02 February 2018
Hannah Murphy and Philip Stafford
The word blockchain has been the equivalent of financial fairy dust in recent weeks, adding tens of millions of dollars to the market value of companies, including former camera pioneer Kodak Eastman, that have announced a project involving the technology or simply added it to their names.
However, technologists and executives warn that blockchain technology is still developing and the high-profile name changes and often giddy reaction in the stock market are far removed from the real-world experiments.
What is a blockchain?
It is an electronic database of transactions, whereby new deals are added to the chain and then stamped and protected with a mathematical equation.
The database is shared among hundreds of other computers, or “nodes” on the network, to make it virtually impossible for one agent to change it. These nodes use their computing power and compete to verify and decode the latest transaction. This is then appended as a “block” to the chain. Its ability to offer a verifiable, immutable and public record is what attracts many advocates.
“It can do for the nearly free and frictionless transfer of assets what the internet did for the nearly free and frictionless transfer of information,” says Jonathan Johnson, an executive at Overstock.com, an online retailer that accepts payment in virtual currencies.
How is it being used?
Its chief use is as the system behind most of the hundreds upon hundreds of virtual coins that are being created, stored and traded online — of which bitcoin is the best-known. Estonia uses distributed ledgers for the public to follow court, legal and democratic procedures.
But interest in its potential is far greater, generating great discussion at the recent World Economic Forum in Davos.
Some countries, such as Russia and China, are interested in creating their own virtual currencies. Sectors from pharmaceuticals to shipping and agriculture are looking at it as a way to streamline record-keeping and improve inventory management through tracking systems.
Financial markets are among the most enthusiastic adopters. Equity funding into companies building on blockchain technology hit $1bn last year, across 215 deals, according to data from CB Insights, a research group.
Ventures such as the bank-backed R3 consortium have raised more than $100m. Crédit Agricole, the French lender, on Thursday took a small equity stake in Setl, the UK blockchain technology developer.
Many institutions — including bulge bracket banks and fund managers — hope that a real-time ledger could automate their creaky and expensive back office systems, saving them millions.
Several test cases are planned, such as the effort by Australia’s stock exchange to replace its system for clearing and settling trades with blockchain. CLS, the world’s largest currency settlement service, is drawing up plans. Setl has more than 20 institutions on its Iznes record-keeping platform for European funds.
“People who are working with us trust us. We’re seen as a really specialist market,” says Peter Randall, chief executive of Setl.
What are its limitations?
Development is slow while institutions become accustomed to blockchain technology’s biggest features — that the records are public but the owner of the digital currency is anonymous and therefore untraceable.
Many are creating their own “permissioned” distributed ledgers, where only those with authorisation can access the network. Some are exploring ways to build privacy options into the technology — for example, the ability to mask certain parts of the data such as trade or customer information.
“Right now any kind of corporate blockchain initiative is using multiple platforms and coins and building their own proprietary technology on top of it,” says Jalak Jobanputra, founder of New-York based venture capital fund Future/Perfect Ventures. “There isn’t anything off the shelf right now that works for these consortia.”
It has also been held back by the troubled reputation of its associated asset, bitcoin. The anonymity afforded to bitcoin users means it has been used to enable money laundering and organised crime.
Some experts have questioned whether the technology can be scaled to process thousands of deals and payments per second that other electronic systems routinely handle. As the market develops watchdogs are also weighing up new specific regulations targeting the technology. “There is a lot of focus on the potential conflict between blockchain and data protection laws,” says Sue McLean, a partner in Baker McKenzie’s IT and commercial practice division.
Does the future of cryptocurrencies impact the future of the blockchain?
The current hype around blockchain is partly because of its link to the mania in cryptocurrencies. More than 1,500 have been launched, eight times the number of recognised government-backed currencies, according to CoinMarketcap.com.
Initial coin offerings (ICOs) — in which blockchain-based start-ups issue their own digital “coins” — have created more incentives for the public to get involved in a nascent market. CB Insights estimates blockchain start-ups using ICO funding pulled in five times as much as equity funding last year, across 800 deals.
But critics say none of the future uses of blockchain technology would make the cryptocurrencies more valuable.
Steven Wieting, global chief investment strategist at Citi Private Bank, says the interest is a further indication of a “bull market psychology” in broader global markets.
“This is evident in the very mild impact that negative events have had in market pricing. The willingness of so many to speculate in cryptocurrencies, an unproven financial innovation separate from the underlying blockchain technology, may be a symptom,” he says.
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