InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
OCTOBER 4 , 2017
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We turn to the hot topic of Cryptocurrencies in the next few issues of IntelDigest. We will divide the subject into two parts, distinguishing the “investable” segment of this new concept from the “speculative.”
Everyone has heard of Bitcoin by now, but many do not yet understand how Bitcoin works. Hopefully, we can clear up the matter somewhat. Today, we will discuss the underlying technology, known as Blockchain. This is a technology which has great and widespread promise for the future, which is why we refer to it as “investable.”
Many believe that the Blockchain technology could be the most important technological development since the invention of the Internet. Blockchain has the potential to change the manner of transmitting documents, the method of selling and recording real estate, registering the transfer of stocks and bonds, and tracking business inventory. In other words, Blockchain could be a “Game Changer” in many ways.
In the coming weeks, we’ll write about the various digital currencies, including Bitcoin, which are created through Blockchain technology; we will use the shorthand name, Cryptos, to refer to the currencies. This is truly the “Wild, Wild West” … investment in Cryptos is extremely speculative. However, those who have the stomach for taking a wild ride can make a good deal of money through speculation.
What is Blockchain?
Simply put, Blockchain is a form of “distributed ledger” system … a decentralized database which records each transaction. Records of transactions and payment details are spread across a massive public database. The process is transparent, and transactions are verifiable. There is no centralized database; rather, the records appear on thousands (or millions) of databases. As a result, no one can hack or change the records because they are “backed up” in multiple locations.
The Blockchain and Cryptocurrencies
A cryptocurrency (Crypto) is a digital currency which operates outside the control of any government or central bank. This means that a Crypto cannot be manipulated by central banks, such as our Federal Reserve or other central banks around the world.
Historically (at least, in modern history, since the development of banking systems), all financial transactions took place through an intermediary, such as a bank. The bank would verify the transaction, adding a certain level of trust.
Cryptocurrencies would completely revolutionize the traditional systems, cutting out the middleman entirely. Digital transactions are made peer to peer, without the middleman.
Blockchain is the backbone of all cryptocurrency transactions. Within the Blockchain, transaction records and payment details are spread across a massive public database open to all Crypto “Miners” in the network. “Miners” are people and organizations which operate powerful supercomputers, each competing to confirm and authenticate each transaction in the network.
A Miner is paid if its computer program validates the transaction first; in these early days of Cryptos, Miners have been paid primarily in Bitcoins. Verified transactions are added to the Blockchain database. Then, the next round of money transfers can be authenticated by Miners. This process is ongoing.
The process is transparent and immediately verifiable. The computer programs of the Miners confirm transactions and reset every 10 minutes. Each 10-minute group is called a block. Each proceeding block is also verified by the mining software and then linked to the last block … creating a chain.
As there is no centralized location where transactions occur, the process has the advantage of airtight security. Everyone involved in creating a unit of Crypto holds a copy of the Blockchain. Essentially, the Blockchain has copies in thousands of locations. A hacker could not change a record when it is reflected and “backed up” on multiple servers.
Ascension of Blockchain Technology
When Blockchain burst onto the scene just a few years ago, the immediate question was: Will this new technology upend traditional financial institutions, such as multinational banks, credit card and merchant payment networks, and money-transfer companies? The answer is: Yes, it has that potential. As a result, many of these “legacy” institutions are exploring ways to leverage the Blockchain.
They are attracted by the potential for lower processing costs and stronger security for a range of transactions, from equities trading and securities clearing/settlement procedures to cross-border payments.
According to a recent Morgan Stanley Research report, these initial efforts by the legacy institutions to test the viability of the Blockchain as a settlement and payment alternative constitute the first critical step toward adopting the technology, which will be followed by broader socialization within the industry, and regulatory scrutiny.
The Structure of the Blockchain
The value to financial institutions of the Blockchain technology is in its structure. The core benefit is the decentralized ledger technology, which logs transactions outside of existing centralized technological infrastructure. By creating a shared permanent record of every transaction between multiple parties, Blockchain creates an ever-expanding transaction record that is irrefutable in its accuracy and reliability.
Blockchain also has the potential to improve efficiency. By using the technology to streamline multiparty reconciliations during settlement and clearing, financial institutions could see lower costs and fewer failed transactions.
Drawn by these potential cost and capital efficiencies, interest among financial organizations has risen sharply.
According to Betsy Graseck, the Global Head of Banks and Diversified Finance Research at Morgan Stanley, “… several consortiums led by incumbents with high market share have emerged to test proof-of-concept Blockchain technologies, particularly in international payments and securities clearing and settlement.”
Significant Hurdles Remain
Even if these tests are successful, some obstacles remain, including the cost of development and deployment. The key question, according to Ms. Graseck at Morgan Stanley, is: “Will the benefits exceed the costs and risks of implementation, particularly relative to simpler alternatives, such as updating legacy infrastructure?”
Other concerns involve the sheer volume of the computer records, and interoperability between Blockchain protocols and legacy systems. The need for computing power, bandwidth, and storage will grow exponentially. And, programming interfaces will have to be developed or adapted to ensure that all of the various Blockchains can talk to each other
Next Week, in IntelDigest
Despite the obstacles, the Blockchain is the wave of the future. We will continue with the discussion of the Blockchain next week, then move on to Cryptocurrencies, which now number almost 1,000 and have attracted investments of up to $200 Billion!