In the last posting, we covered how FinTech emerged and sharing economy platforms have grown. Today, let’s have a look at what blockchains are and how they are applied to financial services.
Although there are varying opinions as to how successful it was, Bitcoin is considered the most innovative service model using generic technology for economic sharing between business, using Peer-to-Peer (P2P) technology.
Bitcoin’s virtual currency, based on digital signatures, P2P networks and Proof-of-Work systems, started with a paper by Satoshi Nakamoto in October of 2008, called “Bitcoin: A Peer-to-Peer Electronic Cash System”. Since January of 2009, it has been successfully used as online currency which enables free transfers of value between nodes without intermediaries while measuring and storing it.
Some point out that there are not that many affiliates exchanging bitcoin to real cash and the exchange procedure is quite complicated. Yet, 1BTC (bitcoin) is currently—as of the end of April, 2016—being transacted for 420 USD, and 15 million BTC, which is 70% of all bitcoin (21 million BTC) expected to be distributed by 2040 according to its mathematical algorithm, has been distributed.
What are the prospects of bitcoin as a business then? Many advanced countries like the U.S. and Germany have recently recognized bitcoin as a product and are introducing policies such as taxation regulations to regulate profit margins. Reflecting this trend, there are mixed expectations, where some believe bitcoin will coexist with the extant system in the financial market as a type of investment product, while others follow the liberalist idea that bitcoin will supplant other currencies like the dollar, pound, and yen, then become an alternative global currency as a key component of a true disruption to economic democratization.
No one can be perfectly sure as to what its future holds, but one thing we should not forget about is the role of blockchain technology, which is a generic technology used to solve the risk bitcoin has called double spending.
The notion of virtual currency itself has been around for a long time and is being used widely in the form of credit cards and membership points at retail stores. P2P based bitcoin which doesn’t have any central server to manage it, however, has a couple of distinguishing characteristics compared to other virtual currencies: Its issuance is limited to 21 million BTC and it settles the possibility of double spending without any intermediaries by utilizing blockchain technology.
Because electronic currencies don’t have any physical mass, they tend to have the risk of double spending, which happens when certain currency is spent in more than one transaction simply by copying it. To solve this problem, bitcoin chose to adopt a method which binds all transactions taking place within a certain period of time (about ten minutes) into a single block, and then connecting these blocks like a chain.
This is basically a type of distributed transaction ledger through which only the blocks that are shared to the entire network and then confirmed by the Proof-of-Work (PoW) from more than half of the anonymous nodes (miners) can be written on the official ledger. This PoW method has been proved quite useful on the public bitcoin network.
As private blockchains are becoming more popular, blockchain technology providers such as LG CNS are developing permissioned blockchain platforms that perform simplified PoW (i.e. Proof-of-State) which is open only to verified miners.
As the original blockchain has the longest transactions, and every node on the network has the same record, forgery is basically impossible unless one can hack over 50% of the nodes. This makes blockchain technology much more secure while keeping records transparent to anyone on the network.
This advantage of block chain technology led to investments for global bitcoin startups. 375 million USD was invested within the first half of 2015, which was 11% more than all the investments made in 2014, despite the continual downturn of the bitcoin price. The major projects run by startups that benefited from these investments are also diversifying from exchange markets and payment systems to financial and crowd funding services.
Blockchain technology was introduced to prevent bitcoin double spending, but various efforts have been made since 2014 to independently apply this technology to other fields. One of the eye-catchers in finance is the R3 CEV project, a consortium involving 42 major global banks.
At the recent “Blockchain & Distributed Ledger”, R3 stated that they were working to apply Proof-of-Concept (PoC) to 8 specific areas—system interoperability, payments, settlement, trade finance, corporate bonds, repossessions, swaps and insurance.
Unlike in finance where the middle-men are excluded, capital markets are developing blockchain projects where the exchanges take central roles. The most outstanding example of this is the blockchain ledger project for NASDAQ’s private market in which the NASDAQ exchange is at its center.
This project, which began in July of 2015, is run in cooperation between a San Francisco based blockchain technology provider called Chain and a NASDAQ subsidiary called OMG, to build a pilot system for information on private companies as a ledger.
CEO of NASDAQ Robert Greifeld gave a presentation on the launch and further prospects of Linq, NASDAQ’s first blockchain based system, at Money 20/20 held last year in Las Vegas.
Chain also stated that they were developing a platform utilizing a multi-signature system for users, affiliates, and issuers to improve mobile gift cards in accordance with a U.S. gift card issuer and distributer Gyft.
The Australian Stock Exchange (ASX) also acquired 5% of shares in a blockchain startup called Digital Asset Holdings, in order to run a project applying blockchain technology to its post-trade services.
In Korea, there is growing need for a platform for private placement of unlisted company shares and distribution reflecting the enactment of this year’s share crowd funding policy, under the goal of vitalization of promising startups.
Although The Korea Financial Investment Association based exchange for unlisted stocks began the service in 2014, limitation on stock types and participants is hindering its active use. Besides, companies that don’t concentrate their deposits to the securities depository cannot participate in the trade at all, hampering stock options in becoming a more efficient incentive for startup executives.
To resolve this issue, LG CNS developed a P2P over-the-counter stock distribution platform service called B-Trading, which applied the blockchain ledger technology as a distribution platform for unlisted companies in Korea.
B-Trading applied a deposit system for better transaction completion and proved to have the blockchain notarization effect on contracts between sellers and buyers, while completing transactions using negotiation “chat windows” for one-on-one transaction.
It is also equipped with an electronic stock issuance function, so that one can issue, trade, settle, and pay for stocks using the Straight-Through-Process (STP) based on blockchain technology. A discussion to launch a service created from the B-Trading solution at domestic and overseas exchanges is currently on the table.
Over-the-counter bond transactions make up the largest proportion of all over-the-counter transactions. Major investors are formed around institutions, and show outstanding records in their frequency and scale (70% of all domestic bond transactions with the smallest unit of 8.4 million USD) compared to over-the-counter stock transactions. For this reason, this area is expected to become a major field for blockchain ledger technology.
There have been demands for improvement in the over-the-counter bond market, as continued covert transactions among bond brokers and asset managers were pointed out as a major problem. Investing institutions also suffered from continuous investment costs during the post-trade process, and are currently considering the application of blockchain technology, in order to efficiently secure transparency and cut system investment costs.
Efforts to apply blockchain technology are also being made at international institutions issuing stocks and bonds such as NASDAQ and ASX. Overstock, an online shopping mall in Utah founded in 1999 has shown a very interesting case for the use of blockchains.
Overstock went beyond the common use of bitcoin as a payment method, and issued their electronic corporate bond worth 21 million USD through a private placement for the first time in the world by utilizing a blockchain ledger. CEO of Overstock, Patrick M. Byrne, stated that they were also in discussions with The Securities and Exchange Commission (SEC) to issue private stocks using a blockchain ledger.
Other numerous efforts are being made in finance, with banking institutions and exchanges looking for ways to cooperate with IT companies regarding the use of blockchain technology. There will be various obstacles and challenges in order for these attempts to go beyond technical verification and to overcome institutional and customary barriers.
Discussions to reach agreements among various participants such as policy makers, consumer organizations, and members of banking institutes will have to be made to lessen these additional difficulties.
Written by Seung-Eun Baek, LG CNS
 Proof-of-Concept: A verification procedure in which a product, technology, data system, etc. can solve problems experienced by an organization. It is commonly used to verify a new product before market release. [back to the article]