have complete visibility, giving auditors and regulators much more confidence in the accuracy.

Reduced Counterparty Risk

The immutability of the blockchain can assign ownership with complete certainty, meaning this reduces the need to use intermediaries.

Improved Security

Blockchain uses asymmetric encryption, giving a very high level of security. This sort of cryptography cannot be broken by any method other than brute force. The only way a blockchain can be compromised is by using a 51 attack – whereby a group can take control of more than 50% of the nodes in a chain. This is unrealistic and becomes more and more unrealistic with an increased number of nodes, even with the advent of quantum computing the investment required make this a small risk, but we do not know the future threats that will be faced.

Consensus

Consensus is the cornerstone of blockchain technology. It is the mechanism the different nodes in a distributed network can agree on the validity of a transaction. Achieving a consensus ensures trust is established and prevents malicious actors from manipulating the blockchain. There are various algorithms that can be implemented to facilitate verification of transactions and creation of new blocks.

Each consensus algorithm has different advantages and disadvantages. For example, it may be mining a new block needs to show an amount of effort has been expended. Maybe it is desirable only a small number of nodes can add new blocks – as you can see, there are a myriad of reasons requirements may differ slightly, and consensus algorithms can accommodate these.

What Are the Potential Challenges of Blockchain’s Use in the Front Office?

As a blockchain gets larger and larger than the chain becomes longer and longer. If this is kept in memory, then each blockchain will need to implement its own methods to deal with this. If, for example, it gets cached and then loaded on demand for less accessed parts of the chain then this can impact performance and complicate implementations.

Consensus algorithms can be created to try to alleviate this, but these come with their own challenges.

Regulatory Uncertainty

Blockchains are still seen as a gamble and regulators have yet to catch up. Because there are many different aspects of blockchain and many potential uses then there needs to be new frameworks in place to be able to govern the use of these.

Interoperability

As there are a large number of different blockchain solutions there are a large number of different implementations. Different decisions were made, different choices were made. This means there is no standard, and there are many different protocols across these blockchain implementations.

The result is there is no standardised way of communicating. This can hamper the seamless processes blockchain promises to deliver. It creates fragmentation across the industry.

Adoption

It seems there are a number of issues that hinder the adoption of blockchain technologies. The most important is they are often seen as a ‘black box’. People focus on benefits, but unless they fully understand the technology then there is a feeling of uncertainty and coupled with the lack of a standard implementation and the distributed nature of the blockchain then it leaves decision makers without a clear picture.

Complexity

The ‘black box’ nature of blockchain and the complexity of the cryptography used means to support a blockchain requires a high level of technical expertise. Mistakes can be made; inefficiencies can easily be introduced. If this is to be used in financial services, then errors cannot be allowed. This complexity makes the need for regulation essential, and this regulation will drive adoption.

Security

We talk a lot about the distributed nature of blockchain, and about how this is one of the core strengths of blockchains. Counterintuitively this is also a weakness, but why? Well, consider the complexity of such a system. This requires knowledge and expertise to be able to support this and keep it safe from attack.

This complexity will be better understood as adoption of blockchains increases, leading to more skilled people supporting, and more secure implementations.

Conclusion

With very little effort it is easy to see how blockchain has the potential to change the whole landscape of the front office and how it can be harnessed and exploited. The adoption is so far from its apogee that there are almost limitless ways blockchain can be engaged. It can be expected there will be transformations on the back of the disruption that will inevitably come, with the potential for reducing costs and speeding up financial transactions.

As the technology advances and matures then the current issues will be solved and adoption will increase, as will the number of use cases that will be implemented. Hopefully the interop issues will result in a set of standards to increase the confidence in blockchains, and regulatory approval will follow.

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