"A New Layer Of Trust: Which key aspects of traditional financial services are affected by blockchain’s technology? How are banks and governments responding to this new technology?"

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A New Layer Of Trust

Which key aspects of traditional financial services are affected by blockchain’s technology? How are banks and governments responding to this new

technology?

Christiaan R.E. van Lennep

Christiaan R.E. van Lennep Student number 1302892

MA Thesis Philosophy, Politics and Economics Supervisor: Dr. J.J.M. Sleutels

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1. Introduction

Technological innovation is restructuring and helping shape the way society functions. The Internet revolutionised the way people could communicate with one another on a global and instant level. Just over a decade ago, the Bitcoin whitepaper published under the alias Satoshi Nakamoto opened up a whole new area of technological advancement. With the coming of Bitcoin came the introduction to blockchain. Creating a peer-to-peer transaction system, based on a decentralised network in which all participants contribute to the distributed ledger was a new way of looking at traditional payment mechanisms. Blockchain technology is transparent by nature and forms the basis of many opportunities - be it instant payments, placing our trust in algorithmic computing validation, and letting go of the idea that ‘trusted’ third parties - or intermediaries - are a necessity when it comes to transferring assets from one party to another. Given the implications blockchain could have for the traditional financial industry, this thesis aims to explore the nature of blockchain technology and its new layer of trust within the financial sector.

The questions that will be addressed throughout the thesis are: “Which key aspects of traditional financial services are affected by blockchain’s technology? How are banks and governments responding to this new technology?”

Each chapter will follow the narrative guideline of the blockchain philosophy. In Chapter 2, the conception of the technology - with broad references to the Satoshi Nakamoto’s Bitcoin whitepaper and the functioning of cryptographic currencies - will be outlined in a foundational understanding of the extent of blockchain’s reach.

Following this, the main functionalities will be described, continuously linking them to the financial sector, whilst finding applied uses that could be viable in the future.

After having sketched the framework for what blockchain is, Chapter 3 segues into answering the research questions at hand. Applying the knowledge acquired in Chapter 2, this chapter delves into concrete examples of several use-cases in which blockchains have been embraced by the financial industry. In doing so, the so-called new layer of trust will be shaped. Also, means of regulation that will be imposed by governments and institutions such as the European Commission will be explored. In addition, the following questions will be addressed: will banks become unnecessary due to blockchains? Are banks able to adapt to this new technology? How will blockchains be regulated and is such regulation desirable? This chapter will also describe a slight paradox in the fundamental vision of blockchains and cryptocurrencies as opposed to the reality of what blockchain-fuelled systems will look like in the future. Due to heavy regulation (insofar as this is possible for the likes of volatile cryptocurrencies), the decentralised, ‘eliminate- the-middleman-and-trust-the-system’ notion will be put to test. Trusting the network is the central theme that will help analyse the research question. Given the marginal amount of actual use-cases in the financial industry, though, conclusions will most likely be drawn based on speculations.

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The fourth and final chapter is the empirical section of the thesis. After having reviewed the questions and agreeing that the nature of blockchain will impact the financial industry, interviews have been conducted with a variety of people who work in the financial, consultancy and political sectors of society - all of which are actively devoting their institutions’ time to the possibilities of blockchain. These interviews are set up in a way that tests the findings of the previous chapters, as well as them acting as an illustration to previous observations.

Some may call it a hype, others the next big thing. One thing, however, is certain: blockchains are impacting the way technology drives our system and a new layer of trust is being built. The core aim of this thesis is therefore to closely dissect the power of the blockchain technology, to understand this new notion of trust and to apply it to the financial services industry that for decades has dominated economic market.

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2. How Blockchain Technology Works

2.1. Satoshi Nakamoto

In 1990, during the launching days of the World Wide Web, its creator Tim Berners-Lee wrote the following: “When we link information in the Web, we enable ourselves to discover facts, create ideas, buy and sell things, and forge new relationships at a speed and scale that was unimaginable in the analogue era” (Mougayar 2016, 2). With the introduction of the Internet, the idea of being intertwined with the world at large was not a mere utopian vision from the past. Rather, it became a reality that would push technology to an efficient, rapid-growing future of connectedness and seemingly endless possibilities. Since its conception, it took less than a generation for those with access to the Web to become dependent on it.

Skip forward eighteen years and the anonymous persona Satoshi Nakamoto publishes a white paper entitled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’, marking the birth of the blockchain-driven cryptocurrency ‘hype’ that is seemingly disrupting the modern-day ideal of centralised financial transactions (Nakamoto 2008). Perhaps blockchains will become the platform that, within the generation the lies before us, can make us dependent on it.

But what is the blockchain technology and what can blockchains do? As William Mougayar puts it, “blockchains are not a product that you just turn on and use”; rather, they must be seen as a platform that creates the foundation of many other products that are able to run using its technology (Mougayar 2016, 1). However, prior to delving into the technicalities, it makes the most sense to start the blockchain journey with a fundamental understanding of Nakamoto’s paper on the electronic cash system that the Bitcoin runs on. Its groundwork can

“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. (...) As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they'll generate the longest chain and outpace attackers. The network itself requires minimal structure (...) nodes can leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.” (Nakamoto 2008, 1).

Bitcoin is essentially a peer-to-peer payment network that offers a solution to the ‘double-spending problem’ by eliminating the reliance on a trusted third party by transferring money directly between parties. Thus, centralised trust is deemed

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networks their decentralised, transparent value. The phenomenon of double-spending implies that, due to a discrepancy in the transaction process, a single asset could be spent twice. If double-spending occurs continuously, inflation follows in order to fill the gap of assets spent that actually never existed.

Moreover, what is compelling about the Bitcoin notion is that it was laid out in a manner that aimed to “align the incentives of all stakeholders” (Tapscott and Tapscott 2016, 35). Those that work hard are rewarded with tokens in the form of Bitcoins, thus the incentive to work (or mine) harder, is greater. Since the wake of the Internet, large corporations and banks exploited financial services to a point of breaking because “incentive structures for most of the top executives and many of the lending officers of these banks [were] designed to encourage short-sighted behaviour and excessive risk-taking” (Stiglitz 2013, 381). Since the idea of integrity is not bound to be successful if there is no clarity nor transparency surrounding the parties in a transaction, the peer-to- peer Bitcoin network has been programmed in a certain way. It does not matter if participants act selfishly; what matters is that all actions can be of benefit to the system as a whole. This is reflected in the consensus mechanism, the technicalities of which will be elaborated on below.

Following the classical economical thought that “the economy works best when it works for everyone”, we can begin to understand Nakamoto’s vision for a capitalism wherein distribution, rather than redistribution dominates (Tapscott and Tapscott 2016, 49). In the current day and age, there are still approximately two billion citizens that do not have a bank account (World Bank 2015). With growing social inequality in both developed and developing countries, there are still too many consumers that are not able to afford the most basic banking services, let alone able to afford certain transaction fees. With mobile connectivity being vital for (mobile) payments in this day and age, it is Nakamoto’s grand vision for anyone that can afford “a flip phone” to “participate in the economy”, without needing a bank account, relying solely on the blockchain system (Tapscott and Tapscott 2016, 50).

In corrupt and failed bureaucracies, it is common for governments to receive funding by the banks, who simply print more money to further finance corrupt practices. This leads to inflation, making the rich the only survivors in these political boardgames, for the freezing of assets in banks would affect those with more less than those with almost nothing at all.

The goal(s) of specifically Bitcoin, but most importantly the possibilities that blockchain- driven technology can offer could potentially put an end to socio-economical inequalities. Furthermore, it could effectively lower the barrier for participants to join a distributed economy that runs on a healthier, more transparent system of nodes than the economy that the world currently relies on.

The proposal that Bitcoin “is often hailed as a means to prevent state intervention in monetary policy” brings together two ways of thinking (Collard 2017). Firstly, preventing state intervention is a favourable idea for libertarians, like for instance Hayek, who entertains the notion that the government’s role must be a limited one in terms of monetary policy, in order to protect (individual) property rights (Hayek 2007). Following the libertarian ideal, having a government that holds a monopoly

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over monetary policy allows it to create money as “a giant scheme of hidden taxation”, which is in breach of private property rights (Gordon 2007). Secondly, both Hayek and Friedman believe that such a monopoly will gradually result in over-inflation, which is sociologically, economically, and politically highly undesirable. Drawing these ideas back to a forum post made by Nakamoto in 2009, “The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust” (Nakamoto et al., 2009). Thus, Nakamoto calls for a new layer of trust in an independent, algorithmically verified network that holds money in a decentralised manner.

What, then, is Bitcoin’s relation to the blockchain technology? The way in which the technical content of Nakamoto’s paper is designed is functionally only made possible through the usage of blockchain. Defining blockchain in non-technical terms comes down to it being a “back- end database that maintains a distributed ledger that can be inspected openly,” whilst simultaneously acting as an “exchange network for moving transactions, value, assets between peers” (Mougayar 2016, 4).

Generally speaking, the blockchain is a decentralised ledger that has the ability to sequentially record direct transactions that occur between parties, eliminating the need for the authentication of a third party. Further, the transactions are recorded in a way that “cannot be later erased but can only be sequentially updated, in essence keeping a never-ending historical trail” (Mougayar 2016, xxi). This not only creates transparency, but it also gives way to a more efficient system of transactions, whilst at the same time reducing transaction costs. But what are blockchains themselves and what components do they consist of? Prior to delving into its functionalities, it is important to discuss the technology on which the system runs, in order to gain a more comprehensive

understanding of what its possibilities truly are.

2.2. The Blockchain Narrative and its Technology

In its most general definition, a blockchain consists of sets of data which “are composed of a chain of data packages (blocks) where a block comprises multiple transactions” (Nofer et al. 2017, 183). Each block, regardless of its position in the chain, contains data. For instance, the Bitcoin blockchain holds information about transactions, such as the amount of coins transferred, where they came from (the sender) and whom they are aimed for (the receiver). As more blocks are continually added to this chain, a (distributed) ledger holding the entire transaction history is created.

The validation of each block occurs cryptographically. In technical terms, each block - whether it is block 1 or block 14.198 - contains the hash value of the previous block, a timestamp and “a nonce, which is a random number verifying the hash” (Nofer et al. 2017, 184). A hash can be likened to a digital fingerprint, which in turn is unique. Each hash in each block builds forth from the hash in the prior block. Tracing this back to the beginning leads to the very first block, or rather, block 0, which has no predecessor. The initial block is named the ‘genesis block’. Figure 2.2.1. below shows what the early phase of a blockchain looks like:

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Figure 2.2.1.

Figure 2.2.1. shows how each block (Block i, Block i+1 and Block i+2 etc.) is built on the premise of the genesis block. The hash of Block i+2 must coincide with the hash given by its predecessor, Block i+1, and so forth. Each block shows the transaction values (TX 1 and TX 2 through TX n), alongside the timestamp and nonce. A nonce is a number that changes in order to get the proof-of-work, in turn verifying the hash of all the blocks. All of these elements pictured above generate the digital signature that adds to the (never-ending) chain of blocks.

Given the uniqueness of the hashes in each respective block, tampering becomes increasingly difficult. However, computers do have the ability to (re)calculate

thousands of hashes per second, which shows that the sole implementation of a digital fingerprint is not enough to guarantee a secured system that is near-impossible to tamper with. Thus, in order to mitigate tampering, blockchains use proof-of-work as an extra security measure. The calculation of thousands of hashes per second is slowed down, which, with any attempt to meddle, would create a long-stretched movement of recalculations just to gain access to blocks in a chain. In any case, such tampering notions would immediately be noted, or rather calculated, by the nodes.

Contrary to the traditional banking system where the control mechanisms are executed by the banks, it is the decentralised nodes and their so-called algorithmic consensus mechanism that perform this controlling task. The effective prevention of fraud is due to the fact that any alteration of a block synonymously alters the hash value of that same block, rendering all blocks that follow invalid. For a block to successfully be added to the chain, it must be validated not by trusted third parties, but by the majority of all nodes participating in any given network.1_{If the hash values are deemed} invalid, the block cannot be added to the chain. On the other hand, for a meddling attempt to be successful, it would essentially come down to redoing all proof-of-work for each block in the chain, followed by taking control of more than 50% of the peer-to-peer network; in short, a task that realistically speaking is close to impossible.

The consensus mechanism is key to the validity and transparency of a blockchain, for it “is the process in which a majority (or in some cases all) of network validators come to agreement on the state of a ledger. It is a set of rules and procedures that allows maintaining a coherent set of facts between multiple participating nodes” (Swanson 2015, 4). It is precisely for this reason that blocks are not just blindly added to the existing ledger; rather, blocks are held for an X amount of time depending on the

1_{The sole purpose of a ‘node’ is to validate the integrity of transactions. Within the blockchain system, each}

computer is seen as a ‘node’ that runs based on the consensus algorithm. If one wants to tamper with the chain, one must, for instance, in the case of a public blockchain, obtain more than 50% of the computing power.

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blockchain network (in Bitcoin, the proof-of-work time is 10 minutes), before being confirmed and added to the chain. As soon as the validation process has been approved by the nodes (or miners in Bitcoin’s case), they are rewarded with actual Bitcoins. Validating transactions by means of trusting a cryptographic network that runs on blockchain technology not only implies that the traditional money transferring process can be changed, but much rather how “people all over the world can trust each other and transfer different kinds of assets peer-to-peer over the internet” by having the security of transparent validation (Nofer et al. 2017, 185).

Once a block has been added to the ledger, all information will stand as it is and there is no possible way of changing it. Given the very fact that this chain of blocks operates as a distributed ledger, one can swiftly see how this contrasts from classical centralised (economic) systems. With its decentralised nature, the blockchain networks remain standing despite certain nodes potentially falling off the chain. The only required necessity is that in removing one’s trust from an intermediary, participants must build trust in this new system. The blockchain networks create a platform that ensures a new layer of “trust in transactions and much recorded information no matter how the other party acts” (Tapscott and Tapscott 2016, 33).

2.3. Public and Private Blockchains

It is key to note that there is no such thing as ‘the’ blockchain or ‘one’ blockchain. Blockchains must be seen as a pluralistic system that can be integrated in different networks and, for that matter, for various purposes. These can be divided into public and private blockchains. In between them stand, as Ethereum’s co-founder Vitalik Buterin calls them, the ’consortium blockchains’.

Firstly, public blockchains are best known to the general public. Public blockchains are open to anyone. In theory, fully public blockchains are uncontrolled (given their decentralised nature), but are nonetheless secured by crypto-economic validities provided by both proof-of-work as well as proof-of-stake. Any participant is able to join the public network and send peer-to-peer transactions, all the while validating transactions done by other participants in the network. If deemed valid, each participant in the public chain is able to see this, for all nodes automatically become part of the consensus process. The most prominent example of a public blockchain is Bitcoin, where one can create a wallet and transfer assets to it, from it, and with it.

Secondly, consortium blockchains stand in between the public and private notion. The process of consensus here is not controlled by the entirety of the blockchain’s nodes (as is the case with public networks), but by a pre-selected group. Herein lies the primary difference between consortium and public networks. For instance, there could be “a consortium blockchain of 15 financial institutions, each of which operates a node and of which 10 must sign every block in order for the block to be valid” (Buterin 2015). This model is hybrid by nature, giving selective rights to those that are granted the ability to read the blockchain, enabling a selection of participants to do the work, rather than to a seemingly infinite number of nodes.

Thirdly, private blockchains are gaining popularity amongst closed institutional networks. Though blockchain technology implies a decentralised system, fully private

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blockchains keep ‘write permissions’ centralised to one organisation (for instance, a bank). On the other hand, ‘read permissions’ can be public or “restricted to an arbitrary extent” (Buterin 2015). Banks could start up a private blockchain with, e.g., 7 partner banks in order to make use of peer-to-peer transactions under the decentralised mechanism of blockchain, whilst still keeping it centralised and restricted to the relevant participants of the chain. Private blockchains can also work using a hierarchical structure in order to keep the levels of control balanced in a way that coincides with the intentions of how the network was initially designed.

There is not an ‘either-or’ answer to the question which of these three technologies offer more advantages over each other. According to Buterin, a vital advantage of private blockchains is that transactions can be reverted and balances can be modified. Private blockchains run on a more controlled system, in which there is a limited numbers of parties involved, as opposed to the countless nodes that are able to join public networks (such as Bitcoin, Bitcoin Cash and Ethereum). Furthermore, all validators in a private network are known, i.e., they are not anonymous, which can be the case for cryptocurrencies in the public domain. This means that the mere possibility of tampering with the network by forging an attack entailing 51% or more of the blockchain is unlikely. Also, given the smaller number of participants, the verification of nodes occurs at a faster pace, which reduces transaction costs. Again, given the seemingly endless amount of nodes functional in public blockchains, each transaction needs to be verified by tens of thousands of laptops, which not only takes time, but also requires more processing powers, resulting in higher costs. Currently, transaction fees in a public blockchain exceed “$0.01 per tx, but it is important to note that it may change in the long term with scalable blockchain technology that promises to bring public-blockchain costs down to within one or two orders of magnitude of an optimally efficient private blockchain system.” (Buterin 2015). Thus, the lower transaction costs of private versus public blockchains could simply be a temporary advantage, keeping in mind that blockchains are only just seeing the light of day. Why financial services such as banks prefer private over public blockchains will be made clear in Chapter 3 in section 3.2.

2.4. Functions of Blockchain

Following the overview of blockchain’s emergence, a basic structure of its functioning and the comparison between the types of blockchains (public, consortium or private), the functions or capabilities will be outlined in Chapter 3 in order to be able to target the research question at hand. The nature of blockchain technology will be assessed on its capabilities within the realm of financial services, in an attempt to highlight the new layer of trust. The complexity of blockchain lies not only in what happens behind the curtain of cryptographic algorithms, but also in the potentially unlimited possibilities that this technology brings with it. Below, the most relevant functionalities of blockchain(s) will be elaborated on. It is key to re-emphasise that blockchains have a variety of functionalities, and that there is no single blockchain. Its five key capabilities, that can act together but also independently from one another, will be described hereafter (Mougayar 2016, 18-23).

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2.4.1. Cryptocurrencies

The most well-known cryptocurrencies are positioned in public blockchains, such as Bitcoin and Ethereum. As Mougayar notes, “Cryptocurrency is generally an economic proxy to the viable operations and security of a blockchain” (Mougayar 2016, 18). However, though digital currencies are much sought after and talked about as payment alternatives, they do have one great disadvantage. In 2017, the virtual cryptographic reality saw an inflation that started at approximately $900 and ended, at its peak, just short of $20.000 towards the end of the year (Higgins 2017). The volatility that cryptocurrencies have been subject to are not their strongest selling points. Stabilising cryptocurrency value could be done in the future given the fact that, according to Nick Szabo, its “main volatility comes from variability in speculation, which in turn is due to the genuine uncertainty about the future” (Mougayar 2016, 18). Cryptocurrencies are, in essence, no different from other forms of currencies in that crypto’s can be traded with, and can be exchanged for goods and services. Despite this, friction still persists between the ‘efficient’ cryptographic system running on a blockchain network, and the real world Fiat currency. Succinctly put, Fiat currency is money that is made “legal tender by (...) (order) of the government” (Lexicon Financial Times 2018).

Cryptocurrencies, on the other hand, are decentralised and thus not backed by the government as an entity.

2.4.2. A Platform for Transactions

Within the network of transactions the nodes validate value-related transactions that have to do with any digital asset. Be it macro- or micro-transactions, all are noted in the chain and will stand as they are. In technical terms and as a link between

blockchain’s transaction potentialities and formal banks, it is interesting to compare the rate of transactions per second (TPS) with Bitcoin (as a public blockchain), private blockchains and traditional payment services controlled by banks such as e.g. VISA credit cards.

In 2015, the credit card company VISA “handled an average of 2.000 TPS (...) and a peak capacity of 56.000 TPS” (Mougayar 2016, 20). In 2016, the Bitcoin blockchain was handling a mere 5 - 7 TPS, but given the expandability of ‘sidechain networks’, this number is expected to increase greatly. Bitcoin’s runner-up, Ethereum, was handling 50 - 100 TPS in 2017, but has a prospect of reaching 50.000 - 100,000 by 2019 (Mougayar 2016, 20). The speed and efficiency of transactions has been touched upon in the subheading Public and Private Blockchains, but it is equally relevant here. Given the more intimate environment within a private blockchain network, these were hitting 2.000 - 15.000 TPS in 2017, with unlimited prospects for the near future.

Placing the blockchain-related statistics next to the bank-backed system

transactions, it is clear that the blockchain potential is enormous. This can be a subtle indicator for banks to either transform the current system, or better yet, implement blockchain technology to increase its transactions per second rates. If banks choose not to incorporate blockchain technology in any way, shape or form, then these TPS figures will keep hovering in the lower thousands segment, whilst blockchain-based

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networks will rapidly rise. This may create a potential gap for start-ups that will use blockchains from the start and be able to facilitate countless more transactions than the traditional banks down the road.

2.4.3. The Distributed (Accounting) Ledger

Blockchains are distributed amongst all participants in the network. These validate, track and process all transactions made. Its distributive characteristic can help avoid the double-spending issues that could occur in banks, for all distributed transactions are secured against tampering. Furthermore, in the light of accounting, blockchains may be the next step: “Instead of keeping separate records based on transaction receipts, companies can write their transactions directly into a joint register, creating an interlocking system of enduring accounting records. Since all entries are distributed and cryptographically sealed, falsifying or destroying them to conceal activity is practically impossible” (Andersen 2016, 3).

2.4.4. A Financial Market Place For Services

Cryptocurrency blockchains are centred around the notion of money. It seems to be a matter of time before scepticism and speculation surrounding the volatile trading environment and actual worth of cryptocurrencies will be balanced, allowing many more financial platforms to safely integrate it in their systems. One could think of, for instance, “Derivates, options, (...), investments, loans” (Mougayar 2016, 22). The ultimate aim is then that all of these instruments will be replaced by an alternative crypto-version, thus creating a ‘new’ financial service market.

2.4.5. The Peer-To-Peer Network (as proposed by the Bitcoin Whitepaper)

Blockchains are not centralised. They have been constructed and designed in a way that allows for transactions on a peer-to-peer level rather than building on the trust of intermediaries or third parties. With the computer being the network - and the nodes the validators - the peer-to-peer phenomenon shall allow for the creation of a

blockchain-based distributed economy and a new layer of trust.

2.5. Smart Contracts

The term ‘smart contracts’ was coined in 1996 by Nick Szabo. The contract is “a computerised transaction protocol that executes the terms of a contract” in order to “satisfy common contractual conditions (such as payment terms) (...) and minimise the need for trusted intermediaries” (Tapscott and Tapscott 2016, 72). Given blockchain’s distributed ledger philosophy, it is the smart contract that enables two or more parties to share such a ledger in order to move assets and come to contractual agreements with one another. The principle aim of a smart contract is to exchange not only money, but virtually anything that is of value “in a transparent, conflict-free way while avoiding the services of a middleman” (Buterin et al. 2016).

With the introduction of smart contracts, one must not assume that these are fundamentally different to the traditional meaning of coming to contractual terms between parties. In fact, the smart contract shares similarities with written contracts.

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Parties must still negotiate the terms of agreement before coming to a mutual decision (Filippi and Wright 2018, 72). Upon agreement, the terms are memorialised “in smart contract code, which is triggered by digitally signed blockchain- based transactions” (Filippi and Wright 2018, 74). The central difference between smart contracts and written contracts is that the smart contract is able to enforce obligations using

automated, autonomous code. The code is, too, distributed, in that the nodes acting in the contract validate the blockchain network, thus eliminating the necessity of a trusted intermediary.

Furthermore, tampering a smart contract is made increasingly difficult, given its autonomous framework. Just like in any blockchain-based network, none of the parties involved in the contract are in control of the smart contract blockchain. In short, “Once the wheels of a smart contract are put into motion, the terms embodied in the code will be executed, and they cannot be stopped unless the parties have incorporated logic in the smart contract to half the program’s execution” (Werbach and Cornell 2017). Another great addition to contractual advancement that smart contracts offer lies in the fact that the outcomes at any moment in time can be predicted.2

Though the apparent benefits of smart contracts seem to be never-ending, they do offer limitations. Due to the transparent characteristic of blockchain technology, smart contracts are completely open. However, in some cases, contracting parties may want to publish content of the contract without necessarily exposing their terms of

agreement. In written contracts these can, in contrast, be kept private. The concealing of an ‘anonymous’ identity is also not guaranteed to be kept secret, for the very peer-to-peer functioning of the blockchain can offer loopholes for identity revelations. Despite efficiency claims that speak for the usage of a smart contract, the issues

concerning privacy could be regarded as a con. When it comes to large sums of money being transferred or even settlement payments to employees, it is quite undesirable to run the risk of exposing the identities of the parties involved in the contractual deal. Furthermore, not all “rights and obligations are easily translatable into the strict logic of code” and thus cannot be correctly memorialised by the smart contract (Filippi and Wright 2018, 77). Some contracts can include “open-ended terms that outline performance obligations” in which promises are made that can be “in good faith” for one party, but on a basis of “best efforts” for the other (Filippi and Wright 2018, 77). Coding such vague terms can prove to be difficult, and so the individual obligations that are generally marked as “time- and sequence-dependent actions” cannot be implemented into the contract (Filippi and Wright 2018, 77). Regardless, smart contracts, when used under the conditions and coded following the appropriate logic for all parties, they do offer a vast amount of opportunities not only for the legal, but

2_{In an interview, Andrew Antonopoulos stated the following: “If I have a fully verified signed transaction}

with a number of signatures in a multi signature account, I can predict whether that transaction will be verifiable by the network. And if it is verifiable by the network, then that transaction can be redeemed and irrevocably so. No central authority or third party can revoke it, no one can override the consensus of the network. That’s a new concept in both law and finance. The Bitcoin system provides a very high degree of certainty as to the outcome of a contract” (Tapscott and Tapscott 2016, 86).

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also the financial services industry. This thought will be elaborated on in the chapter that follows.

To summarise, it may have become clear that the blockchain’s narrative is not one that is simply understood by following its storyline. Much rather, it is a disruption to a technology-based world in which we have lived for many decades; a virtual reality in which so many of us have found the comfort of being regular consumers. With the coming of blockchain’s technology and its seemingly endless possibilities, we must not downplay the severe impact it may have for particularly the financial industry, but also for most other aspects of society. These include the moving around of assets,

contractual agreements, and the ability to partake in the circular (distributive or redistributive) capitalist enterprise we call ‘the economy’.

In the following Chapter 3, the knowledge of just how blockchain works and what it entails,will be linked to the new layer of trust that blockchain creates for the

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3. How Blockchain Affects Financial

Services Industries

The power of blockchain to contribute to, or even replace means of payments is unquestionable. Letting go of the idea that transactions must be done from one party to the other with a trusted third party acting as intermediary, we seem to be on the eve of a technological revolution that could change the way the traditional banking works.

Blockchain-technologies are not only the framework for Bitcoin transactions; rather, they are able to support “a new generation of digital currencies that know no geographic boundaries and can be sent across the globe in a matter of minutes, without the need for a central authority” (Filippi and Wright 2018, 61). With the arrival of this new technology, a new trust layer is born. As Mougayar notes, when disregarding the emotional or even philosophical meaning(s) of trust, we are left with trust in the business transactional sense, which includes: “reliance, predictability, confidence, truth, (...) credence (...) responsibility” (Mougayar 2016, 30).

3.1. A New Layer of Trust

This chapter analyses how blockchain technology is changing the nature of trust and related key features of the financial services industry. The questions that this chapter will address are (a) whether banks will become obsolete due to blockchains; (b) if banks are able to adapt to blockchain technologies; (c) whether governments will be able to regulate this new layer of trust and (d) if such regulation is desirable or even necessary.

In our current financial services industry, the notion of trust is institutionalised in the form of banks acting as ‘trusted entities’ and of governments introducing regulatory frameworks that offer stability in the system. What blockchains initially aim to step away from is precisely those ‘trusted’ third parties or intermediaries. By replacing banks as the trusted middlemen, blockchain’s technological network evolves in order to give this new layer of trust its standing.

As a consumer, there are several trust entities that we are in contact with on a regular basis. One could blindly assume that the bank does its job fairly well in that it makes sure, that when a transaction is performed, money from consumer X will eventually reach recipient Y. Depending on the (trans)national scope of these

transactions, these can take a few minutes or a few days. A bank holds your money, but does not take it from you; much the same as credit card companies allow customers to lend money, given this amount is paid back at the end of the agreed term. One must, however, not forget that such ‘trusted’ institutions are always prone to corruption or abuse. Banks have the power to delay the speed at which transactions occur, causing inconvenience for the party sending the money, but also for the party on the receiving end. Simultaneously, though borrowing money from the banks by using a credit card may seem like an handy asset, the interest rates are staggeringly high - running up to 23% depending on the card service used (Mougayar 2016, 31).

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Blockchain technology offers numerous solutions for examples such as noted above. This does not immediately imply that by implementing blockchain networks on traditional banking systems, all common mistakes are suddenly nonexistent. These will continue to pertain, but given the transparent mechanisms which the blockchain technology adopts, these trusted entities will “decentralise their potential failures”, allowing the participants within the network “to be part of early warning systems,” consequently lowering levels of risk (Mougayar 2016, 31).

Blockchains trigger a clear shift from placing trust in individuals entities and centralised organisations to putting one’s trust in a network that follows a

decentralised, peer-to-peer protocol. The blockchain protocol does not merely act in the interest of those in power; but rather, of all nodes within the system. In order to enable a future that is based on decentralisation and a new form of - algorithmic, network-based - trust, there are several elements that must stand at the heart of this technological revolution. Mougayar’s ATOMIC model will illustrate how trust in the traditional banking sense shifts meaning as this new layer of trust emerges.

The identity of traditional banks rests on what Mougayar describes as the ATOMIC model. ATOMIC stands for the core notions of financial services: “Assets, Trust, Ownership, Money, Identity, and Contracts” (Mougayar 2016, 45).

Today’s financial industry is marked by outdated flaws that could be mended with the induction of blockchains. Concepts that are common in current-day financial services are centralisation, banks as trusted intermediaries, high costs, slow transaction settlements and risk management. As technology advances at rapid speed, it seems only logical for institutional systems to catch up and adapt. To this day, the adaptation has been sluggish, resulting in unreliable transactions and decreasing levels of trust, most notably since the 2008 crisis.

The centralised economy has given a monopolistic, even exclusive touch to the financial world, permitting only those with the necessary means to partake in the system, whilst excluding billions of people who lack access to it. Its centralised status opens doors “to data breaches, other attacks, or outright failure” whilst “reinforcing the status quo and stifling innovation” (Tapscott and Tapscott 2016, 58).

Assets are moved from institution to institution through the financial system on a daily basis. This system makes sure that money is not double-spent, be it a transaction that entails a few cents or hundreds of millions of dollars. Blockchain(s) can do this too, but in a quicker fashion. The creation of digital assets can occur on a blockchain. Upon creation, they can be managed and used as transaction tools on the network “without incurring clearing-related delays due to the existence of intermediaries” (Mougayar 2016, 45). The verification process that is validated by the consensus algorithm is a new form of trust, upon which nodes can rely. Furthermore, assets that are held on the blockchain will always be added to the longest, most valid chain. All that is necessary to withdraw, transfer or deposit assets is virtual storage space, without having to resort to intermediaries. The essence here is that one trusts the validated chain and the network in which nodes can transact with each other. Given the

transparency of blockchains, the registration of assets also becomes different. Real estate registries are placed in contracts that are cleared only upon approval of transaction

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validity. Questions about ownership will also become clearer, because the parties involved are up to date with all terms of agreement. With trust being the layer that will create a new understanding of the ‘traditional’ financial services industry, it is

important to illustrate precisely what it meant in the past, and what it can mean in a blockchain future.

Trust is the umbrella-term that will (re)define the shift from our traditional financial services to blockchain-fuelled services. The notion of trust has for decades been linked to the banks that acted as ‘trusted’ intermediaries. Unless one stores cash or other forms of assets under one’s bedside table, banks have always been the go-to trusted storehouses for the holding of value. But, how do parties that principally do not trust each other conduct business with one another? With the rise of blockchain, business between two such parties is made possible. Formerly, it was the role of financial intermediaries to verify, for instance, the identity of those transacting and those receiving. Now, the blockchain is able to “establish trust when trust is needed by verifying the identity and capacity of any counterpart through a combination of past transaction history (on the blockchain), reputation scores based on aggregate reviews, and other social and economic indicators” (Tapscott and Tapscott 2016, 58). In other words, trust, in our current-day understanding of it, is not removed- or replaced by the simple implementation of blockchains. Rather, trust is moved from a centralised institution (the bank), which enjoys the trust of the consumers, to a system in which the consumers are part of the trusted network. Is trust, therefore, a fleeting commodity that must adapt to technological developments? Or can trust be created and held within a new network of institutions? The notion of blockchains creating more transparency will, for instance, make it easier to signal trust-breached insecurities faster than in the current ‘trusted’ banking system.

Furthermore, current economic trust revolves around centralised power. In the current centralised system, all trust is placed in the non-transparent network of banks. Contrastingly, the distributive nature of blockchain would enable the coming together of trust in a decentralised network community. Thus, trust is now not held by a single unit, but it creates “multiple, singularly harmless, but collectively powerful entities that authenticate it” (Mougayar 2016, 31). Next, should we want to believe in the new layer of trust blockchain could offer, Mougayar states that we must believe in a few core principles first. For instance, he stresses that blockchains are not a “tool for the disintermediation of trust” but rather, they “only enable a re-intermediation of trust” (Mougayar 2016, 32). Again, this shift in trust must not be confused with the

elimination thereof. Blockchains can distance our understanding of traditional trust and bring us closer to challenging “the roles of some existing trust players” and in doing so, reassign “some of their responsibilities” (Mougayar 2016, 33). Trust is, and always has been, an expensive tool which banks feed on in order to function. The distribution of trust, enabled by blockchains would, therefore, lower the costs of banking.

Traditional financial services are known for their high costs. The blockchain - in contrast - verifies, settles, and enables peer-to-peer transactions performed within the network. This way, the (distributed) ledger is not only validated, but also continually updated, emphasising its verifiability and henceforth its trustworthiness for the chain.

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Trust rules are, essentially, embedded inside transactions, making the blockchain a new validator for transactions based on logic rather than centralised authority trust. Each node joining the network will automatically join the longest, most valid chain to ensure security. Banks do not (yet) have such a systemic approach. However, if they were to “harness that capability, they could eliminate an estimated $20 billion in back-office expenses” (Tapscott and Tapscott 2016, 59). It must be made clear that

implementing such a framework is not the elimination of the already-running system; rather, it can be seen as an addition. So, by decreasing its (back-office) costs in the existing model by implementing blockchain technology, front-end costs would decrease simultaneously, making transactions not only validated by a system, but also more user-friendly for the wallets of the parties in question.

By exploring new grounds of trust, possibilities for the implementation of a disruptive technology can, and most likely will, change the way the financial services industry has thus far operated. The immeasurable breadth of transactions done on a daily basis extends to “trillions of dollars daily” serving “billions of people” and supporting “a global economy worth more than $100 trillion.”3_{As our understanding} of trust shifts from traditionally handling the transaction of assets to a more efficient, transparent and cost-reduced system, the blockchain ideal will come to flourish.

Ownership is the next concept inherent to the ATOMIC model that will undergo a shift in trust levels as blockchain’s efficient transaction mechanisms enable a change in who owns what and how quickly such ownership can change. High costs and slow transaction settlements are no recipe for prosperity. Currently it can take between three to seven days for payments or settlements to be made. Surprisingly, bank loan trades can take up to twenty-three days. During the so-called ‘settlement lag’, who is the rightful owner of the assets? Will the transaction even go through? For instance, the world’s most upfront provider of secured financial messaging, SWIFT, “handles fifteen million payment orders a day between ten thousand financial institutions globally, but takes days to clear and settle” (Tapscott and Tapscott 2016, 59). To compare: it takes the Bitcoin network a mere ten minutes to clear and settle transactions, making the shift in ownership a fast, transparent and efficient one. Banks using several intermediaries take time, cost money and bring with them the risk of performing invalid transactions. Given blockchain’s transparent, decentralised nature and its algorithmic validation process, such risks are reduced to near-nothingness. Furthermore, according to a report by Santander InnoVentures, “by 2022 ledger technologies could save banks $15–20 billion a year by reducing regulatory, settlement and cross-border costs” (Botsman 2017).

Risk management is another central concept to traditional banking. According to Tapscott and Tapscott, there are several forms of risk when it comes to financial transactions: settlement risk (the question whether or not trades will successfully settle), counterparty risk (uncertain whether or not the other party will or will not comply with the terms of agreement) and systemic risk, which involves “the total sum of all

3_{According to the IMF, estimates range from $87.5 million to $112 million (Tapscott and Tapscott 2016,}

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outstanding counterparty risk in the system” (Tapscott and Tapscott 2016, 60). Again, such settlements can be made near-instant through blockchains. By eliminating numerous intermediaries, instant settlements can manage the aforementioned risks. Furthermore, the transparency allows all parties involved to gain insights into where the transaction is and what is happening with it at any time. The risk of the

management exploiting the transaction history is hereby made redundant and the question of ownership is more easily clarified.

In essence, through the notion of time-stamping transactions in each block, ownership is cryptographically secured through the “irrefutable proofs” that the blockchain fosters (Mougayar 2016, 46). As we have seen, once blocks are validated and added to the chain they cannot be altered, therefore emphasising the right of ownership of any given transaction in the digital ledger at any given time.

Money, as a notable asset, feeds transactions and forms a fundamental backbone to the financial industry. As noted earlier, the global financial industry is built on a somewhat archaic framework. How can it be that, although banks do offer Internet banking services, they still provide paper checks and have systems that stem from the 1970s? Transactions are not direct. When customer X buys an item from store Y transacting money using a card-payment system, the currency first needs to pass through at least five intermediaries before reaching the bank account of store Y (Tapscott and Tapscott 2016, 55). Though the transaction an sich is done in the blink of an eye, the actual credit is only realised after several days. Such a system is irrefutably inefficient. In the time that it takes for the money to leave its ‘owner’ and reach its ‘destination’, neither parties can spend that money. This settlement lag “increases the risk that the trade won’t go through” (Botsman, 2017). The reason behind this phenomenon is that the intermediaries earn interest in this process of transactions floating from sender to recipient.

Another example of how money works in the traditional banking system is linked to the stock exchange market: “Traders buy and sell securities on the world’s stock exchanges in nanoseconds; their trades clear instantly but take three full days to settle” (Tapscott and Tapscott 2016, 56). The mechanism seems to function well - in that the direct transaction is sheerly a matter of nanoseconds. But the execution of transactions performed does not have to take so long. This is precisely where blockchain’s new layer of trust comes into play. Trust is, then, undeniably linked to how transactions are done. According to Mougayar, the verification of transactions “is done by the blockchain’s black box, and the trust component is the part of the transaction”, making the end- result a “self-clearing transaction” (Mougayar 2016, 46). In short, clearing and settling assets (or money) becomes one single process, rather than the traditional and distinct set of rules that take time and are costly.

Lending money traditionally occurs through financial institutions issuing loans, “credit such as credit card debt, mortgages, corporate bonds, (...) and asset-backed securities” (Tapscott and Tapscott 2016, 92). If trust is put into blockchains, they could technically speaking create a system whereby anyone - from the average individual to large-scale institutions - “will be able to issue, trade and settle traditional debt

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instruments” directly. This, again, will enhance efficiency and transparency (Tapscott and Tapscott 2016, 62).

The identity of users holding crypto-wallets and participating in a blockchain network is often believed to be anonymous. In reality, it is not as secret as one would assume. Digital currencies are not completely “anonymous; they are pseudonymous” (Filippi and Wright 2018, 68). Each transaction that is made is indeed stored on the chain, but digital currency exchanges still have the ability to retrieve where such transactions came from due to the simple nature of the blockchain system: everything is stored on the chain and can thereafter never be changed. For the outside world, however, the identity of nodes that are part of a network are called ‘keys’ and are secured by the network. This security is “achieved via cryptographic technologies, and it will result in new levels of decentralised data privacy” (Mougayar 2016, 46).

No matter how decentralised individual identities are in essence, “Third parties can map out blockchain-based transactions and combine that analysis with personal information to discern not only the identities of these account holders but also their financial transaction histories” (Filippi and Wright 2018, 68). Banks (and regulators) are still able to gather financial information, since coin exchanges are linked to passports or IDs, IP addresses and ultimately to bank accounts. Despite the advantages of peer-to-peer technology, such Orwellian mass-surveillance appears to go against the ultimate goal of anonymity that all decentralised proponents strive for. In terms of trust though, it seems that “The only things which can be trusted are the transactions in the

distributed ledger and the tokens themselves” (Burrows 2018).

For traditional banking systems, “Online identity management has always been a time- consuming and costly process” (Boersma 2016). Issuing loans or mortgages require security measures that must adhere to specific ‘Know-Your-Customer’ regulations, all of which takes time to register. Scanning official identification documents and authorising individuals is a process that must be repeated by the institutions each time a new client comes on board. The efficiency in this is

questionable. With blockchain, trusting the network and cutting out the middleman will lead to a single ‘source of truth’, establishing a community in which all documents are visible for the registered parties. Initial registration on the blockchain is clearly needed. Once this is complete, no further registration is needed if, e.g., a client wants a mortgage after having received a loan (Boersma 2016). When all trust is placed in the network, efficiency levels rise. However, a clear downside to letting go of the middleman and having a private key as the personal identifier is that once this key is lost, it cannot be given back. The pseudonymity that, in most cases, comes as an advantage can, in other cases, be counterproductive. The only solution to such problems is - for now at least - to re-register with a new private key.

The technicalities and capabilities of (smart) contracts have been discussed in Section 2.5. in the previous chapter. With smart contracts, “debt can be issued, traded, and settled on the blockchain” all based on what is agreed upon in the algorithmic contract (Tapscott and Tapscott 2016, 64). If everyone can join a public network and transactions take a mere handful of minutes, the traditional days of transaction traffic could become numbered. This would have huge implications for those that are unable

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to pay the basic bank fees and the costs that come paired with maintaining an account. The peer-to-peer nature of the blockchain network could then trigger the creation of more wealth and immeasurable growth of the economy, simply because more participants gain access to the (transparent and decentralised) system. It must come as no surprise that industries can be changed in the wake of blockchain technology; much like the Internet created countless opportunities for existing industries.

Physical contracts in traditional banking have visible disadvantages. They can lead to delays and they are more prone to fraud and error. Furthermore, “Financial

intermediaries, while providing interoperability for the finance system and reducing risk, create overhead costs for and increase compliance requirements” (Capgemini 2016). For instance, a mortgage requires much paperwork, including “verification of a huge amount of property and financial data by all parties involved in the transaction” (Murphy 2018, 5). Not only does this delay the contractual agreement, it also costs money due to the additional work of the traditional bank. Now, if trust is shifted towards the logic of a smart contract, cost and time is immediately reduced as a result of automation and “shared access to electronic version of verified physical legal documents between trusted parties” (Murphy 2018, 5). Thus, the money that is saved can be reinvested in better loan or interest agreements with the customers, creating a circle of trust and reliability between the network, the institution and the clients.

In the light of the ATOMIC model and a new layer of trust, the term ‘contracts’ will further be discussed using The Decentralised Autonomous Organisation (hereafter The DAO)44

hack as an example of this shifting trust. In 2016, hackers were able to tamper with the network, exploiting “a vulnerability in The DAO code” that enabled them to “siphon off one-third of The DAO’s funds to a newly created subsidiary account (thought to be worth about $50 million)” (Murphy 2018, 4). For the entire Ethereum economy, this meant that $700 million was gone. The investor’s trust in the logic of code had been harmed by a loophole in the system. The challenge for the Ethereum Foundation was, therefore, to restore trust in the network. The Foundation suggested changing the rules of code, “introducing the equivalent of a constitutional amendment to freeze the account to which The DAO’s funds were being diverted” (Murphy 2018, 4). Given the functioning of the Ethereum blockchain, this would have required a majority vote to change the system. The fundamental issue with a sudden change in a ‘tamper-proof’ network was that “this would undermine Ethereum’s bedrock principle that smart contracts will run exactly as programmed, without third-party interference” (Murphy 2018, 4). Such rules are handy when the network is run smoothly, but a vulnerability such as The DAO attack showed that blindly trusted, logically programmed algorithmic contracts do not always coincide with what seems morally appropriate.

Unlike traditional banking contracts, “Smart contracts are meant to be stand-alone agreements – not subject to interpretation by outside entities or jurisdictions” (Siegel 2016). Vulnerabilities like this should not occur in trusted coded logic. Though the

4_{DAO’s are organisations that use smart contract agreements among members. The DAO as noted above}

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hack was eventually made undone, it shows how the shift in trusting physical contracts to smart contracts can be exploited. To ensure and in some unfortunate cases, restore trust is the challenge blockchains in general will have to face. The fact that blockchain proposes to bring countless advantages, examples such as The DAO show how ‘easily’ a fault in code can lead to the loss of substantial sums of money.

The DAO hack is a prime example of how such a vulnerability was necessary in order to restructure the network in order to regain trust. Repairing faults and creating a stronger system is precisely what is needed to build this new layer of trust. Enlarging trust, by changing the code to remedy the vulnerabilities was needed to re-establish the blockchain operations. In short, one could argue that The Dao ensured an opportunity to remedy a systemic fault, which in turn has strengthened and contributed to the new layer of trust.

To summarise the notion of this new layer of trust, establishing such trust takes time and experience. The ATOMIC model has shown how traditional banking concepts, from assets all the way through to contracts, is experiencing a shift in the respective definitions of trust. The fundamental shift boils down to trusting a network rather than an institution. We must highlight the fact that blockchain has huge potential, but without trust there will be no opportunities to prove what it can do for a.o., the financial services industry. Banks must realise these potentials and embrace them. Indeed, as Keynes noted, “The difficulty lies not so much in developing new ideas as in escaping old ones” (Keynes 1935).

With banks regulating money flow, ensuring financial stability and being in control of which intermediaries come into play at any given time in the settlement chain, it is then only a mechanism as decentralised as a peer-to-peer system that can interrupt this. Why? Due to the fact that the centrals bank would then “lose its ability to influence the economy of a country by regulating the overall money supply - because the conditions for the issuance of these digital currencies are predefined and dictated exclusively by code” (Filippi and Wright 2018, 70). Once again, this is a call for placing our trust in technology. Exchanging information in an efficient, cost-reduced and transparent manner will have the most impact on how we transact with one another today. In 1993, the so-called ‘information superhighway’ was an unknown phenomenon, later to be understood as the Internet. Years later, we needn’t forget how “The internet transformed how we share information and connect”; one could

therefore argue that “the blockchain will transform how we exchange value and whom we trust” (Botsman 2017).

3.2. Banks Prefer Private Blockchains

If the aforementioned implications seemingly speak for the implementation of

blockchains within the financial sector, why is it that banks still appear to be hesitant to dive into this technological world? Banks need control to ensure financial stability. Imagine all banks adopting public blockchains, then the control mechanisms would go down the drain within the blink of an eye. There must always be some means of controlling who joins which network and why. Imagine a restaurant that works without reservations, but has no strict entry policy. This would immediately lead to an

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overly packed area without control and only leftovers for those that are lucky enough to still get a table. The same goes for the financial industry: banks need to create a system in which there is not only regulation, but also control. With Buterin’s

comparison between public, consortium and private blockchains, we see a tendency of banks to turn to private or permissioned blockchains to eventually obtain the best of both worlds: efficiency (and more transparency) but still some means of control. The following will break down just why banks step away from public, and will generally move towards private blockchains. Furthermore, this shift will emphasise one of the central questions in this chapter: whether banks are able to adapt to blockchains.

One of the largest hubs known in the economic market is undoubtedly Wall Street. According to Amy Nordrum, the finance industry is willing to adopt

blockchain technology, however the question remains to what extent this willingness will stretch (Nordrum 2017, 40-45). Eliminating the (financial) middleman, as Bitcoin so clearly proposed almost a decade ago, is in no way beneficial for banks. Thus, we see the tendency of banks to pick out advantageous elements of the network that can help the economy and putting them on top of the already-existing backbone of the system. Are banks, therefore, becoming unnecessary? Quite on the contrary, they still stand and will tend to adopt the use of private blockchains to further their means of operating.

The blockchains that banks are willing to use do not entirely coincide with the initial vision: Nakamoto’s whitepaper speaks of the anonymity of users, decentralisation and the ability for each node to follow the transaction history. Banks are creating permissioned systems in which one’s identity must be revealed and the system’s administrator approves the nodes (Nordrum 2017, 42). According to the banks, “a permissioned network is the best way to satisfy regulators and protect client privacy”, though “purists argue that trying to keep a close hold on information removes the very point of blockchains” (Nordrum 2017, 43). Again, the contradictory nature of the problem is highlighted. We see how industries want to benefit from the efficiency of blockchains, but they do not want to lose their grip on the system. Thus they seek a balance between the two networks, which best suit them, even though this does not always satisfy the core philosophies of the technology.

In theory, the use of- and reliance on code seems to be a stunning idea. However, as noted above, the “high-profile $60 million heist at the DAO” acted as a “painful reminder that blockchains and their accoutrements are still written by humans, who inevitably make errors in their code” (Nordrum 2017, 43). It makes sense that a trillion dollar industry does not want to risk being exposed to such errors. A closed network that is smaller in scale is easier to oversee and intervene with, should mistakes be made. This may be a shame for the institution and early proponents of a decentralised Bitcoin utopia, but there surely is no harm in being realistic and seeing what works best for the system as a whole. Just how the industry will adapt to- and adopt blockchains is subject to the test of time.

The Depository Trust and Clearing Corporation (hereafter DTTC) “is a financial utility that holds the books on which firms record their trades” and will be launching its permissioned blockchain in the latter half of 2018 (Nordrum 2017, 44). Bonds,

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shares and other trading securities (based in the U.S.) are settled through this corporation, which emphasises the relevance of this launch. Though it hopes to save costs and, perhaps, time, Nordrum argues that an upgrade towards a permissioned blockchain “will ultimately change little about the way the financial system works today. As envisioned, it is still a proprietary system through which centralised players control trading behind walled-off networks” (Nordrum 2017, 44). Nordrum remains critical towards the relevance not of banks, but of the underlying impact blockchain might have on banks. If we follow her trail of thought, we can safely conclude that banks will not become unnecessary, for the system will hardly change. However, one fundamental change in how the system works today is the embracement of

permissioned blockchain to retain control but offer more efficiency in transactions. This is a clear shift in trust towards the technological future, and must not be underestimated.

To give an example, 98% of the credit-default swaps that occur in the world are all settled by the DTCC, amounting to approximately 60.000 transactions on a daily basis. Though this has worked for a decade, the DTCC is convinced it can be handled in a more efficient way. Instead of manually submitting orders for a swap, resulting in costly translations and time-consuming reformatting, the buyers and the sellers will be able to send swaps to a blockchain that has the terms and agreements set in a smart contract, thus automating the trade-process. Now, all firms that form a part of the DTCC network are participants, and as such are always prompted with the most up-to- date version of the terms and agreements, because the technology validates transactions and stores a history of the (transparent) ledger which eventually reduces things like payment reconciliations.

Surely, a system that has existed for many decades will not change overnight, but blockchain does mark the first steps towards a shared network system in which participants can trace (trans)actions of the counterparts involved. This in part lives up to what the blockchain initially strove for. In the light of the question at hand, the vision was to be fully decentralised, but if banks tend to adopt the innovative notion of blockchain technology in a way that best fits their regulatory consensus, is blockchain then truly living up to its essential aim - the aim of pure decentralisation, no regulation and pure anonymity? Perhaps not, but the fact of the matter is that even if parts of the technology are adopted, we can clearly conclude that a shift is occurring. If

blockchain’s potential were in no means relevant to the industry, then why bother adopting parts of it? At the end of the day, we must remain optimistic if we want to give blockchain the chance it deserves and it will do blockchain proponents well to see large institutions such as the DTTC adopt permissioned blockchains. In section 3.3., we will look at the R3 Consortium, which has also delved into blockchains capabilities.

3.3. Will Blockchains Replace Traditional Banks?

It seems to be more of a natural, but also viable tendency for banks to lean towards arguing that blockchains could be the addition to- rather than the mere replacement of banks. Again, a blockchain itself will not produce money. The blockchain technology, however, offers a platform which businesses can use, to enable the likes of financial

"A New Layer Of Trust: Which key aspects of traditional financial services are affected by blockchain’s technology? How are banks and governments responding to this new technology?"