Between the flashy Instagram celebrities who claim to have made millions with Bitcoins to hackers claiming to be Elon Musk luring in victims with free crypto giveaways, for most, blockchain is limited to crypto-currencies only. Now, it is quite normal given the excessive amount of time people are exposed to social media, but among these superficial feeds, the humongous potential of the technology in Business and Finance remains widely ignored to this very day.
So, what is the blockchain?
Let us imagine, you live in an imaginary farming town where everyone’s transactions are recorded by the town mayor. If you want to buy a cow, you, with the person you are buying from, have to go to this wise person, brief him on all the details of the transaction and he will write it down in his trusty old notebook. Now what if let’s say, he forgot to write, lost his notebook, or even worse, denies that you paid money? Can you justify your stand as the one responsible for verifying is stating against you? The person, you bought the cow from, can now sue you claiming with evidence that you didn’t pay for his property. And now you are in a heap of trouble.
It might seem a bit exaggerated but on a large scale, that’s how most businesses are running. The town represents the financial structure and the mayor represents the banks. If your company is transacting through the bank, it is recorded, executed, and verified by the bank only. So you could say that is a “centralised” system with banks at its centre.
Now, let us imagine our farming town differently. Instead of the mayor, there is a board of seven members who sit at a round table each with a notebook of their own. Each transaction briefed to them is recorded and verified simultaneously by all of them. All seven notebooks have a summary of your purchase. And now, even if one or two notebooks are lost or a member mistakes, it can be verified by others, and only the collective decision counts.
In this allegory, the town is still the financial structure but the seven members are each considered a “node”. A node is typically a computer or a server that is connected to the other nodes via a network or chain. This network architecture or chain is what we call the blockchain. Since the blockchain is centred on not one bank or computer but multiple nodes, the communication in a blockchain network is “decentralised” or “distributed”. The notebooks represent online ledgers maintained by the nodes that keep a reference to each transaction that has been performed in the blockchain network and can be accessed by all in the network, hence the term “open ledger”. Although the records in an open ledger are public, they are encrypted or represented by hash values thus the information, despite being openly available, is still secure.
But, how are the transactions verified?
- Proof of Work (PoW): Simply put, PoW is a competition among the node owners or miners in a blockchain to execute complex calculations which are required to perform any operation in the blockchain. The miner who cracks it first is rewarded with crypto-currencies such as Bitcoins.
PoW is very secure as the transactions are expressed in complex and encrypted problems, which are highly effort intensive to solve. However, the consensus process is quite resource-heavy, requiring powerful processing power. Now you might understand how miners were partly responsible for the GPU crisis!
- Proof of Stake (PoS): PoS was introduced to compensate for the limitation of PoW where instead of the one miner burning expensive GPUs to solve blockchain problems, stakes are distributed among nodes called “validators”. The validator with the highest stake is the one who gets to verify the transaction. It is less secure but doesn’t require powerful hardware.
How can blockchain benefit business and finance?
Now that you have a sense of what blockchain is and how it verifies trade, you might be wondering how these features can benefit traditional business and finance. To answer the question let us first consider what are the issues businesses and finance generally face in a centralised system.
First of all, centralised systems such as banks have to maintain a level of secrecy thus their operation is not transparent and it’s mostly about trusting the reputation. Second, data stored in a centralised system can be altered by third parties without a trace as once the source is altered, there is none else to verify. Next comes the dependency issue on centralised institutions where if the bank defaults, all clients are immediately affected. There is also a noticeable delay for transactions as they are verified by one party only, typically the bank. Overall, the system is also quite expensive as to maintain finance business institutions have to resort to middle-parties for various services. Now let us see how blockchain can mitigate such limitations.
- Transparency and immutability: As previously mentioned, transactions in the blockchain are included in an open ledger which is encrypted providing transparency for each transaction. Furthermore, these ledge entries are immutable, that is, once recorded, the data cannot be altered by third parties. Let’s consider that one node is corrupted and the data has been altered but it is not practical to simultaneously alter the thousands of nodes in the network that hold the same data. During verification, the corrupted node would be easily detected and excluded from the network. Thus there are low risks of data corruption.
- Enhanced security: The security in blockchain networks is the trait that makes it most useful. As mentioned earlier, all types of data in the blockchain are highly encrypted and the copies are distributed over all the devices connected to the network. Thus, first of all, it is very hard for hackers to decrypt sensitive data, and second, even if decrypted, altering one node data will do nothing as all other nodes can verify the corruption instantly and exclude the node compromised. The process is instant compared to the traditional centralised system where much damage is already done when the breach has been detected.
- Faster transaction: Let us go back to the first farming town in our allegory. If all the transactions are passed through the same person, there would be a huge queue of people waiting for long periods as it would be very time and effort intensive for one authority managing all those transactions. The same thing applies to banks.
Typically, a reputed bank may have thousands of clients simultaneously performing transactions, all of which have to be verified and processed by the bank. Thus this process is quite time intensive, especially for larger transactions. There are formalities, paper works, asset transfer, and other redundancies that further slow it down. In a blockchain, on the other hand, the transaction is instant, as first, there is not only one managing authority but thousands, and second, the record of the transaction is the transaction itself. So the moment you send your cryptocurrency or what money is in the domain of blockchain, you are done!
- Reduced cost: Bank fees, fees for paper works, hiring finance advocates and record keepers – there are just too many aspects to pay for in traditional finance. In a blockchain, on the other hand, the middle parties are hugely reduced, digital finance is all managed by wallets and all you pay for is a small price for the transaction known as “gas”.
- Finance automation: Your business finance can be easily automated by blockchain using “smart contracts”. These are programs written to harness the decentralised nature of blockchain to perform assigned tasks such as paying bills, transferring assets, and so on. Since there are records for every operation in the blockchain, these can be used as triggers to automate financial operations using smart contracts.
- Regulatory compliance: Because blockchain is open and auditable, it can help organisations in highly regulated sectors streamline regulatory compliance because regulators can get the essential information straight from the blockchain.