Imagine a financial system that is far more efficient than the one we have today. One that is less expensive to run and therefore less costly to use, yet at the same time more robust, easier to control and far more difficult to abuse. Imagine a financial system that allows individuals to take more control over their financial transactions, while offering them increased privacy and protection of their identities, and that gives businesses the means to drastically simplify and reduce the cost of many of their financial and related processes. Finally, imagine a financial system that can be far more easily monitored and controlled by regulators – allowing them to be more efficient and to nip future financial crises in the bud.
A revolutionary new technology, the blockchain, has arisen that is allowing banks like ours to imagine rebuilding our financial system to do many of these things. And while it may not be possible to fully reach the utopia sketched above, at UBS we believe this technology will be truly transformative. Along with our peers we have been studying and experimenting with its possibilities. The potential is indeed intriguing.
The trust engine
The blockchain is a breakthrough in computer technology that allows parties to carry out financial (and other) transactions directly between themselves without the use of a trusted intermediary. In essence, it is a way for people to share reliable and self-updating lists, ones that cannot be tampered with and that are available to all to inspect.
If this doesn’t sound exciting on the face of it, consider that one of the fundamental functions of banks is to keep just such lists – the records of our wealth and financial dealings. Thanks to reliable and discreet record-keeping in the form of the millions upon millions of databases in the thousands upon thousands of financial institutions around the world, we think the financial system we have built does a pretty good job of helping people safeguard and use their money. But no one would deny that this form of list-keeping is also immensely complex, often redundant, and very expensive.
The blockchain offers an elegant, open source, decentralized and radically simplified means of doing the same thing. That’s big news. It could lead to radically different and improved paradigms for our financial system and for those who use it.
Let me give a few examples: Since the blockchain allows direct transactions that are immediate and irrevocable, we could introduce real-time settlement – something the industry has dreamt of for a long time. This could go a long way to eliminating counterparty risk and would free up a great deal of capital while dramatically reducing transaction costs.
By adding full programming capabilities to blockchains we could create “smart contracts”, autonomous financial agreements that live online and can enforce themselves as soon as certain predefined conditions are fulfilled. Smart contracts in turn could be used to develop “smart securities”: smart bonds, equities and other instruments that could service themselves throughout their life cycle, for example paying their own coupons and dividends and acting as their own custodians.
We could in theory be able to build “smart wallets” for individuals that would allow them to carry out a great deal of their financial transactions on their own. Direct connections to the financial system, these wallets could be programmed as private portfolio managers and give individual investors capabilities, like big data research, that today are reserved for institutions.
And this just touches the surface of the kinds of use cases we are currently exploring. And while we cannot yet know how much of what today seems possible will actually come to pass, we believe this technology will leave as deep a mark on our world over the next 20 years as the internet has over the past 20.
Now for the hard part
That said, there are a number of very significant challenges before we get there. Some are technical: blockchain has issues of speed and scalability that will need to be overcome; and while blockchains themselves are extremely secure thanks to cryptography, a blockchain-enabled financial system will face serious security challenges – for example in safeguarding the now extremely important cryptographic keys.
Other challenges involve connecting blockchain-type record-keeping to the “real world.” If we want to develop truly autonomous smart contracts, we will likely need a new legal framework to go with them, one that handles the issues that arise when contracts meet code. If we want to have truly direct financial transactions between parties, we will have to somehow move “real money” onto the chain. While central banks and regulators have talked about fiat currency on blockchains – raising the prospect of crypto dollars and crypto pounds – there is still a long way to go.
Using blockchains in the real world will also require solving important challenges regarding identity. Through cryptography, blockchains allow people to make verified transactions without revealing who they really are. Used honestly, this is a highly desirable trait. But this capability can be abused. There has long been tension between the seemingly mutually exclusive goals of improving transparency in financial transactions while strengthening privacy. Blockchain holds the potential to square the circle by doing both simultaneously. The devil, however, will be in the details.
Do it now, do it right
Finally, and perhaps most importantly, to realize the full potential of blockchain we will need to collaborate on a common platform. We must develop an industry-wide, strategically designed architecture, and an open source framework covering the basic functionalities, or we face the prospect of mass fragmentation that has so bedeviled the introduction of new technologies in the past.
Let me explain.
Past technological revolutions have often been characterized by a race among individual actors to develop – and profit from – proprietary standards. The battle between direct and alternating current when electricity was introduced, or between Betamax and VHS with video, are classic examples, but there are many others.
While competition can spur technological advancement at first, the full benefits of most technologies can only be reaped after common standards evolve. This can take a long time, delaying benefits to end consumers. Luckily, we have an excellent example before our eyes of how to do this the right way: the internet. A set of basic functionalities, protocols and services that nobody owns but everyone can build upon, the internet revolution is a stunning illustration of the power of common technical standards.
With the blockchain we have the potential to build a highly advanced financial protocol equally as revolutionary, but only if we in the industry build the basic fabric together. This would be good for us banks, because it will give us far better tools to work with than if we went it alone. And it will be a boon to our clients, who will benefit far more quickly and more profoundly from a far broader slice of blockchain’s potential than if we did not work together.
Collaboration is key
The good news is that such collaboration is already happening. Last year a group of global banks, including UBS, joined the R3 consortium, which is working to develop standards in the blockchain world. We have also seen the rise of the Linux Foundation’s Hyperledger Project, which is similarly working to foster an open-source future for blockchain.
Many individual banks are examining and experimenting intensely with the technology on their own as well – but are doing so in an open, collaborative way. At UBS, for example, we set up our blockchain laboratory in the famous Level39 technology incubator in London, where we can rub elbows with over 190 fintech start-ups, sharing our insights and profiting from theirs. We are also working closely with peers on developing blockchain capabilities.
With these initial experiments and projects the industry is collaborating on solving some of the smaller, individual blockchain puzzles, in the hope they will provide the pieces needed to one day solve the great puzzle of a blockchain-enabled financial system. That would benefit everyone involved.
At the moment it is impossible to say how or when this puzzle will be solved, or what it will look like when it is. But if we do manage to build a common fabric, using the example of the internet, then I believe these large-scale transformations will happen sooner rather than later.
With that, many of the things we are only imagining today will likely become tomorrow’s reality.
For more information and analysis, see the UBS White Paper “Building the trust engine: How the blockchain could transform finance and the world.” The paper, and related material, is available here.