In the digital age, how business gets done is speeding up. Legal, financial, and other transactions that typically take days or weeks to complete are now occurring in hours or even minutes using a technology called blockchain.
Blockchain is a unique kind of computer coding in which data gets structured in encrypted records, called “blocks,” all linked together. Each block in the chain contains an entry in a public distributed ledger that everyone in the network can see.
Only those with the encryption key can add to the ledger, however, and entries cannot be deleted or reversed.
Invented as the basis for Bitcoin, which is a cryptocurrency, a digital form of money, blockchain has many other uses. Its structure enables peer-to-peer, or direct, sales of goods and services and payments—in cryptocurrency—without an intermediary, similar to the way email enables the direct exchange of correspondence without a postal or courier service needed to collect and distribute letters, documents, photographs, and other mail.
If someone generates power using solar panels, for instance, they may choose to sell that energy directly to a neighbor using blockchain, bypassing the utility company.
If someone wants a ride, they may use blockchain to directly hire and pay a driver without using a ride-sharing company.
In the music industry, blockchain would tell musicians, artists, and writers when they make a sale, then pay them instantly, instead of their publishers and galleries sending them periodic statements and royalties. And they could use the data they see on their copy of the transaction ledger to help them market their work, or even to decide what to create next.
In insurance, blockchain enables application-based “microinsurance” policies that offer coverage on demand for specific purposes—increased medical insurance while playing football, or short-term car insurance while parked in a high-crime neighborhood—without an agent as go-between.
The financial sector, which includes insurance, may benefit most from blockchain technology, especially cryptocurrency. Cryptocurrency can be deposited and withdrawn immediately in even the most complex transactions such as international currency exchanges or complicated contractual agreements, all of which could, before blockchain, take hours, days, or even weeks to complete.
The technology’s impact stands to extend beyond banking to financial services, including trading, cross-border money transfers, and growth capital. Blockchain enabled peer-to-peer transactions may reduce or eliminate the need for wire services, investment bankers, crowdfunding sites, and even the stock exchange.
The Four Industrial Revolutions: Finance
1. Development of the banking system (mid-eighteenth century)
Humans may always have traded or bartered, but the earliest recorded instances occurred in 9000 BCE, with Neanderthals using cattle as currency.
Not until 6000 years later was the first monetary coin used: the Sumerian shekel dates to pre-3000 BCE.
The use of paper money began in China, printed by the Song dynasty in 990 CE. Lending and borrowing, as well, have occurred since ancient times, in cultures around the world. With the industrial revolution came the demand for loans of large sums with which to build and operate factories filled with expensive machinery as well as to pay employees, and capital for investors hoping to turn a profit.
2. Cross-border money wiring (1872)
Second-industrial-revolution technology included the telegraph, the first instantaneous, long-distance form of communication, pre-dating the telephone. The telegraph used Morse Code, a system of “dots” and “dashes” sent over a wire by making and breaking an electrical connection. These short and long “taps,” when deciphered in a codebook, formed
letters, which made up words.
In 1872, the US company Western Union began using the telegraph to send not just messages but also money. To “wire” funds, a customer paid a telegraph operator in one office, who “sent” them to an operator in another office, who would then pay the recipient. Revolutionary at the time, this service became essential to business: within five years of its launch, Western Union was wiring millions of dollars per year.
3. Banking 24/7 (mid-twentieth century): A new era in finance arrived with the universal credit card (Visa and MasterCard are examples) allowing purchases from a variety of businesses, especially when banks began issuing cards that could be used anywhere in the world.
In addition, automated teller machines (ATMs), which distributed cash on
demand, and Internet banking enabled consumers around-the-clock access to their financial accounts for the first time in history.
4. Blockchain (early twenty-first century): Invented in 2008 as the technology behind Bitcoin, blockchain-enabled instantaneous payments using a universal currency. Since then, it has been used for fast, inexpensive, direct transactions, including contracts, payments, loans, and cross-border money transfers.
How Finance Works Today
The financial system is often characterized as a slow-moving, inefficient beast delayed by massive amounts of redundant paperwork and rife with unnecessary costs—and reluctant to change.
One example is cross-border money transfers, which can take weeks to complete and require many steps.
When a US company needs to make a payment to a foreign person or company, it makes a request to its bank to send the funds. The bank may send the funds to a correspondent bank, also known as an intermediary bank, a third-party bank that coordinates international monetary transfers and transaction settlements, which sends the payment to a correspondent bank in the destination country, which then transfers the money to the destination company’s account at still another bank.
The transfer, in this case, requires four banks as well as originating and receiving businesses or individuals to participate, provide verification, and complete paperwork.
The transfer can take days or even weeks to complete, and the risk of fraud
and other economic crimes increases with each transaction. Bribery, corruption, fraud, theft, money laundering, and cybercrime touch all areas of the global financial system, resulting in losses of many millions of dollars
The Digital Revolution
Blockchain speeds the transfer of money: Bitcoins can be transferred in minutes, to anywhere, from anywhere, and at any time, and without the need for correspondent banks, wire transfer services, or other third parties to be involved.
Increasingly, blockchain technology is being used for non-Bitcoin purposes, as well, including:
- Smart contracts: Digital agreements that define rules and set penalties, just as a traditional contract does, but with “if–then” scenarios coded in so that rules are enforced automatically.
- Compliance: Banks and other large institutions must secure users’ account information against cybercrime and provide proof that the data is secure. With blockchain-based software, they can automatically create a record of who has gained access to information, and control who is allowed to see that data. These records can make security audits much easier.
- Stock and bond ownership: Digital “tokens” allow someone to buy or receive a real object digitally, and either store it, give it to someone else or exchange it for the item it represents—whether it be money, music, wine, or stocks.
- Stock trading: Blockchain-based platforms allow private companies to issue and trade shares directly, without an intermediary.
- Crowdfunding: Software using blockchain technology enables anyone to solicit and give crowdfunding donations without using a third-party service, and to write their own rules. For instance, one project allows donors to vote on how funds contributed to a project would be spent, with those who give the most having the most influence.
- Clearing and settlement: In the analog world, “T + 3” is the term used for the time needed to clear and settle a transaction: trade day (T) plus three days. With blockchain, the entire lifecycle of a trade—execution, clearing, and settlement— occurs at the trade stage. Trade is settlement, occurring more quickly and, without third-party involvement, more cheaply.
- Accounting and auditing: Blockchains are databases with context. Each record builds on the last, and all information about a transaction is visible, from its origins to the present moment. This information can be very helpful for accounting and audits.
- Reducing crime: Blockchain technology is virtually bulletproof against fraud. Entire networks of computers share—and can view—each transaction. Every change or addition not only requires a special code, or key, but it must be verified by a majority of participants in the network, making it much less likely that an unauthorized entity could make changes.
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