In Part 1 of our series on blockchain, our Technology team examined what blockchain and distributed ledger technologies are and how they work. In this Part 2, we analyse how blockchain and distributed ledger technologies are set to rapidly change certain industries and consider some of the non-financial applications of blockchain and distributed ledger technologies.

Pattern of disruptive innovation

Blockchain fits into Fintech’s general pattern of disruptive innovation in the banking and financial services industry. Among other things, advocates of the ‘genius of blockchain’ claim that it can reduce costs, improve service delivery and streamline digital processes. In fact, last year Santander’s Fintech investment fund calculated that blockchain could slash settlement, regulatory and cross border payment costs by $20 billion each year.

Traditionally, banks and financial institutions have been seen as trusted third parties assisting consumers and businesses in paying and getting paid for goods and services. Blockchain and distributed ledger technologies are decentralised which removes this intermediary and allows parties to transfer the assets more quickly at a reduced cost. Blockchain may therefore pose a major threat to traditional bricks and mortar financial institutions that do not adapt or respond to it.

Response from banks

Banks and financial institutions that see the potential threat of blockchain are already investing millions in developing and testing blockchain technology in order to figure out how they can incorporate it into their e-commerce and crypto-currency strategies. For example, in January, the Australian Stock Exchange ("ASX") announced that it was developing a blockchain and distributed ledger solution to replace its current platform for clearing and settling trades. Similarly, Bank of America indicated to reporters that it was filing a number of US patents in relation to protecting its blockchain-related technology and inventions.

Uses beyond Bitcoin

Blockchain and digital distributed ledgers that offer the power to transfer value from one public ledger to another have many potential applications outside of Bitcoin. Innovative companies that can leverage the cryptographic protocols of blockchain could use it to authenticate the exchange of almost anything, provided that ‘thing’ can be recorded in a register in the form of an asset.

The UK government’s Walport report notes that blockchain and digital distributed ledger technologies “have the potential to help governments collect taxes, deliver benefits, issue passports, record land registries, assure the supply chain of goods and generally ensure the integrity of government records and services." Smaller, more nimble economies like Estonia are already developing blockchain technology to securely store health records, vote electronically and provide public e-notary services.

Registries

For lawyers and anyone who needs to be able to trust electronic registers and databases, blockchain and digital distributed ledger technologies could be a very important IT invention. In simple terms, a blockchain-based document or registry is shared among its users and requires any changes to be verified by all of its users, making it effectively incorruptible and tamper-proof. This in turn decreases errors and fraud while simultaneously reducing the cost of traditional paper-based processes. Honduras is considering a prototype blockchain-based land registry that it hopes will reduce instances of the official land register showing two individuals holding title to the same property.

‘Smart’ contracts

Legally binding contracts are the building blocks of finance and commerce. A smart contract built on blockchain technology could provide parties with a cryptographically secure replacement for traditional business documents for everything from wills, to corporate share purchase agreements, to real estate conveyances. In legal transactions, blockchain and distributed ledger technologies could be adapted to track the location of a contract, record an undisputable history of changes to a contract, and to verify electronic signatories.

Large tech multinationals, like IBM, are developing self-executing smart contract programmes that utilise blockchain technology. In IBM’s platform, the blockchain database hosts the secure smart contract along with an algorithm specifying the execution rules. Once the execution rules are met, the contract is automatically executed. An obvious benefit of no one party controlling the self-executing contract is that all parties can trust it. There are other potential benefits such as lower compliance costs and scalability that may arise with the wider uptake of smart contracts.

Where to from here?

Blockchain and distributed ledger technologies bring a unique opportunity for governments, banks and the private sector to make electronic payments, execute contracts, provide secure online registers, and facilitate other transactions more efficiently while reducing fraud, corruption and errors. But there are still major legal and regulatory issues that businesses will need to address in order to be able to fully harness the power of blockchain. In Part 3 we will discuss these risks and how governments and regulators are approaching blockchain.

If you are a market participant interested in learning more about blockchain and distributed ledger technologies and how we can help your business, or if you have any questions about this article, please contact one of our team members below or your usual MHC contact.

Read: Blockchain Gamechanger: Part 1 - What is blockchain and distributed ledger technology?