Many of us have only heard of the blockchain in the context of bitcoin. But it’s far more than that- bigger, and with a reach that may soon touch your trading in positive ways.
Every transaction needs authentication, whether it’s for money, or for proof of some other kind. At its most fundamental level, let’s say you go to a yard sale. You see an old lamp and decide to buy it. But you want to be reasonably sure you’re buying it from the person who actually owns it, right? Your authentication for this comes from the fact that the person running the yard sale appears to live there; so they probably own it. You offer them five bucks. They want to be sure you actually have ownership of that five bucks and haven’t already spent it on something else someplace else, and this is satisfied by the fact that they see it in your hand. The transaction is thereby authenticated and you walk away with your lamp.
Now let’s get more complicated. You’re buying $5000 of AAPL stock online. First, you need a broker. In a first authentication step, the broker checks your account to be sure you have the money. You do. The broker then places a bid to buy your AAPL shares and gets them. In a further authentication step, a clearinghouse ultimately verifies that the seller of those shares (a market maker) had them to sell in the first place and, in a few days, reassigns ownership of the shares to you in your street name (your broker’s name). When you finally sell the shares, the process works in reverse. In this transaction, there have been three intermediaries: the broker, market maker, and clearinghouse. And while we’re at it, we may as well include as intermediary the bank you used to fund your account. So that’s four toll-collectors on your money on its journey to getting you what you want.
Before we run that same transaction through a blockchain concept for comparison, we need a simplified description of what a blockchain is and how it works.
Simply, a blockchain is a timestamped continuous transactional record stored on multiple servers which keep updating each other as each node receives a new transaction. It’s public and therefore transparent to anybody who looks (they only see “you” as an encrypted string of code, not your name, unless you want them to). Its multiplicity of servers and their continuous mutual updates make it all but impossible- or at least highly unprofitable- for anyone to hack into it and commit fraud.
Let’s expand on that last point because it’s so important. Complete updating of a large blockchain network might take less than 15 seconds, worldwide. Each server node has a complete copy of all transactions. Before any transaction is authenticated, hundreds, or even thousands, of nodes must reach a consensus that the records underlying the transactions are all TRUE. So it becomes virtually impossible for someone to spend the same money twice. It also becomes virtually impossible for someone to pretend to be you in order to steal your money, since your encryption key is linked to your PC or mobile phone. Anyone attempting such theft- even assuming they could fake being you somehow- is still faced with the daunting task of accomplishing the fakeout, within 15 seconds, across hundreds or thousands of nodes, each of which may have a different set of authentication protocols. Not a profitable criminal enterprise.
Now let’s again run your AAPL transaction. You decide to buy $5000 of AAPL stock. You go out to Nasdaq (Nasdaq: NDAQ), type in “AAPL”, “Buy to open”, “Number of shares”, click “Confirm”, and the blockchain authenticates that you have the $5000 to do it and that someone else has the shares to sell. And that’s it: the blockchain record will show that you own those shares. When you’re ready to sell them, the blockchain will allow an authenticated buyer to take them off your hands. In the extreme (a long way off), the blockchain could even eliminate Nasdaq and all other exchanges.
Bottom line: the blockchain has eliminated at least three toll-collectors on your money- the broker, the market maker, and the clearing facility. There are even tiny blockchain add-ons that will watch markets and execute a trade based on a simple algorithm that you create.
And there’s another trading benefit to blockchain use. NYSE and Nasdaq recently eliminated the use of stoplosses, billing the move as a protection for retail traders from extreme volatility and stophunting. High-frequency trading programs (HFTs) do exploit stoplosses if they can see them. If you have the right broker, you can still set an internal stoploss, but even that’s vulnerable, since a crooked employee could routinely and secretly transmit that data to a point outside the office. By eliminating the broker and using blockchain technology, you eliminate that risk.
Blockchain is already reality
The May 2016 edition of Modern Trader (formerly Futures Magazine) noted on p. 28, in a comment from QBEATS‘ Joel Kandy, “Blockchain and Bitcoin will be the biggest things that the financial services community will adopt [in 2016]. Nasdaq is partnering with a company called Chain and plans to go live with a beta by the end of the year.”
In fact, by then Nasdaq had already done a minor system test using its Nasdaq Linq blockchain ledger technology to record a private securities transaction. The client was Chain.com, a privately-held company who used the Linq system to transfer shares to a private investor. Even more aggresively, on February 12, 2016, Nasdaq and the Republic of Estonia collaborated to permit shareholders on Nasdaq’s Tallinn Stock Exchange to vote in shareholder meetings via a blockchain-based service. In a related interview with World Federation of Exchanges, Nasdaq president Hans-Ole Jochumsen responded to the question of wider blockchain applicability:
“This still needs to be proven… We need to be sure… that this technology can handle large volumes in a secure manner. If and when we can prove this, blockchain will indeed become a disruptive force throughout the industry.”
Don’t get too giddy- just yet
Doubtless, the toll-collectors will not go quietly into the night. The fight may well be spectacular. But, what these siphoners of your wealth are up against is, in a sense, their own money. Think about it: brokers and market makers have a vested interest in getting rid of clearinghouses; in turn, brokers would like to see the market makers go bye-bye and vice-versa. And, of course, the rest of us would love to see them all get the boot.
Government’s role in this will be pivotal. There are concerns- of questionable legitimacy- that blockchains will hinder law enforcement in tracing bad money, or open the door to massive fraud. Etcetera, etcetera. Well, first off, the blockchain can very precisely track bad money, far better than the existing financial system, since the blockchain is specifically designed to authenticate parties and assets. This quality likewise severely limits opportunity for fraud because of the near impossibility of modifying a blockchain record, while present banking systems are notoriously sketchy in matters of security.
But government is an inherently political animal, so we should all expect a less than optimal outcome for the time being.
Other blockchain uses
Beyond the financial world, it’s easy to envision other blockchain applications, some of which could put a lot of people out of work.
You go to the DMV to register your vehicle. They keep a hardcopy and digital record of your ownership. Both of these data storage methods are vulnerable: paper can be burned or lost; existing digital systems can be hacked and compromised. Wouldn’t a blockchain registry be better? But then, just think of all those employees and bureaucrats who’d be blockchained out of a job.
Did you just write the novel of the century? The blockchain could store it, with a timestamp. Exit the copyright office, with all of its fees and employees. A patent would be a different matter, since patent reviews really do require human intermediation.
Wrote some special computer code, did some unique research, or made some really cool artwork, but not interested in copyright or patent? Still, you want credit as being the original author or researcher. Blockchain, timestamp, done. Or maybe you want to sell versions of the work- that’s still okay. There are tiny programs you can insert into your block that will only release a copy under certain conditions, i.e., only if someone pays for it. But do you really want to put PayPal out of business?
We’re still a long way from widespread blockchain implementation, but it’s coming on fast.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of FinancialPress.com. Readers should not consider statements made by the author as formal recommendations to buy, sell or hold any financial instruments and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: www.financialpress.com/legal-disclaimer/.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of FinancialPress.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://financialpress.com/legal-disclaimer/.