Vice President of Agricultural Bank of China: Blockchain technology may fundamentally change the transaction rules between financial institutions

Author: Lin Xiaoxuan, member of China Information Technology Hundred People Forum, Vice President of Agricultural Bank of China

Source: China Finance, Issue 8, 2016

As the basic technology supporting the development of Bitcoin, blockchain technology has been favored by professionals in the Internet and other fields in recent years and is widely regarded as one of the basic protocols for the next generation of global credit authentication and value Internet.   Its emergence indicates that the use of the Internet may gradually change from traditional information transmission to value transmission, thus bringing an unprecedented revolution and challenge to the traditional financial industry. In September 2015, the blockchain alliance led by financial technology company R3 was announced to be established, mainly dedicated to proof-of-concept experiments and the formulation of blockchain technology standards. As of December 2015, 42 large commercial banks (financial groups) around the world, including Citi and HSBC, have joined the alliance. Citibank has also issued its own digital currency "Citi Coin" internally. The Swiss Union Bank (UBS) has tested more than 20 financial applications on the blockchain, including financial transactions, payment settlements and the issuance of smart bonds. The frequent actions of foreign banks in blockchain technology have also attracted widespread attention and attention in China. Beijing, Shanghai and other places have successively established blockchain organizations and held related activities. Governments, academic institutions, financial institutions, Internet companies, etc. are optimistic about the development potential of blockchain. On January 20, 2016, the People's Bank of China held a digital currency seminar and proposed to strive to launch the digital currency issued by the central bank as soon as possible.

Basic characteristics of blockchain technology

Blockchain can be defined as a distributed shared database generated based on cryptographic technology. Its essence is a technical solution to collectively maintain a reliable database in a decentralized manner. This technical solution allows any number of nodes participating in the system to calculate and record all information exchanges within the system over a period of time into a data block through cryptographic algorithms, and generate a digital signature for the data block to verify the validity of the information and link it to the next data block to form a main chain. All nodes in the system jointly determine the authenticity of the records in the received data block. In layman's terms,   Blockchain is a collectively maintained public ledger established on the Internet based on a consensus mechanism. Its core features include the following three:

The first is decentralization. As the Internet makes the world more and more interactive, a huge trust gap has emerged. The existing mainstream database technology architecture is private and centralized. The key to solving the value transfer in this architecture is to solve the problem of mutual trust. The blockchain system envisions a peer-to-peer network composed of a large number of nodes. There is no centralized hardware or management agency. On the Internet, the rights and obligations of any node are equal; all nodes in the system participate in the recording and verification of data, and send the calculation results to each node through distributed communication; in the case of damage to some nodes, the operation of the entire system will not be affected, which is equivalent to each participating node being "self-centered".

The second is to establish trust based on consensus. The biggest disruption of blockchain theory lies in the new credit formation mechanism. In the traditional Internet model, strangers establish credit and conduct transactions through trusted third-party institutions (such as banks, clearing organizations, etc.). Blockchain technology has fundamentally changed the centralized way of creating credit. It uses a set of consensus-based mathematical algorithms to establish a "trust" network between machines, thereby establishing credit through technical endorsement rather than centralized credit institutions. Through this mechanism, the participants do not need to know who the counterparty of the transaction is, nor do they need to rely on third-party institutions to endorse or verify the transaction. Instead, they only need to trust the common algorithm to establish mutual trust, and the algorithm creates credit, trust and consensus for the participants.

Third, the information cannot be tampered with. Blockchain is a database that cannot be tampered with or forged based on timestamps. The addition of blocks (complete history) and chains (complete verification) forms a timestamp (traceable complete history). Timestamps store all transaction histories executed in the network, provide retrieval and search functions for each piece of data, and can be traced back to the source and verified one by one with the help of the blockchain structure. Each participant stamps the timestamp when recording and generating blocks, and broadcasts it to all nodes in the network, so that each participating node can obtain a copy of the complete database. Once the information is verified and added to the blockchain, it will be stored permanently. According to the principle of "the minority obeys the majority", from a probability perspective, in order to tamper with historical information, more than 50% of the nodes in the entire system must be controlled at the same time. Therefore, blockchain technology believes that the data reliability of its system is very high, and the more nodes involved in the system and the stronger the computing power, the higher the data security in the system.

Application prospects of blockchain technology in the financial industry

Currently, the Internet financial wave is changing the existing financial business model on a global scale. However, whether it is Internet banking, Internet insurance, or Internet brokerage, they are only changing their business model, not the financial structure. However, blockchain technology believes that   It will make the next upgrade of the financial industry closer to the essence of finance - credit. In theory, if the technical recognition ability is sufficient, blockchain technology can enable both parties to the transaction to carry out economic activities without the need for a third-party credit intermediary, thereby achieving low-cost global value transfer.

In the future, blockchain technology may be applied to multiple fields such as digital currency, bills, clearing and settlement, equity transactions, auditing, and notarization.   Digital currencies represented by Bitcoin are the most extensive and successful application of blockchain technology. Compared with traditional paper currency, issuing digital currency can effectively reduce the cost of currency issuance and circulation, and improve the convenience and transparency of economic transactions. Therefore, in the Internet era, it is natural for blockchain to be an optional technology for the central bank to launch digital currency.

In the bill market, digital bills based on blockchain technology can become a safer, smarter and more convenient bill form. Peer-to-peer transactions realized with the help of blockchain can break the existing functions of bill intermediaries and realize the disintermediation of bill value transfer; based on the information immutability of blockchain, once the bill transaction is completed, there will be no default phenomenon, thus avoiding "one bill sold multiple times" and asynchronous payment endorsement, and effectively preventing bill market risks. Based on the timestamp formed by the connection between the blockchain data, its fully transparent data management system provides a trusted traceability path, which can effectively reduce the audit cost of supervision.

The expansion of the distributed clearing mechanism brought by blockchain technology, if applied to inter-bank clearing, can reduce a lot of management costs and improve the efficiency of clearing. At present, commercial trade transaction clearing and payment all rely on banks. The traditional transaction method requires going through the account opening bank, the counterparty account opening bank, the domestic clearing organization, the international clearing organization, the overseas bank, etc. In the process, each institution has its own accounting system, and needs to establish an agency relationship with each other and have a credit line; each transaction needs to be recorded in the bank, and clearing and reconciliation with the counterparty, etc., resulting in slow speed and high cost. Compared with the traditional payment system, payment through blockchain technology is completed directly by the two parties to the transaction, without involving intermediaries. Even if some nodes in the network are paralyzed, it will not affect the operation of the entire system. If a universal distributed inter-bank financial transaction protocol is built based on blockchain technology to provide cross-border, any currency real-time payment and clearing services for access banks, cross-border payments will become convenient and low-cost.

The application of blockchain technology in payment and settlement is not out of reach. At present, SWIFT and non-bank payment institutions are already facing the challenge of new blockchain technology. Some blockchain start-ups and cooperative institutions have begun to propose some new clearing and settlement standards. For example, the R3 blockchain alliance has been formulating standards for interactive settlement. In addition, the Australian Stock Exchange has considered using blockchain to replace the original clearing and settlement system and started upgrading the clearing and settlement system at the end of 2016. At present, major Australian banks have joined the blockchain project run by R3.

Although blockchain technology has broad application prospects, as an emerging technology, it still faces many key challenges such as security, supervision, capacity, and timeliness. In the short term, the large-scale application of blockchain technology within banks still needs to be observed. In particular, after more than 30 years of electronic construction, China's commercial banks have achieved centralized processing of all businesses and centralized sharing of data. If the "decentralized" model of blockchain technology is used for internal redeployment, the human and material costs cannot be underestimated. At the same time, blockchain technology has high requirements for computing resources and storage resources of each distributed participating node, and transaction broadcasting puts great pressure on the network. From the current technological development, blockchain technology is still difficult to support the existing transaction scale of banks, and its application scenarios will remain limited for a considerable period of time. For example, the average daily transaction volume of the current largest blockchain Bitcoin network is about 200,000 transactions, the general ledger storage capacity is 50G, and there have been cases where a transaction takes more than ten hours to be confirmed, and some bitcoins have been reused. Therefore, the large-scale application of blockchain technology in the financial field still needs a process. However, with the extensive participation of financial institutions, the pace of application of this technology is likely to accelerate further.

Dealing with the impact of blockchain technology on the financial industry

Blockchain is essentially a mathematical solution for building a trust mechanism between all parties involved in a transaction. It is still immature in application and faces many challenges. However, once the idea of ​​reconstructing the credit formation mechanism is successful, this technology will profoundly change the current financial industry and business model, and may fundamentally change the transaction rules between institutions.   Blockchain technology is certainly a complex technology, but even more complex are the rules designed for its application. Regulatory authorities and financial institutions should pay close attention to the development trend of blockchain technology, strengthen research and technical reserves, actively participate in exchanges and discussions on rules and standards among relevant parties at home and abroad, and prudently carry out actual application verification.

One of the characteristics of blockchain technology is decentralization, but in a decentralized business system, centralized departments are also needed to provide norms and rules . It is recommended that the People's Bank of China take the lead in establishing an organization to strengthen the cooperation between the central bank and financial institutions and Internet professional institutions, conduct research on financial application scenarios of blockchain technology, and organize some financial institutions to carry out some joint experimental applications first. In addition, regulatory rules and technical application standards should be established simultaneously to avoid barbaric applications that have adverse effects on society and risks to financial operations.

In short, blockchain technology is both an opportunity and a challenge for financial institutions. In the context of widespread attention paid to the application of blockchain technology at home and abroad, commercial banks should pay close attention to the research direction and application results of foreign banks, and actively participate in the research and standard rule-making organized by regulatory authorities. Domestic banking institutions should strengthen exchanges and cooperation, carry out joint research, and actively explore the application of blockchain technology.