Iycee Charles de Gaulle Summary Abstract: on the concerns around privacy and

Abstract: on the concerns around privacy and

Abstract:

Financial services industry is currently the leader in experimenting
with the technology. Today’s digital age and hyper-connected environment
requires banks to re-imagine their business continuously. So let us consider
the emerging blockchain technology that underpins bitcoin and other
cryptocurrencies in revolutionizing the digital world bringing a new
perspective to security, resiliency and efficiency of systems. Bitcoin may have
attracted great hype but alongside there are many doubts rising on the
underlying technology, there may be some drawbacks but it is only when the
possibilities are explored in more detail that the true scale of possible
change can be appreciated.This paper deals with this technology’s characteristics
and its potential to solve various weaknesses in existing financial sector. In
this context it is also equally important to stress on the concerns around  privacy and scalability issues surrounding the
technology, regarding which there is intensive research going on by different
companies.

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Key words: Block chain technology, security, privacy and
scalability.

 

 

 

 

 

 

 

 

INTRODUCTION:

Blockchain was first conceptualized by Satoshi Nakamoto in 2008,
followed by implementation in 2009 with the Bitcoin.Block chain is an open
distributed ledger that can record transactions between two parties efficiently
and in a verifiable and permanent way. For use as a distributed ledger, a
blockchain is typically managed by a peer-to-peer network
collectively adhering to a protocol for validating new blocks. Once recorded,
the data in any given block cannot be altered retroactively without the
alteration of all subsequent blocks, which requires collusion of the network
majority.

How it works?

 A blockchain system is
composed by two types of entities:

• Participants, who perform transactions.

• A peer-to-peer network of nodes, who validate transactions and participate
in the consensus process.

To understand where the name “blockchain” comes from, it is
necessary to visualize how validated transactions are recorded. Transactions
are grouped into blocks that are submitted to a network of validating nodes.
Every time a block is validated, it is broadcasted to the network and added on
top of the blockchain. Since every block contains a timestamp and a reference
to the previous block, the blockchain is fundamentally a time stamping system
represented by the chain of all blocks, starting from the first block.

The peer-to-peer network guarantees transactional security
throughout the consensus process. Every time a new block is validated, each
node verifies the block and updates its local copy of the database, adding a
new block to the chain. Nodes follow the protocol that is embedded in the
blockchain software, which determines a single state of the database even if
there is no single authoritative copy of it. While in a centralized
architecture there is a single authoritative database operated by a single
entity, in the blockchain every node has a local synchronized copy.

Once a block is validated, it is infeasible2 to change the
blockchain without any tampering evidence. Immutability property is achieved
throughout the combination of public-key cryptography and digital signatures.

• A private key, which the user must not reveal, since it is used to
sign transactions and to unlock cryptocurrency funds.

• A public key, which corresponds to the address of the associated
account. It is used from participant to identify the receiver of a transaction.

Also it uses cryptographic hash functions and consensus mechanism to
guarantee transaction security and ledger integrity.

Cryptographic hash function

Block chain is tamper evident ledger, to achieve this feature it
uses cryptographic hash functions, this function maps inputs  with a fixed size hash tags. Any minor
differences in the input will exhibit major difference in the hash tag, thus
creating tamper evident structures.

 

Consensus mechanism

Bitcoin follows a standard majority consensus, where each miner may
choose which block in the chain to append to, and eventually the longest chain
sustains. It is widely believed that as long as honest parties control majority
of the computing power, the longest chain will grow and outperform other forks.
Also each node is required to perform a certain amount of computational work in
order to create a valid block, controlling a large part of the network for a
malicious actor would be costly, difficult and would probably lap the gained
advantage.

Classification of blockchain ledgers

Blockchain architecture may be classified broadly into three
categories

Public blockchains:

A public blockchain is a blockchain that allows anyone in the world
to read, send and participate in the consensus process – the process for
determining what blocks get added to the chain and what the current state is.
As a substitute for centralized or quasi-centralized trust, public blockchains
are secured by cryptoeconomics. These blockchains are generally considered to
be “fully decentralized” and permissionless network.

Private blockchains:

A private blockchain requires permission from either network starter
or authorised party involved. Depending on the usage, existing participants may
decide new entrants, or a consortium and regulatory authority could make
decisions instead. But once entrant has joined the network, they maintain the
blockchain in decentralized manner.

Consortium blockchains:  

Consortium blockchain tries to remove the sole autonomy in private
blockchain. So Instaed of having one in charge, we have a group involved, which
come together and make decisions  for the
best benefit of whole network. Such groups are called consortiums. consider a
Central Bank which allows only specified, trusted Banks to provide the
necessary calculations and thus verify transactions before adding them to the
block. Thus making it partially decentralised.

 

Applications of blockchain in banking and finance:

A Permissioned blockchain technology is often far more appealing to
enterprise and financial services. It has potential to address certain
limitations of current process by simplifying the traditional design of the
industry.

Know your customer process:

According to a Thomson
Reuters Survey , financial institutions spend on average $60 million
on KYC and customer due diligence while some banks spend up to $500 million per
year. Thus by developing KYC processes on Blockchain technology, banks can
reduce operational costs and also can increase efficiency of compliance process
as when one bank verifies a new client , it can be accessed by other banks and
accredited organizations , without the need for the KYC process to be started
all over again by each individual party.

A report given by investment bank Goldman Sachs states that a 10
percent headcount reduction would be achieved by introducing blockchain
technology in KYC procedures, which would result in annual saving of $160
million.

 

Reduction of fraud

One of the primary issues that the banking sector is facing today is
the increase in fraud and cyber-attacks.

Currently, most of banking systems are built on a centralized
database, which makes them more susceptible to cyber-attacks as all information
is stored locally in one place. Also, many banking systems are outdated,
therefore making it more vulnerable to new forms of cyber-attacks.

By building new banking systems on top of blockchain technology, the
chance for data theft and fraud can be curtailed substantially as the
distributed ledger technology secures the records by encrypting and verifying every
single bit of data in a transaction. Therefore if any data breach or fraudulent
activity occur, it will be intimated to all parties who have permission to
access the transaction data on the ledger.

Payment clearing system: distributed clearing mechanism

Interbank payments often involve intermediary clearing firms, which is
following a complicated process of bookkeeping, balance reconciliation, transaction
reconciliation, payment initiation, etc. Thus making the process lengthy and
costly. Lets consider cross-boarder payments, in these payments as the clearing
procedures for each country is different, a remittance requires nearly
3 days to arrive. This demonstrates the low efficiency of the process
underneath.

Block chain implements point to point payments, thus eliminating the
intermediary link of third-party financial institutions, which will greatly
improve service efficiency and reduce the transaction costs of banks. This will
also enable  to create rapid and
convenient payment clearing services for cross-border commercial activities.
McKinsey has made an estimation which shows that the cost of each transaction
in Cross-Border business can be greatly reduced due to the application of
blockchain, the details are shown in Fig. 3.

Application of Blockchain in Cross-Border Payments. Source: McKinsey
(Report
by McKinsey: Blockchain—Disrupting the Rules of the Banking
Industry,2016-05.)

 

 

 

 

Capital market:

Capital markets have a complex structure of interconnected banks and
intermediaries. Each transaction involves multiple intermediaries maintaining
different database, with unnecessary reconciliation errors , duplication of
data and delay of settlements.Blockchain has the potential to address these
challenges by eliminating multiple intermediaries and reducing settlement time.

Integrating documentation frameworks within an enterprise:

As the Transactions in the capital market involve transportation of
documents between parties, cryptographic system in blockchain helps secure
transpotation . here all documents are stored in a ledger and are keyed to
concerned key party or signatories involved. Also only certified parties can
add the documents through a common consensus avoiding duplication of documents.

Faster clearing and settlement:

As there is swift record of submission and confirmation on a
blockchain , settlement time can be drastically reduced. This further improves
liquidity And promote better capoital usage . In present traditional system
payment setlements happen only when banks are open. But through blockchain
where with one accounting for ownership of money and other accounting for
ownership of securities, a settlement at any time in a matter of seconds with
legal finality and certainity.

 

 

 

 

Trade finance:

Trade finance is one such area which is full of inefficiencies and
open to fraud. Letter of credit and bill of lading are the traditional methods
which are managing the trade of goods and services domestically and across
boarders, which involve large volumes of paper based documentation taking
several weeks to process, involving high cost and making data vulnerable to
manipulation and errors. This inefficient trade practice making it difficult
for companies to access financing and limiting their ability to trade across
boarders and grow revenues.

Blockchain technology can solve these issues in trade finance to a
greater extent.

It creates a feasible decentralised distributed ledger , which substitutes
the single master database, making  it
more simplified, secure and reliable. It also provides unique non forgeable
identities for assets along with an inalienable record of ownership, this
ability of transparency and consensus will help reducing current documentary fraud.
Smart contracts have the potential as the self executing contracts triggered by
exchange of digital data, thus replacing the traditional letter of credit. Thus
allows real time settlement for transactions, reduces counterparty risks and
transaction costs.

To bring out the full potential of block chain, industry wide
collaboration platforms like R3 consortium plays a major role.one company
working with this consortium and trying to enter trade finance is TradeIX. This
company is rewriting the traditional trade finance  ecosystem by establishing
a secure  and connected infrastructure
for corporates, financial institutions, and B2B networks by leveraging
blockchain technology.

 

Limitations:

Scalability:

There are two bottlenecks which are hindering the scalability of
blockchain; latency and throughput.

Latency is the time taken for processing  a transaction. Throughput is the number of
transactions that can be processed in a particular amount of time. In
bitcoin whenever transaction is received it requires confirmation from other
nodes that it is valid. This involves hashing calculations that serve as the
proof of work. Thus new block is created, which is the way of verifying a
transaction.

In bitcoin it takes 10 minutes to confirm transactions, and can
achieve 7 transactions/sec maximum throughput, whereas mainstream payment
processor such as visa processes 2000 per sec on an average. This problem is
because of the limited block size. In order to become a real-world payment
alternative, blockchain must support at least the transaction volume of credit
cards. When we look at larger scale capital market use, it is clear that there
is a need for  further innovation around
performance and scalability.

Privacy:

Blockchain’s potential impact on the confidentiality and information
transfer about record changes may also be of concern to some users. For
example, in finance, the acquisition and data analysis are key to a firm’s
competitive advantage. Some firms may not be ready to participate in a shared
database if there is leakage of information that could cost the firm’s
business.

Regulatory and legal compliance

At the moment there is a lot of uncertainty towards the use of
blockchain technology. For the blockchain based solutions to work, there is a need
to ensure that  they comply with all
regulatory and legal compliances. Without any legal cover, it would be risky
for businesses to adopt these technologies because their investment will go
waste if the relevant authorities do not consider it permissible.

 Thus there is a need for
mechanisms or solutions to handle enforcement, dispute resolution, and
accountability in this technology.

 

 

 

 

 

Conclusion:

 

As a  part of the natural
cycle of evolution. Blockchain, as a new technology that has real potential,
has to go through the Gartner cycle. However, the full potential of blockchain
technology will only be realized through cooperation among market participants,
regulators and technologists, and this may take some time.