Banks’ adoption of blockchain: an updated primer

Banks are kicking the tires on blockchain technology, but implementation is some time away – especially since banks need to learn to collaborate extensively to make it work.

By Rubert G. Walker

Blockchain is a type of “distributed ledger”, that is, a database maintained collaboratively by several participants. The computers update transactions using a “consensus mechanism” after which the modifications they have settled on are made immutable. Once information has been fixed in this way, it can be used as proof of ownership.

This can help banks improve efficiency and reduce costs. Here are some attractions, according to the Economist.

Efficiency: Instead of tracking assets in separate databases, financial firms can share just one.
Faster settlement: Trades can be settled almost instantly, cutting out layers of intermediation, so less capital is tied up during a transaction, reducing risk.
Improved record-keeping: Ledgers make compliance with anti-money-laundering and other regulations easier because they provide a record of all past transactions.
Unified systems: Incompatible IT systems and expensive middle-men can be side-stepped.
Innovation cachet: Adopting the technology makes banks appear innovative.

But there are at least three obstacles:

Scalability: Distributed ledgers can’t handle the huge volume of transactions that take place every day, hour, and minute
Confidentiality: Encryption techniques that allow distributed ledgers to work while keeping other information private, such as trading patterns, are in their infancy.
Cooperation: Banks tend to compete rather than collaborate.

The Economist also notes that despite their messiah-like presence in media, at conferences, and in front of venture capitalists, disruptive fintech startups might lose out.

“In markets where the success of a technology depends on its adoption by many counterparties, as is often the case in finance, incumbents have an advantage.”