Bitcoin witnessed a great Diwali this year! One of the biggest news hitting headlines across the world was the surging price of bitcoin. Bitcoin market cap touched $6 billion on November 4 when the its price broke the $400 mark for the first time this year. In late October 2015, European Court of Justice, Europe’s highest law court decided to exempt bitcoin transactions from Value Added Tax (VAT). This landmark ruling was seen as a great milestone for bitcoin and generated lot of positive sentiment amongst Bitcoin enthusiasts. Adding fuel to the positive sentiments, a recent survey report by Magister Advisors (a London based M&A advisory firm) claims that bitcoin is expected to become the 6th largest global reserve currency by 2030!
It has barely been 7 years since the legendary Satoshi Nakamoto published his ground breaking paper on a peer-to-peer electronic cash system. The paper provided a framework for online transactions without the need for trusted intermediaries (financial institutions). The framework makes innovative use of existing cryptographic techniques and game theory concepts to implement a proof-of-work based financial incentives to process online transactions over a decentralized peer to peer network. Every transaction would leave a public record trail in a distributed ledger while protecting the identities of transacting parties. Eliminating third party mediation would greatly decrease transaction processing cost thereby enabling online micro transactions. It would also eliminate payment uncertainties for merchants (e.g. chargebacks) through non-reversible transactions. We do not know who Nakamoto is. We do not even know if Satoshi Nakamoto is a pseudonym of an individual or a group of researchers. However, one thing is clear: The document has triggered a flood of innovations that can impact our lives in ways its creator may not have imagined!
Big banks are investing in R&D on blockchain – the distributed consensus ledger technology that powers Bitcoin. Application of decentralized ledgers for purposes other than digital currencies is commonly referred to as “Bitcoin 2.0” (or sometimes more generally “crypto 2.0”). Distributed ledger technology can potentially revolutionize the way capital markets clear and settle transactions to enable trade settlement to happen in almost real time which would be a huge improvement from the current T+2 days. Banks will benefit from reduced risks and reduction in operational costs for post trade processing.
Visa, Nasdaq, Citi and other key investors have invested $30 million in Chain.com, a blockchain developer platform that serves an enterprise market. Another distributed ledger startup, R3 CEV recently announced that 13 new banks have joined its project, bringing the total numbers of partners to 22. The list includes top banks like Citi, Bank of America and other well-known institutions. One thing is clear: financial institutions will have to collaborate with each other to realize the benefits of distributed ledgers. Perhaps this is good news to many, as the benefits can get passed on to consumers through reduced commission and fees while improving the speed of payments and order processing.
Back home, Ratan Tata recently joined a group of investors including American Express to invest in a US-based startup Abra, which has harnessed the power of bitcoins to build an Uber like crowdsourced platform to send and receive money without needing any bank account. Like Uber drivers, anybody can sign up as tellers to exchange digital currency with fiat currency (or the reverse) while bidding for competitive transaction fees. People can use a mobile app to locate the human tellers to send and receive cash to anybody globally. Overall, a staggering $1 billion has been invested in tech startups working on bitcoin and blockchain technology!
The results are now beginning to show. Nasdaq recently unveiled “Linq”, which is a first of its kind platform to leverage digital ledger technology for facilitating issuance and shares transfers of privately-held companies on Nasdaq Private Market. On November 10th, Microsoft joined the party by launching a cloud service to enable financial institutions to build and deploy distributed ledger applications using Ethereum’s programmable blockchain platform with very little upfront investment in technology infrastructure.
While the recent investments have largely focused on payment processing and banking and capital markets; there are other potential use cases for blockchain technology beyond banking. Smart contracts and digital assets are active areas for startup activity. Deloitte recently announced their Rubix platform that leverages blockchain to streamline reconciliations and audit, improve record keeping for property deed transfers, health records, etc. Consensys Balanc3 is a smart contract powered Triple-Entry Accounting system. Triple entry accounting is an enhancement to the traditional double entry system in which all accounting entries are cryptographically signed. Transactions cannot be falsified if they are cryptographically sealed with digital signature of counterparties. With triple entry bookkeeping, auditors can easily verify transaction data which feeds financial statements. Cost and time necessary to conduct an audit would decline considerably. Regulators, investors and lenders can easily trust the integrity of a company’s financial statements.
Many advocates of big banks have dismissed the potential of bitcoin as a currency while expressing interest in the underlying blockchain technology. Supporters of Bitcoin believe that it is indeed the future of money promising to insulate common people from inflation due to rampant government mismanagement of fiat currency and risk taking by big banks. A currency war is already raging with many countries attempting to devalue their currencies hoping to stimulate economic expansion through exports. Inflation has always been the collateral damage, adversely impacting lives of millions of people worldwide and destroying trust on governments and banks. British economist, John Maynard Keynes once remarked that “Through inflation, governments can confiscate, secretly and unobserved, the wealth of their citizens and it can be done in a manner which not one man in a million is able to diagnose”. From this perspective, bitcoin appears ideally suited as a global reserve currency, free from control by any particular central bank.
We are still in the early days of Bitcoin. Skeptics are eagerly watching early adopters before investing their own money. Despite the skepticism, today, a few big businesses have started accepting Bitcoin as a form of payment. These include Dell, Expedia, PayPal, and Microsoft. As with most innovations, initial interest is usually centered on process efficiency and cost reduction. The current wave of research is mostly focused on how distributed ledgers and blockchain technology can help reduce costs by eliminating redundancies and disintermediating middle men who don’t add lot of value in many transactions. The immediate challenge is to make the technology scale for mainstream adoption. The next wave of innovations will ride on the success of the current wave and can impact our lives in ways we cannot foresee today.
Saurabh Banerjee is senior specialist, platforms, Sapient Global Markets.