While investors and asset managers have mixed opinions on the future of cryptocurrencies, many agree that blockchain–the technology that enables crypto trading–holds the potential to transform many different industries.
Blockchain technology is the infrastructure that makes trading Bitcoin and thousands of other cryptocurrencies possible. Invented in 2009 by a person or group known as Satoshi Nakamoto, a blockchain is one example of what’s known as distributed ledger technology (DLT).
Distributed ledgers keep records of transactions spread across different servers in multiple locations. Blockchains are special types of distributed ledgers that are immutable (they can’t be changed) and decentralized (they’re outside the control of a single entity).
Understanding Blockchain Basics
Blockchain technology processes transactions into groups referred to as “blocks.” Each new block gets attached to the block that came before it, creating an ever-growing chain of blocks. This is where the term “blockchain” comes from. Altering the data inside any single block would require changing the entire chain, something which requires massive amounts of computing power and is almost impossible in most cases.
However, the data held in blocks can take many forms, not just financial transactions. The ability to create an immutable, transparent, decentralized ledger of data creates many new possibilities. In addition to altcoins, several other industries outside of cryptocurrency are looking at different blockchain applications, including Fintech.
Blockchain Applications in Fintech
There are myriad ways that financial services can make use of blockchain technology. Most of them currently exist in a proof-of-concept or pilot phase, meaning their real-world applications have yet to be consistently utilized or widely adopted.
Payment systems represent the most tried-and-true use case for blockchain in finance, since that’s essentially how crypto trading works. Sending money across national borders using the traditional financial system takes a long time, and can get costly as each intermediary that facilitates the transaction receives a fee. Blockchain has the potential to make this process faster and more affordable by enabling things like:
• Fast and secure cross border payments
• Multiple forms of payment – cryptocurrency, stablecoin cryptocurrency, etc.
• Reduced fraud risk through digital Know Your Customer (KYC) and Anti-Money Laundering (AML) data
• Smart contracts, digital agreements between two parties that get stored within the blockchain.
Blockchain could allow insurers to more efficiently handle claims. IBM reports that it is already using blockchain technology to help clients automate underwriting, settle claims, and reduce fraud.
When it comes to asset management, blockchain financial services can help real estate funds, private equity firms, venture capital firms, and similar institutions. These groups often find themselves to remain compliant with changing regulations and improve risk management. Blockchain security could also offer an additional layer of protection for their assets.
Blockchain improve efficiency in asset management through:
• Tokenization of securities, leading to greater liquidity and market access
• Customizable privacy settings for confidential transactions
• Reduced human errors in shareholder voting
• Improved governance with greater transparency for investors
• Automation of other tasks
Keeping up with the pace of regulatory change can be challenging for some financial institutions. That’s especially true when an organization conducts business across national borders and exposes itself to regulatory frameworks in multiple jurisdictions. Blockchain can help in ways such as:
• Programming digital assets with specific governance attributes
• Eliminating human errors that occur in manual processes
• Improving network governance
Potential Drawbacks of Blockchain in Finance
As you can see, there are a variety of ways that fintech and blockchain could improve many cumbersome tasks that people and organizations deal with today. The main benefits have to do with increases in speed, automation of complex processes, and “trustless” processes, meaning a central entity doesn’t have to be trusted with information or transactions.
There are also a few potential drawbacks, though. They mostly have to do with the impracticality of creating and maintaining an independent, decentralized blockchain.
Decentralization democratizes blockchain by making it resistant to central authority and makes things more secure by eliminating any single point of failure. But when a single organization creates its own blockchain for specific purposes, they might be the only ones with an ongoing incentive to maintain it. This could lead to the nodes becoming centralized, somewhat defeating the purpose of having a blockchain in the first place.
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With the Bitcoin blockchain, users trust the transaction data because Bitcoins are “born” on that blockchain. From the moment Bitcoin is mined into existence, everyone can see where coins go and what wallets they’re in. However, most of the potential use cases for blockchain finance involve assets that were not born on-chain (insurance claims, securities, loans, titles, etc.). For this reason, it’s possible that the data being put onto a blockchain in this manner could contain mistakes or inaccuracies.
The blockchain requires massive computing power, which makes it an inefficient industry from an energy standpoint.
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Creating a blockchain in finance, while appealing in principle, might be hard to do in practice while still preserving the unique features that make a genuine blockchain desirable. Still, the technology holds significant promise for improving the way that many financial transactions occur.
Regardless of your thoughts on the blockchain, a great way to get started building a portfolio including cryptocurrency is by opening an account on the SoFi Invest brokerage platform. Using the platform, investors can buy cryptocurrency online, including Bitcoin, Litecoin, Ethereum and others, right from their SoFi app.
Photo credit: iStock/Eoneren
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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.