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What financial advisors and banks need to know about Bitcoin and Blockchain
Advisors and banks have all heard a lot about Bitcoin. To the untrained eye, Bitcoin is a currency that represents an investment vehicle. But what if I told you that Bitcoin’s biggest impact will be to change all financial transactions from simply buying stocks to financial derivative trades?
To clarify, Bitcoin will not change those things – the technology behind Bitcoin (Blockchain) will drive this disruption. Blockchain is a disruption play on transactions. Our financial system is built upon the ability to make transactions with our assets. Disrupting one of America’s largest industries can have monumental impacts for our whole economy.
How does Blockchain technology work?
Blockchain is a decentralized public ledger of transactions by which a record of who owns what can be derived by everyone.
For example, say that Alice wants to pay Bob in Bitcoins for his apples. Bob agrees to being paid five Bitcoins for his apples, so Alice opens her phone and creates a transaction to Bob for five of her Bitcoins. This transaction is sent out to everyone who passively use the public ledger to validate that Alice owns the Bitcoins she is using to pay Bob. If acceptable, the transaction moves to the confirmation stage.
In the confirmation stage, participants – which we will call miners – work on confirming a block of the most recent transactions by solving complex mathematical calculations based upon the answer to the previous block of transactions.
Once the computation is solved, the winner adds the new block of transactions to the current ledger and sends the ledger out to everyone on the network. The first miner to solve the block correctly receives a prize of 25 Bitcoins. Solving the block completes the confirmation of all of the transactions inside the solved block, thus Bob receives Alice’s Bitcoins and is able to spend them.
Blockchain is powerful because it creates a consensual and fixed record of transactions. Blockchain is a consensual record system because at any given moment every participant has the same up-to-date version of the ledger. Therefore, there is one singular record of the truth for all participants. Blockchain creates a fixed record system because of the use of miners.
If a miner wanted to alter a transaction in a previous block (e.g. to give himself more money), altering that transaction will change the complex computation answers to all the subsequent blocks following the altered block because each answer for the block is dependent upon the previous blocks answer. Meaning the miner trying to alter the transaction must solve multiple blocks up to the most current block before all other miners are only working to solve only the most current block.
Use case: stock market trading
Blockchain can provide trades in the stock market with the same benefits as all other transactions, a consensual and fixed record. However, the use case for Blockchain in trading only starts there, it can even go into the post-trade process of clearing and settlement.
Clearinghouses are an important part of our current financial system because they assume the risk of a transaction failing during the trading process. The assumed risk is that the buyer does not have enough money for the payment and that seller does not have the assets. Blockchain technology solves this problem because everyone can look at the ledger and confirm the buyer has the funds and the seller owns the assets in question.
Marc Andreesen, co-founder of the venture capital firm Andreessen Horowitz, states, “Bitcoin gives us, for the first time, a way for one internet user to transfer a unique piece of digital property to another internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer.” Blockchain/Bitcoin empowers the internet to be our primary method to transact anything and everything, from gift cards to financial derivatives.
Also check out this brief clip on how trusts and inheritance will be changed with Blockchain and programming.
Application to financial advisors
Financial advisors’ jobs will not change with the implementation of Blockchain technology. Blockchain technology will change the backend operations of many processes. However, advisors will still see benefits from the move to Blockchain technology.
According to The Fintech 2.0 Paper: rebooting financial services, “Our analysis suggests that [Blockchain] could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.” There will certainly see an overall reduction in the cost of banking with the introduction of Blockchain. This will result in a lower cost of business, allowing advisors to reexamine fee structures.
While these changes are not coming overnight, the future is coming. Many major banks are already looking into the potential of Bitcoin, including UBS, Barclays, and Goldman Sachs. Current projections have Blockchain technology being implemented in three to five years.
Major economic change brings about opportunity for people to benefit from the new wave of technology. The next time you sit down to look at your business plan for the next five years, I encourage you to ask yourself how will you work to benefit from new financial technologies to drive client engagement?