Blockchain development is still in the process of improvement, and financial applications will face ten major challenges

The biggest challenge of blockchain application lies in the "gray area" between financial services and data services. There is no doubt that the core role of blockchain technology in finance is to rely on new models to determine value, store value and transaction value. In fact, distributed technology ultimately affects the financial manifestation of people's "identity information", that is, the form of accounts. In the transition from information Internet to value Internet led by blockchain, this challenge always exists, and we need to pay close attention to issues such as regulatory adaptability and risk control.

As the distributed ledger technology behind Bitcoin, the craze for blockchain seems to be unstoppable. Whether people are actively embracing it or have doubts, they are beginning to face up to the impact that blockchain will have on the economy and finance.

Theoretically, the application scope of blockchain technology can cover many fields such as currency, finance, economy and society, but it is not so simple in reality. In essence, the development of blockchain technology is still in its infancy and improvement stage, and it is in urgent need of "nurturing" and avoiding "overpraising". Especially in the financial field, the industry's particularity and the unique pattern faced by my country require us to think deeply about a series of major problems and challenges.

Challenge 1: Can blockchain technology really “practice internal skills”?

Just as "there are a thousand Hamlets in the eyes of a thousand people", as blockchain becomes increasingly popular, people's interpretations of it are also "varied". The inherent characteristics of "decentralization" and "immutability" that were originally insisted on are gradually shaken in reality. Therefore, when we discuss blockchain technology, we may need to jump out of the constraints of typical cases such as Bitcoin and Ethereum, and more accurately describe the unchanging essential connotation of blockchain technology.

It must be acknowledged that as an emerging technology, blockchain is bound to have many immature aspects and urgently needs self-improvement and rational questioning. In the financial field, blockchain advocates and users also need to gradually shift from the early "coin circle" and "technical geek thinking" to the effective integration of technology and financial thinking.

For example, we can comprehensively reflect on the generally recognized characteristics of blockchain. The first is transparency. So, are the initial rule settings beneficial to the majority? Are there any misleading and information distortions? Is absolute information transparency possible? Will it bring about information protection problems? The second is credit. From information to credit, it means transforming it into tradable financial information; how is the "intelligent rights and responsibilities processing" based on blockchain rules related to offline asset rights confirmation; how wide is the coverage of the smart transactions and rights and responsibilities constraint mechanism of the blockchain online ecosystem, and can it be separated from the existing system? The third is that it cannot be tampered with. According to Gartner experts, a rough estimate is that a third party can rewrite the Bitcoin blockchain ledger with $400 million. So how far is the cost problem of "more than 51% of the computing power of the entire network to attack" from true security? Have the "hard fork" disputes brought about by the DAO incident and the attack on Krypton changed the characteristics of the blockchain? Do various ledger maintainers have moral risks? The fourth is low cost. Will the ledger scale expand? Will transaction fees and energy consumption rise rapidly?

All of these need to be carefully examined. Just as: if you want to change others, you must first change yourself; if you want to integrate others, you must first improve yourself. Through cross-border cooperation in technology, finance, law, etc., we can jointly find the defects and shortcomings of blockchain, so that this revolutionary technology can usher in a longer-term vitality.

Challenge 2: Does blockchain solve the value exchange between "people and people", "machine and machine" or "people and machine"? <br/>Economist Robert Shiller believes that "the financial system is essentially an information processing system - a system based on human power rather than electronic components, and artificial intelligence is still a long way from completely replacing human intelligence." From a certain perspective, Shiller may be a bit conservative, and new technologies have already had a huge impact on traditional theories. For example, behavioral finance seeks to reveal the irrational behavior and decision-making rules of the financial market. A common criticism of it is the lack of models and empirical systems that conform to the research paradigm of economics. However, information, big data and blockchain have brought changes. Individual behavior and value transfer can be effectively observed and identified. Does this mean that the hypothesis foundation of micro-finance is really challenged?

The essence of financial transactions is also to exchange and process specific information between different nodes. Some people believe that blockchain can make machines the main body of financial activities. In terms of the impact of technology on finance, its path is from "people-to-people" finance, to "human-machine collaborative finance", and then to "finance between machines". The reality is obviously still far from the third stage. Considering financial activities, it is inseparable from the attention to people's irrational behavior and moral risks. Behind the blockchain consensus rules and network nodes, there is still uncertainty brought by human nature.

Challenge 3: Are blockchains a concern for centralization or decentralization?

It should be said that information asymmetry, search costs, matching efficiency, transaction costs, economies of scale, risk control, etc. in financial transactions determine the necessity of the existence of centers and intermediaries, such as central banks, financial institutions or central counterparty mechanisms. The value of centers (intermediaries) is changing under the new technological environment. For example, from solving information asymmetry to identifying information flooding in the era of big data. On the one hand, in the process of new financial innovation and transformation, there are a large number of "pseudo-decentralizations". For example, whether it is Internet companies doing finance or many P2P online lending and equity crowdfunding platforms, they actually appear in the form of new intermediaries. On the other hand, under the existing economic and social organization model, real large-scale decentralization is basically impossible. It is more of a limited and small-scale "experimental field". What is meaningful is multi-center or weak center to achieve shared financial development. Therefore, although it is technically understandable, when blockchain is applied to finance and other fields, "decentralization" should be downplayed and distributed and weak center characteristics should be emphasized.

At the same time, we need to pay attention to several points: First, traditional financial institutions have huge resource advantages (2005.242, -2.59, -0.13%), and can fully utilize blockchain technology to play a central role in reform. If the internal system is out of control, it may bring greater risks. The recent "myth shattering" of Deutsche Bank and Wells Fargo has given us a warning. The innovation out of control and moral risks of traditional institutions may be further amplified in blockchain innovation, especially when they are heavily involved in the construction of the blockchain ecosystem; second, for governments or public institutions, we must also prevent them from using "all-powerful" new technologies to exceed the reasonable boundaries of power; third, for those gray or black financial activities that evade supervision and are under the banner of decentralization, they are "bad money" that all parties need to spurn.

Challenge 4: The prospects of blockchain depend on the “triangle constraints” of interests, efficiency and security

The changes brought about by blockchain are also inseparable from institutional changes under the breakthrough of path dependence. The so-called path dependence means that once people choose a certain system, due to the existence of factors such as economies of scale, learning effects, coordination effects, adaptive expectations, and vested interest constraints, the system will continue to self-reinforce in the established direction. The so-called institutional change includes bottom-up induced institutional change (demand-driven institutional change) and top-down mandatory institutional change (supply-driven institutional change). Whether blockchain can truly gain vitality and "break through" and integrate in traditional rules depends on whether it can find the balance point of "triangular constraints". On the one hand, achieving a balance of interests and benefiting the majority is the starting point for whether a change can be continued, and it is necessary to fully anticipate the resistance to breaking the existing interest pattern. For example, public blockchain can be used to store certificates and diplomas safely and at low cost, but it will bring challenges to traditional certificate authentication intermediaries, illegal industries and personal information protection. On the other hand, the efficiency of financial operations is sometimes not "the faster the better", such as the "double-edged sword" of high-frequency trading on the capital market has made us vigilant. Third, new technologies and rules also need to be stress-tested based on security, including product security, technical security, system security, information security, financial security, national security, etc. In short, the inherent concept of blockchain has been explored for many years, and now it needs to return to the mainstream, find the "soil" for the theory to take root, explore the integration point with the mainstream financial system, from subversion to supplementation, and realize a new ecology of sharing and integration.

Challenge 5: Can blockchain address the “shortcomings” in financial development?

For example, our research found that the gap between the scale of payment and clearing business and the total GDP in 2015 was further widening. The scale of payment system business required to create 1 yuan of GDP increased from 53.25 yuan in 2014 to 64.77 yuan, with a growth rate of 21.65%, the highest since 2007. In the first three quarters of 2016, the amount of payment business was as high as 71 times the total GDP in the same period. In recent years, the correlation between payment and clearing system business indicators and macroeconomic operation has also weakened significantly. In 2015, the fitting effect of macroeconomic variables based on payment and clearing indicators was generally unsatisfactory. Except for bills in non-cash payment tools, the economic growth rate or inflation rate given by other payment and clearing indicators greatly exceeded the actual value. This shows that a considerable number of payment activities have not made effective contributions to the real economy. In other words, the payment and clearing business reflects the improvement of the activity of the financial market, while the contribution of the real economy has been weak, and the "self-game" of finance is increasing.

The key here is whether blockchain financial innovation can promote financial service entities and solve the many contradictions that plague China's financial reform and development, such as the imbalance of structure and function under scale growth, "two mores and two dilemmas", etc. It may also aggravate certain contradictions, such as financial self-game, uncontrolled innovation of structural financial products, and chaos in the over-the-counter factor market.

Challenge 6: Blockchain application scenarios change from "grand narrative" to "small and beautiful"

We need to lower our expectations for the application of blockchain, because the road to programmable economy is very long. In this process, we need to reject the "omnipotence theory". The blockchain has great value if it can be applied in some scenarios. Among them, on the "big tree" of the financial system, the application of blockchain is like pruning and grafting "branches" first, starting from small. On the path connecting industry and finance, we should strive to make some optimizations and contributions. In terms of the model in blockchain financial applications, it is not easy to implement a pure business model, because it not only requires clear projects, conversion of discourse methods, clear profit points, and greater scene support, but also requires more efforts to find the value of intermediary existence in weak centers and weak intermediary chains. At the same time, the public welfare model can be more widely used, as long as some "fake public welfare" is excluded.

In addition, new technologies have made the boundaries of financial elements more blurred. When blockchain technology is added, it is even more necessary to move from the logic of financial entities to the logic of functions. Specifically, blockchain applications are no longer limited to financial institutions, products, and markets, but start from improving and optimizing financial functions, including: clearing and payment, financing and equity refinement, providing channels for the transfer of economic resources in time and space, risk management, information provision, solving incentives, etc.

Challenge 7: Is blockchain still far from the era of technological standardization?

Represented by R3, more and more organizations hope to promote the exploration of blockchain technology standards. In my country, in addition to non-governmental organizations, many government-backed institutions are also involved. But objectively speaking, blockchain seems to be still far from the mature stage of standardization development, because there are still many shortcomings and it has not been fully tested by the market and industry. In addition, it depends on the changes in the following situations: First, in the development of the modern financial system, whether in the front or back office, there is a synchronous evolution of centralized standards and "weak center" standards. For example, in the United States, regulators promote the construction of central counterparty mechanisms for financial market infrastructure. At the same time, the Federal Reserve believed last year that compared with clearing transactions through a hub-and-spoke network structure, the information distribution architecture between financial institutions based on public IP networks may reduce costs. The central authorities should establish a common protocol for message standards, communications, security and recording transactions in the central ledger to facilitate the corresponding inter-bank settlement. Second, blockchain standards need to face contradictions at different levels. For example, based on market principles and national financial interests and security, different ideas for standard formulation may be brought about. The coordination of software standards and hardware standards should not be ignored in financial applications. Based on commercial principles or public principles, different standards and scenarios are brought about for the underlying or application layers of blockchain technology. It should be said that although the exploration of blockchain standards is important, it should not be divorced from reality or rushed for quick results. The recent crisis encountered by R3 also reflects this point. Whether the era of competition among many so-called blockchain standards will cause market chaos and bubbles is also worth considering.

Challenge 8: The biggest challenge of blockchain lies in the “gray area” between financial services and data services

In summary, the core of future blockchain applications lies in how to truly realize the Internet of Value. From a technical perspective: one is the digital token ledger, such as digital assets and digital asset claims; the other is the activity register, such as data records (representing certain goods or services; financial data may represent transaction facts). At present, with the rapid evolution of new technologies in the Internet era, the boundaries between financial services and data services have become blurred. For example, in May 2014, the US Federal Trade Commission issued a report focusing on the opacity of data service providers; for example, in 2015, the UK Treasury led the establishment of an open banking working group to explore how to use the data open to the outside world by banks to assist people in transactions, deposits, loans and investments, and banks have also become data service providers.

There is no doubt that the core role of blockchain technology in finance is to rely on new models to determine value, store value and trade value. In fact, distributed technology ultimately affects the financial manifestation of people's "identity information", that is, the form of accounts. In the transition from information Internet to value Internet led by blockchain, this challenge always exists, and we need to pay close attention to issues such as regulatory adaptability and risk control.

Challenge 9: Blockchain is the core tool for comprehensive risk management

For all kinds of new financial innovations, risk is the biggest concern of all parties. Therefore, on the one hand, in-depth research is needed to determine whether blockchain, as a new technology, increases or reduces risks overall; on the other hand, the initial focus of blockchain innovation applications can be placed on the application of financial risk management. Further, when using blockchain for financial risk management, we must first distinguish between traditional financial risks and new financial risks. The former include credit risk and liquidity risk, and the latter include long-tail risks in the Internet era and the amplification of the herd effect. Secondly, from the perspective of the impact of risks, one is systemic risk, which considers too big to fail; the other is non-systemic risk, which is the risk created or faced by different participants in financial innovation), including: individuals (financial consumer protection), platforms (traditional and new risks, KYC, AML), enterprises (illegal fundraising, financial management), etc. From this point of view, the application of blockchain in the optimization of new financial risk management can have different focuses: first, at the regulatory level, comprehensively promote RegTech exploration similar to that of the United Kingdom; second, at the industry level, promote information transparency and use it in institutional risk control models; third, combine insurance, guarantees, etc. to develop new risk management products.

Challenge 10: Blockchain innovation supervision requires "bottom-line thinking"

Here, we can also continue the transformation of Internet financial supervision thinking, and through penetrating supervision, strip off the "cloak" of fake blockchain projects. In practice, first, we need to promote "good money drives out bad money" for blockchain startups, so that companies with core competitiveness can truly receive effective support, and those that "stunts are greater than content" or even "selling dog meat under the guise of sheep" will be "cried out by everyone"; second, we need to distinguish between digital currencies based on blockchain ledgers and the application of blockchain in financial transactions. The former needs to be more strictly regulated because it challenges the central bank's right to issue currency; third, we should give relatively higher innovation space and tolerance to non-core systems of financial organizations, the margins of financial markets and small-scale areas.

In short, we can clarify the "bottom line" of blockchain financial innovation by focusing on the essence of blockchain financial activities and the nature of the behavior of participants. The recent regulatory focuses include: illegal fundraising activities in the name of blockchain projects; various pyramid schemes under the banner of digital currency; and high leverage risks of blockchain entrepreneurial projects.