Blockchain A disruptive technology with the power to ...€¦ · 3 PwC Global FinTech Survey 2016 /...

March 2017

BlockchainA disruptive technology with the power to revolutionize financial services

A White Paper by EquiSoft

Table of Contents

Foreword ................................................................................. 3

What is blockchain? ......................................................4

How does blockchain work? ................................ 5

Is blockchain secure? ...................................................7

Blockchain applications in

the financial services

and insurance industries ...........................................8

The challenges ...................................................................9

Towards global standardization ...................... 10

Conclusions ........................................................................ 11

Previous white papers from EquiSoft:

Invasion of the Robo-Advisor: Is the Threat Real?, February 2016

CRM2 and its impact on the Canadian Retail Investment Industry, January 2015

ForewordBlockchain is a technology you need to be aware of.

Because of its immense potential, more than 70 of the world’s largest financial institutions

(including Barclays, J.P. Morgan, Royal Bank of Scotland, State Street and UBS to name a few)

are part of a consortium researching and developing blockchain technology. Moreover,

PwC’s Global Blockchain Team has identified more than 700 start-up companies in the space1

and blockchain technology is viewed by some as the fifth paradigm of computing following

the mainframe, the personal computer, the Internet and finally the mobile and social

network revolution2.

Not yet familiar with blockchain? You are not alone. In fact, according to a 2016 survey

of top-tier executives at some of the world’s top financial institutions, less than 20%

of respondents described themselves as “very familiar” or “extremely familiar” with the

technology. That being said, 56% of survey respondents recognize its importance3.

Why that lack of familiarity with a technology that has the potential to revolutionize

commerce as we know it? We believe that this is, in part, attributable to the fact that many

industries are still focusing their efforts on leveraging the Internet and mobile technology

to enhance client front-end experiences. The financial services and insurance industries in

particular are playing catch-up in this space. With so much attention focused on the front

office platforms, little attention has been paid to archaic back-office and mid-office systems,

where blockchain technology is most applicable. Another factor contributing to the lack of

knowledge in this space may be that people have a hard time wrapping their heads around

what amounts to a paradigm shift in how humans have always conducted business.

At EquiSoft we believe that blockchain technology and its potential implications to the

financial services and insurance sectors warrant close attention. As such, we have formed an

internal blockchain task force to better understand the technology and how it can be leveraged

by our clients. The group’s first initiative was the development of the basic introduction

to the topic contained in the following pages. We trust that our overview provides you with

some clarity and food for thought regarding this potentially game-changing technology.

Jonathan Georges, CIM, FCSI

Vice President, Wealth Management Solutions

EquiSoft

1-888-989-3141, ext. 201

[email protected]

1 PwC Global FinTech Survey 2016

2 Blockchain: Blueprint for a New Economy

3 PwC Global FinTech Survey 2016

/ EquiSoft / 3

Blockchain: A disruptive technology with the power to revolutionize financial services

“The first generation of the digital revolution brought us the Internet of information. The second generation — powered by blockchain technology — is bringing us the Internet of value: a new platform to reshape the world of business and transform the old order of human affairs for the better.”

Don Tapscott, CEO of the Tapscott Group and bestselling author of Wikinomics, The Digital Economy and Blockchain Revolution

What is blockchain?

Blockchain was first introduced in a 2008 white paper published under the

pseudonym Satoshi Nakamoto and is best known today as the platform behind the

Bitcoin cryptocurrency. While the terms blockchain and Bitcoin are often used

synonymously, it is important to note that Bitcoin is but one of an infinite number

of applications for blockchain technology.

Blockchain can be defined as a distributed public ledger designed to record

transactions in a trusted environment. In other words, it is a type of database for

recording transactions that is copied to all computers participating in the network.

To truly understand what this means, it is helpful to first remind ourselves of the

inefficiencies in existing transaction processes. To illustrate how a typical transaction

occurs in today’s world, let’s take an example of John, who is buying a shirt in Jane’s

store. Because John isn’t carrying enough cash with him to pay for the shirt and

John and Jane don’t know each other, a trusted third party (such as a bank or credit

card company) is required to validate John’s ability to pay for the shirt before the

transaction is complete and John can take the shirt home. So, John swipes his debit

or credit card in the terminal in Jane’s clothing store, the purchase is approved

and John leaves with his new shirt. Simple enough, right? Well, not really.

On average, five institutions need to be involved in a routine transaction like the one

between John and Jane: John’s bank, Jane’s bank, Jane’s merchant service provider,

card processors and, in some cases, the credit card company (e.g. Visa or MasterCard).

With this many players involved in the transaction, it could take up to a week

for Jane to get her money and there are many points along the way that are subject

to fraud and theft. For obvious reasons, this process is both expensive and inefficient.

What if there was a better way to execute John and Jane’s transaction? Blockchain

technology eliminates the need for the trusted third-party intermediaries and allows

John to transfer payment to Jane directly in a way that is cheaper, faster and safer.

“Blockchain is a really disruptive development, and banks have a lot of fear concerning this technology because in the pure theory of blockchain, a lot of processes within a traditional bank would be obsolete.”

Thomas F. Dapp, Research Analyst, Deutsche Bank

4 / EquiSoft /


How does blockchain work?

In any transaction system there must be a ledger with everyone’s balance in it. In today’s

world, these ledgers are isolated and closed to the public and, as such, trusted third parties

(e.g. governments, banks, trusts, accountants, notaries and paper money) are required to

facilitate and approve transactions.

Blockchain technology is free open-source software distributed worldwide that eliminates

the need for the trusted third parties by enabling a network of computers to maintain a

collective ledger via the Internet. This collective ledger is public and fully distributed across

a network of “nodes” that all own a full copy of the ledger or blockchain.

In a blockchain, all new transaction details are logged, time stamped and verified by

“miners” who compete in solving complex mathematical problems for the ability to post

the next block of transactions to the ledger (or chain of historical transactions). Miners

are individuals who run complex computer systems designed to solve the mathematical

problems, and they are rewarded for their efforts through some type of financial

compensation. Once the block of transactions is uploaded by the miner that solved the

calculation first, all nodes in the network automatically validate the ledger and every

transaction in it. Generally, a majority (51%) of the nodes must agree that the block is valid

for it to become part of the chain of transaction blocks or blockchain. Transaction blocks are

generally posted to the shared ledger in ten-minute intervals.

“It’s hard not to be fascinated by something so transformative.”

Carolyn Wilkins, Senior Deputy Governor of the Bank of Canada

/ EquiSoft / 5


In this basic example, the terms of John and Jane’s agreement for the purchase of the shirt are straightforward. However, the

type of details that can be included in the transaction details are limitless. This means that not only can a simple transaction

be efficiently executed on a blockchain, the terms of a complex contract (e.g. mortgages, options and futures, employment

contracts, insurance contracts, etc.) can also be managed through a blockchain. A “Smart Contract” on a blockchain will store

the contract terms and even automatically execute the terms of the contract through automated money flows, for example.

These smart contracts eliminate the need for intermediaries between parties, automatically ensure compliance and significantly

reduce bureaucracy. In fact, Capgemini estimates that Smart Contracts will be implemented into practical and mainstream

applications by the year 2020 and could save consumers US$ 16 billion a year (US$ 500 for the average consumer) on banking

and insurance fees4.

LET’S REVISIT OUR EXAMPLE OF JOHN AND JANE, BUT THIS TIME WE WILL USE BLOCKCHAIN

TECHNOLOGY TO PROCESS THEIR TRANSACTION.

JOHN uses a digital wallet app (like

a mobile banking app) on his smart

phone by entering Jane’s public key

obtained by scanning a QR code from

her phone or by having her email him

an encrypted payment address.

John’s transaction is grouped

with many other transactions

that are requested within

a ten-minute period and the

block of pending transactions

is submitted for verification.

When a miner solves

the mathematical

challenge, they

announce it to the

rest of the network.

All the miners around the world

compete for the right to

post the block of transactions

to the shared ledger by solving

a complex cryptographic

computation.

The miners

validate that

John has enough

money in his

wallet to make

the payment.

The winning miner is

issued a financial reward

(the buyers and sellers

in the network generally

bear these costs) and the

new block is added to the

front of the blockchain.

Within ten minutes of the initiation of

the transaction, JANE receives payment

for John’s purchase (compared to one

week in our previous example).

4 Smart Contracts in Financial Services: Getting from Hype to Reality – Capgemini’s Digital Transformation Institute

The app alerts the

“miners” around

the world that John

wishes to execute

a specific transaction

with Jane.

APP APP

6 / EquiSoft /


Is blockchain secure?

Given the shared and public nature of the blockchain, it is only natural to

question the security of transacting on such a network. In fact, blockchain is

much more secure than existing transaction networks.

First off, while the ledger and all its transactions are public, people participate

in the blockchain anonymously through public and private encrypted keys.

The implication is that even though everyone knows all the transactions

and account balances of everyone on the blockchain, there is no way of linking

them to a specific person.

Secondly, because every single node on the network holds an up-to-date

record of the ledger, to modify transactions on the blockchain, a hacker would

be required to hack at least 51% of the miner nodes (because without

consensus, a block of transactions cannot be added to the chain) around

the world within a ten-minute period (the frequency at which a new block of

transactions is validated and added to the chain). As such, it is estimated

that it would require 200 of the world’s largest super computers combined to

hack the system5.

5 Future Bank Today

“Blockchain trading is much more secure than the current system. The distributed nature of the network that verifies the integrity of the transactions and associated account balances makes a successful attack mathematically impossible.”

Judd Bagley, Director of Communications, Overstock.com

/ EquiSoft / 7


Blockchain applications in the financial services and insurance industries

The obvious and well-documented applications of blockchain technology center on the

concept of facilitating the exchange of money and the related updates to ancient legacy

transaction and settlement systems. However, there are countless other opportunities

for financial services firms and insurance companies to use blockchain to optimize

processes and improve services.

For example, preventing money laundering and the financing of terrorism is extremely

expensive for financial firms. In fact, it is estimated that the global spending on

Anti-Money Laundering compliance alone totaled $10 billion in 20146. Furthermore,

Know Your Client (KYC) requirements tend to delay transactions and entail substantial

duplication of efforts between firms. A blockchain-based registry would not only

eliminate the duplication of effort to complete KYC checks, client detail updates could

be distributed to all institutions almost in real time. Also, the distributed

ledger would provide a historical record of all documents and compliance activities

for all clients.

Likewise, in the insurance industry, smart contracts on a blockchain could provide

customers and insurers with the means to manage claims in a transparent and

efficient manner. Not only could insurance contract details be stored on a blockchain,

but the platform can be used to validate claims (thereby reducing the frequency

of fraudulent claims) and even trigger payments automatically when conditions

are met and validated. The result would be streamlined processes and a better

customer experience.

“Blockchain technology will not only change the way we do payments, it will change the whole trading and settlement topic.”

Oliver Bussmann, CIO, UBS

“Blockchain technology continues to redefine not only how the exchange sector operates, but the global financial economy as a whole.”

Bob Greifeld, CEO, NASDAQ

6 Global Anti-Money Laundering Survey 2014, KPMG, January 2014

8 / EquiSoft /


The challenges

While having the potential to power a paradigm shift in how the world does business, blockchain is not without its

challenges. Some of the primary challenges associated with the adoption of this young technology are outlined below.

BUY-IN Because blockchain is so unprecedented, there will be

challenges in gaining understanding and buy-in among

system developers, users and operators. In fact, because

blockchain represents a way of thinking that is so far

from how things are done today, IT skills in this area

may become hard to come by because they fall outside

the traditional IT skill set.

COST While blockchain technology could offer organizations

incredible cost savings, the high initial costs may be

a deterrent. The move from a centralized system to a

decentralized network will require significant changes

or the complete replacement of legacy infrastructure.

REGULATORY ISSUES Today’s world currencies are generally created and

regulated by national governments. Crypto currencies,

managed by blockchains, may struggle achieving

widespread adoption with existing financial institutions

if question marks surrounding their government

regulatory status are unresolved.

ENERGY CONSUMPTION Blockchain technology requires a substantial

amount of energy to maintain. Just take the Bitcoin

blockchain as an example. The network’s miners are

attempting 450 thousand trillion solutions per

second to validate transactions7! As new blockchains

are added, the computing power requirements could

grow exponentially.

STANDARDIZATION For blockchain to effectively accelerate trade processes,

improve recordkeeping, enhance fraud detection

and much more, some global standardization across

institutions is required. Unfortunately, this is easier said

than done. Country customs, regulatory regimes and

political processes often slow standardization efforts.

“It’s a wonderful technology [blockchain], and I do think it will be disruptive. I just think we’ve got a lot of work to do.”

Peter Cherecwich, President of global funds services, Northern Trust

7 Deloitte Insights, Blockchain technology: 9 benefits and 7 challenges

/ EquiSoft / 9


10 / EquiSoft /


“Distributed ledger technology has the potential to change financial services as profoundly as the Internet changed media and entertainment.”

r3cev.com

“… Ethereum is also attracting attention from giants in finance and technology, like JPMorgan Chase, Microsoft and IBM…”

The New York Times

“Not since the Web itself has a technology promised broader and more fundamental revolution than blockchain technology.”

Hyperledger.org

Towards global standardization

There are already several efforts underway to help standardize distributed ledger

technology.

R3 is a technology company leading a consortium of over 70 of the world’s largest

financial institutions in the research and development of distributed ledger technology

in the financial system. To date, their efforts have resulted in an open-source

distributed ledger platform called Corda, designed to record financial events and

execute smart contract logic.

Ethereum Foundation is a Swiss nonprofit organization that developed a

decentralized platform that runs smart contracts on a custom-built blockchain.

This platform, originally funded by an online “crowdsale” in 2014, enables developers

to create markets, store registries of debts, move funds and much more.

Interledger is an open-source, collaborative project to build a universal payment

system allowing payments between participants regardless of the medium the payee

and payer are using. The project is led by the World Wide Web Consortium (W3C),

the main international standards organization for the World Wide Web.

The Hyperledger project is an open-source collaborative effort created to advance

cross-industry blockchain technologies. This global collaboration includes leaders

in finance, banking, the Internet of things, supply chains, manufacturing and

technology. The project aims to bring together a number of different independent

efforts to develop standards by providing a framework that supports different

distributed ledger technology components for different uses.

Conclusions

Today, blockchain is an emerging technology with some important challenges ahead.

However, if properly harnessed, blockchain has the potential to completely disrupt

traditional business models and render some current industry leaders obsolete within the

next five to ten years. That is precisely why global industry leaders and start-up firms

alike are pouring billions of dollars into researching, developing and testing applications

based on the distributed ledger technology.

As such, the EquiSoft blockchain task force will continue to closely monitor developments

with this exciting technology, with the objective of guiding our clients through a potential

paradigm shift in how the world does business.

Regardless of when (or even if) blockchain technology becomes mainstream, it does warrant

your attention today. After all, weren’t the mainframe, PC, Internet and social media once

emerging technologies that had uncertain futures?

“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” Bill Gates

/ EquiSoft / 11


EquiSoft specializes in the design and development of digital business solutions for the financial and insurance industries. To find out more about our products, custom solutions or our expertise on demand, please visit our Website: www.EquiSoft.com.

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