Cryptocurrency applications have dominated the use cases for blockchain-based distributed ledger technology (DLT) in the past. They have been met with celebration and despair in equal measure as cryptocurrencies have been both heralded and the weaknesses of some of them have been exposed. These issues have seriously affected the perception of DLT and the development of broader blockchain applications, which has impeded the adoption and broad-scale use for business transformation. Let’s take a look at the wider possibilities of blockchain and the next-generation DLT-enabled solutions for the finance sector.
Blockchain-based DLTs have many potential applications in the financial services industry. Blockchain delivers immutable storage, along with the trust and provenance that correctly organised ledgers provide. The technology is highly compatible with financial transactions and record storage and management; regulatory compliance and audit applications; and supply chain financing and management. However, much confusion and misunderstanding persist in this space, so let’s take a look at the key reasons.
The challenges and best practices for success for blockchain-based DLT in finance
Blockchain-based DLT has been dominated from the outset by cryptocurrency applications, which has sometimes overshadowed the potential for efficient blockchain software development for other business applications. Most business use cases are concerned with storing and managing data and digital assets, which are not any type of coin or currency and do not require the movement of any coin or currency.
Security concerns
Cryptocurrency applications are typically supported by public, permissionless blockchain-based ledgers, where the members or users are anonymous and each transaction can only be completed by running a smart contract. This means that for every single transaction, the associated smart contract must run everywhere across the system, and each node can see the transaction and the data involved. This process results in security weaknesses, as well as latency and scalability issues. The only notable exception among the coin-carrying ledgers is Bitcoin, which uses a script process.
The core Bitcoin system has never been hacked, but smart-contract-based systems have been hacked multiple times — a security reality which continues.
Cost and performance
Another aspect of these coin-based ledgers is that each transaction has a cost per transaction, and it is often impossible to predict the total cost of operation. The fee charged varies depending on the loading of the network at the time each transaction is performed. The so-called private forks of the public blockchain-based ledgers may zero-rate these actual fees, but coins are still being moved to complete any transaction. So, smart contracts still need to be run, thus reducing security, increasing latency, and affecting scalability. It is difficult, or in some cases impossible, for companies using large public ledgers for their applications to provide service-level agreements for these transactions because the overall performance of these ledgers is totally beyond their control. Such ledgers are also difficult to integrate with existing ERP and other legacy systems.
Identity management
The alternative to using public ledgers is to use a private-permissioned blockchain ledger, where users (who are usually “known” anyway) are admitted to membership of the ledger via know-your-customer and anti-money-laundering (KYC/AML) processes. These ledgers have no native coin, so transactions can be processed without the need for smart contracts. These solutions are clearly much closer to satisfying the needs and requirements of a financial services organisation with known customers and trading partners, and where an application may need to massively scale and perform without excessive latency. Identity management carried out on the ledger is the ideal.
Trust, provenance, and the single-source-of-truth
Ledgers such as Hyperledger and R3 Corda are private/permissioned solutions, but none of these solutions have generated the predicted explosion in mainstream adoption. Something is clearly stopping the adoption of these solutions. This is not the place to dive into a detailed analysis of them, but architecture, scalability, latency, and total cost of ownership issues persist — all of which are significant limiting factors.
We must not forget that decentralisation is another crucial aspect of these technologies. The most important feature of decentralisation is that it delivers trust and resolves disputes via a federation (a marketplace) of identified users — all sharing a single source of truth, with no one entity controlling everything. This means that, implemented correctly, a truly decentralised system avoids the creation of data silos and the storage of multiple copies of the same data across an organization or a business/trading network, which is a recipe for confusion and dispute.
