One of the terms synonymous with blockchain technology is bitcoin. Before delving into the aspects of cryptocurrencies and bitcoins we must be aware of the multiple applications of blockchain technology in the financial sphere and currency transactions. Finance and trade laws are one of the most heavily regulated areas in India. With the arrival of blockchain technology, the financial sector such as banking and trade has been severely disrupted resulting in the regulatory framework desperately trying to keep up with the exponential evolution of technology. ‘Multiple use cases of blockchain technology are getting explored across industries as everyone has started realizing the disruptive potential of this technology. Financial players are the first movers to capitalize on this technology even though it is still in a nascent stage.’[1] The need for blockchain technology in the ever-flourishing market of financial transactions is twofold: (i) Difficulty to monitor and evaluating asset ownership and its transfer in a trusted business network. (ii) Inefficient, expensive, vulnerable.[2]
Blockchain technology aims at disrupting and making the financial market and trade in general more efficient by three primary limbs of its functioning. Firstly, the decentralization nature of blockchain technology provides for the equal distribution of control amongst all the players in the transaction chain. This equates to the replacement of all intermediate regulators such as banks, RBI, Major departments of the Ministry of Finance, etc by the blockchain network. A substantial part of the functions of these intermediaries gets taken care of by the blockchain rendering their services to one of a rudimentary nature. Secondly, the use of the Digital signature on the blockchain facilitated by the public key and the private key hash encryption architecture ensures absolute accountability and identity security of the participants in the financial arena. Thirdly, the Data integrity that the blockchain network guarantees ensures that data stored on the blockchain can never be tampered with thereby resulting in an almost certain impossibility of financial frauds occurring in any manner whether resolutely or by accident.[3]
REASONS FOR THE INEVITABLE IMPACT OF BLOCKCHAIN ON THE FINANCIAL INDUSTRY
There are six primary reasons why blockchain technology will bring about a huge change in the way in which business across the world is done and transactions are being carried out. These six key reasons are[4]:
Attestation
Blockchain technology enables two parties who have no prior relationship between them and no reason to trust each other to enter into a financial transaction due to the level of security the blockchain provides. Verifying the identity of the parties and establishing the trust to conduct business used to be endowed on various intermediaries such as banks, brokers, etc. however with the advent of blockchain technology the underlying cryptographic mechanism provides this trust which enables and facilitates a more efficient system of business and financial transactions.
Cost
With the elimination of the middlemen: banks and brokers, blockchain technology seeks to reduce the costs of doing business to an unprecedented extent. There will be a huge drop in transaction costs once the peer-to-peer blockchain network is set up as this will do away with all the costs associated with running a bank including payment of employee salaries, physical resources, stock, etc. apart from a monetary reduction of costs, in due course of time the legal regulations of the financial sector also will reduce as the blockchain network will tend to regulate itself as described in the rule of code elaborated in chapter two of this dissertation.
Speed
At present, remittances in banks and other financial institutions take two to three days to settle and sometimes even longer. Stock trades take two to three days whereas bank loans may take up to twenty-three days to settle. In this contrast, the bitcoin network for example takes around ten minutes to clear and settle all transactions conducted in that period. Thus with the new age of technology, there will no longer be any delay in the transfer of funds between any two parties connected on the blockchain network irrespective of where they may be located provided they are all peers on the blockchain network.
Risk Management
The risk involved in the financial world today is huge. Despite stringent laws and regulations, there are situations wherein a person subjecting himself to the risk of the transaction will suffer losses. Blockchain technology seeks to deal with this in a manner that tends to render risk an impossibility. For example, if there is any error or discrepancy in the transaction by any one party, the transaction on the blockchain will automatically not be carried out and the funds due will be returned to the rightful owner. This system mitigates the settlement risk. Similarly, the counterparty risk is mitigated as the blockchain technology does not allow the counterparty to benefit from any transaction unless both sides of the deal are adhered to. Failing this the transaction will simply not occur or if started, will reverse itself on the network. Agency risk is another type of risk that blockchain technology will do away with as it eliminates the need for any third-party intermediaries such as managers who may act fraudulently in a transaction.
Value Innovation
The blockchain was initially created with the intent of facilitating the use of cryptocurrency. However with the success of the bitcoin revolution, there has been further development in this aspect and innovators are developing various supplemental variations such as sidechains[5], initial coin offerings, asset value transmission, etc. Thus apart from cryptocurrency, blockchain technology will impact the finance sector in a number of other related aspects as time progresses.
Open Source
Being an open-source technology, blockchain enables the users connected to the network to constantly innovate, improve and adapt the technology to suit the everyday need of the industry. This results in the regulation of the system being in the hands of the members of the system itself and not that of an external party like a bank or a state government for instance. This creates an unparalleled space of efficiency in terms of the system being able to keep up with the day-to-day demands of the financial world.
REGULATION OF BLOCKCHAIN TECHNOLOGY IN THE FINANCE SECTOR
At the outset, it is to be noted that with the constant development of technology the world over, it is not the technology per se that needs to be regulated but it is the use of such technology within the ambit of the law that needs to be regulated. As far as the blockchain is concerned, it is becoming more and more difficult due to the complexity and differences of different forms of distributed ledger systems related to cryptocurrencies, shared ledgers, smart contracts, etc.
In an ideal world, if there was a minimum level of regulation over blockchain technology, it would result in the maximum value-adding and efficiency advancement of financial services, thereby expanding accessibility and therefore financial inclusiveness. ‘In the USA and the EU, a smart regulatory hands-off approach has been adopted which to a large extent bodes well for future innovative contributions of blockchains in the financial services and related sectors and toward enhanced financial inclusiveness.’[6]
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[1] Shah Tejal & Jani Shailak, Applications of Blockchain Technology in Banking & Finance, Faculty of Management Studies, Parul University, Vadodara, (2018)
[2] Id.
[3] Crosby M, Nachiappan Pattanayak P, Verma S & Kalyanaraman V, Blockchain technology: Beyond bitcoin, APPL INNOV REV 2:6–19 (2016)
[4] Tapscott, D. & Tapscott, A., blockchain revolution: how the technology behind bitcoin and other cryptocurrencies is changing the world (New York, Penguin., 2018)
[5] Sidechains are blockchains that have different features and functions from the bitcoin blockchain but have leveraged bitcoin’s established network and hardware infrastructure without diminishing its security features.
[6] Peter Yeoh, Regulatory issues in blockchain technology, 25 JOURNAL OF FINANCIAL REGULATION AND COMPLIANCE 2, 196-208 (2017)