Forget Bitcoin, but Remember Blockchain?

Ever since bitcoin came on the scene in 2009, evangelists have proclaimed that the end of fiat currency is nigh. A so-called cryptocurrency, bitcoin uses complex encryption and an ingenious governed incentive structure to regulate the supply of bearer tokens and police the authenticity of transactions of those tokens. There is no central bank, no national treasury, that governs bitcoin. Transactions are irreversible, ownership is untraceable, and mainstream uses abound. In 2016, you could use bitcoin to buy a Dell computer or plane tickets on airBaltic, donate to a US presidential candidate, or load up a special Visa debit card to spend virtually anywhere.

The Complex and Expensive World of Bitcoin

Yet for all the hype, European Tech analysts from Credit Suisse's Global Markets Research department say bitcoin is not the end of cash, debit cards, and digital payment systems such as PayPal. Cryptocurrency networks are relatively slow, with confirmation for Bitcoin transactions taking anywhere from 10 to 40 minutes.

What's more, maintaining the integrity of the network requires miners – the users who actually run bitcoin software and maintain the ledger, as opposed to those who use third-party wallets and exchanges to participate in the cryptocurrency – to invest in expensive hardware and consume fantastic amounts of electricity. Indeed, while the direct costs to those taking part in transactions have averaged just 0.013 percent of daily transaction volume over the last 12 months, the costs to the miners who actually run bitcoin software and maintain the ledger are 1.3 percent of daily transaction value. Still, miners have a powerful incentive to maintain the network: Doing so allows them to collect brand-new bitcoins. These new issuances have disguised the rising cost of maintaining the ledger for some time now, but that won't be true forever. The number of bitcoins that miners collect for every new block they add to the chain is cut in half roughly every four years. Eventually, the value of new bitcoins won't be worth the cost of running bitcoin software, and casual users of bitcoin will have to pay higher transaction fees to incentivize miners. 

Easier, Faster and Cheaper with a Blockchain Database

While the bitcoin network itself is virtually unhackable, third-party wallets and exchanges are vulnerable. Finally, the network is difficult to scale, as the system can only process three transactions per second, and subject to both legal and regulatory risk.

Blockchain, the "cryptographically secure system of messaging and recording in a shared database" that makes it possible to transact value without a third party, is the more powerful potential disruptor. When one institution or company controls a database, it's easier for bad actors inside or outside the institution to manipulate the information on it than when records are distributed across multiple stakeholders who must achieve consensus to update the ledger. What's more, having a single blockchain database to which all users have access eliminates the need for a central counterparty and for maintaining multiple individual databases, which can make transactions and record-keeping easier, faster, and cheaper.

Blockchain – the New Kid on the Block

The most obvious potential use for blockchain technology is the one that already exists – payment systems. While Credit Suisse doesn't see blockchain as a threat to Visa and MasterCard – the major card networks have built up trusted brand names, enormous scale, and fast processing speeds that would be difficult for blockchain applications to match – the Bank believes interbank payment systems are ripe for disruption. Interbank payment systems such as SWIFT are old, inflexible, slow, and increasingly prone to cyberattacks at a time when banks are under tremendous pressure to cut costs and protect customer data from hackers, which blockchain could achieve.

Spending and Saving

Banks spend 14 percent of the GDP they generate on information technology, a figure blockchain could reduce. Individual banks maintain numerous different ledgers that are costly and complicated to update, and there is a great deal of duplication among bank ledgers, too. When one bank owes the other money, each one keeps separate records of that debt. One shared ledger across and among banks would significantly reduce IT and compliance costs, as it would be easier to trace asset ownership to comply with anti-money laundering, anti-terrorism, and know-your-customer regulations. Shared ledgers would also give bankers more visibility across divisions, potentially helping to identify customers for specific products. Goldman Sachs, JPMorgan Chase, Santander, and many more are all investing in blockchain research and applications.

Stock Exchange Benefits

Blockchain could also accelerate the ponderous process that occurs after an order is placed on the stock market. Though stock orders are placed and filled in nanoseconds, trades take several days to settle. The transfer of stock assets is already becoming increasingly digitized, and the European Union even plans to eliminate physical stock certificates by 2025. The next logical step is to digitize and combine the individual ledgers that brokers, exchanges, clearinghouses, registrars, central securities depositories, and custodians keep to make reconciling trades cheaper, faster, and, for clearinghouses that hold assets while waiting for trades to settle, less risky. Humans won't be completely extraneous: Credit Suisse believes the financial system will still need brokers or exchanges to reverse accidental trade orders, registrars to match online blockchain identities with real-life traders, and central counterparties to net trades – that is, reconcile the net effect of market moves when institutions trade with one another multiple times over a three-day period. The Bank also believes the price discovery mechanism that exchanges provide would still be necessary in a blockchain world.

Lower trading costs could result in higher trading volumes, a potential boon for exchanges with significant cash trading and derivatives businesses such as BME, Deutsche Borse, and Euronext. As for other exchanges, NASDAQ has implemented blockchain technology to complete and record private-market transactions, which have been historically kept in manually updated, error-prone spreadsheets, as well as a blockchain-based proxy-voting tool for shareholders in Estonian companies. The company sees additional efficiency opportunities in post-trade operations, private placements and IPOs. Meanwhile, the vertically integrated Australian Securities Exchange (ASX), which has until recently had a monopoly in clearing and settling trades, is also experimenting with distributed ledgers. It's something of a risk: By settling trades faster, the exchange could justify higher prices for its services, but if blockchain eliminates the need for clearing services, up to 7 percent of the company's revenue could disappear.

Keeping Piracy at Bay

Reducing the costly problem of piracy would be a significant boon to media companies, and blockchain could help. Blockchain systems could create "a world in which all content and its metadata (information identifying those with legitimate revenue claims…) is transparently, accurately and immutably stored," making it harder to pirate. Reducing piracy worldwide could add as much as $6.1 billion (40 percent) to incremental revenues for global music companies, Credit Suisse estimates. A blockchain system could also be configured to automatically distribute revenue to each party with rights to it, such as the songwriters, labels, artists, and licensees who own pieces of a single song.

Weapon against Bureaucracy

Finally, blockchain might even slash through government red tape. The British Government Office for Science said in a recent paper that distributed ledgers could one day be used to collect taxes, pay out government benefits, issue passports and driver's licenses, and create a single database of government identifications. "The implications of this, if ever implemented, could be profound in terms of the eradication of bureaucracy and the acceleration of process speeds," Credit Suisse analysts write. That would be good news for the consultants and business services companies that would set up the new systems, but ultimately begs the question of whether their services would be needed in the future.