Is it a good idea for the central bank to set up a "blockchain bank"?

At the beginning of this year, the leaders of the central bank pointed out at the digital currency seminar that with the development of information technology, as well as the evolution of technologies such as mobile Internet, trusted and controllable cloud computing, terminal security storage, and blockchain, the payment methods around the world have undergone tremendous changes. The development of digital currency is bringing new opportunities and challenges to the central bank's currency issuance and monetary policy. At the world's first blockchain summit held in Shanghai in October last year, many experts conducted in-depth research on the application prospects, opportunities and challenges of blockchain technology.

However, as the economy continues to develop and financial needs grow exponentially, the operating costs and management methods of the traditional financial system have been questioned. For example, at the end of 2015, there were 1,478 licensed financial institutions in Shanghai, an increase of 429 from the end of 2010; in 2015, the total transaction volume of Shanghai's financial market reached 146.27 trillion yuan, an increase of 2.5 times from 2010; the total assets, loan balances, and deposit balances of the banking industry were 1.86 times, 1.53 times, and 1.49 times of those at the end of 2010, respectively; and the assets of non-banking financial institutions were 3.4 times of those at the end of 2010. The contradiction of the traditional financial data processing center being overwhelmed began to be exposed. Therefore, the model of blockchain banking has attracted widespread attention and research.

1. Market value of blockchain

"Blockchain" refers to a dynamically programmed data block chain generated by cryptographic methods. From a financial perspective, in a public distributed ledger system for line business, each trader is a node in the block network, and each node has a complete backup public ledger that records all business transaction information. Any transaction generated by any node will pass the relevant information to every node in the block network, and all node ledgers can verify the transaction and update it accurately. Due to the storage characteristics of the ledger block, the new data blocks added after the transaction will be attached to the existing nodes at any time, thus forming a chain structure of blocks.

Of course, any extended blockchain can be converted into analytical data for verification, transfer and recording through consistent mathematical algorithms. Since each data block contains network transaction information for the past 10 minutes, the authenticity and validity of the information can be verified and the next block can be generated. Blockchain has the advantages of decentralization, mutual supervision and verification of smart contracts, convenience, high security, fast accounting and low cost under the conditions of smart trust technology. There is no need to accumulate credit, and a reliable database forms a distributed shared ledger that is almost impossible to be changed.

From the perspective of database, blockchain can realize distributed recording of data (collective maintenance by system participants) and distributed storage (all nodes can or choose to save data). From the perspective of effect, blockchain can generate a set of chronologically recorded, tamper-proof and trustworthy databases, and this database is not stored on a central server, but is maintained by decentralized, trustless and encrypted algorithms to operate this distributed database. From the perspective of time series, blockchain can record all information containing data and code generated in a certain period of time. The page header of each block contains the index information of the previous block, and the end is connected to form a chain. The complete historical record of the block plus the complete verification of the chain form a traceable and complete historical record timestamp. All historical data storage in the system provides retrieval, search and verification for each piece of data.

From the perspective of the symmetry of the key, through the "key pair" algorithm of encryption and decryption, after the blockchain encrypts a key, only the unique key can decrypt it. When a key is made public, all participants can see the public key and can encrypt a piece of real information, while others cannot calculate the other key. Only the owner of the information can verify the signature through the public key and decrypt it with the private key, which reflects the confidentiality and authenticity of the recipient and ensures that the information is sent by the real holder. The private key signature and asymmetric encryption technology of the information make it easier for participants to reach a consensus, reduce the friction boundary of the transaction, realize the anonymity of transparent data, and protect personal privacy.

From the perspective of smart contracts, blockchain introduces point-to-point intelligent programmable transmission functions, uses instruction summary lists to achieve value exchange, sets restrictions in a targeted manner, and implements value constraints and re-transfers according to specific purposes based on the various constraint instructions after screening. In this way, in the process of embedding programming scripts, both parties use smart contracts to handle unforeseen transaction patterns, ensuring the effectiveness of smart contract technology in continuous use. Therefore, any value exchange activities based on blockchain can be controlled through intelligent programming to control the use, direction and various restrictions of various targets in economic and financial activities, omitting the soft constraint costs of laws or contracts.

From this analysis, blockchain technology absorbs the assessment process of operational risks and credit risks in the process of economic and financial interactions, and realizes five major industry advantages such as decentralization, trustlessness, timestamps, asymmetric encryption and smart contracts. It provides technical guarantees for a programmable society for the development of Internet finance and inclusive finance, the development of transaction banks, cross-border e-commerce and the implementation of the "Belt and Road" strategy.

2. The formation of blockchain banks

From the perspective of blockchain technology development, it can be divided into three stages: the first stage is the application of digital currencies such as encrypted currency, transfer, remittance and digital payment system; the second stage is the application of more generalized asset targets such as encrypted stocks, bonds, futures, loans, smart assets and smart contracts; the third stage will be applied in government, health, science, culture and art. At present, the application of blockchain technology is only in the process of transition from the first stage to the second stage.

In 2015, financial institutions such as banks, top investment banks, exchanges, etc. in various countries gradually attached importance to the application development of blockchain technology. Many top investment banks, including Barclays Bank, Credit Suisse, JPMorgan Chase, Bank of America, Citibank, HSBC and Goldman Sachs, joined the organization led by financial technology company R3 to develop industry standards and protocols for the use of blockchain technology in the banking industry. So far, more than 42 banks have joined the R3 alliance worldwide.

At present, commercial banks are actively involved in the research and development of blockchain technology, and are formulating rules for the development of applications, industry standards and protocols, etc., aiming to form a simple financial service paradigm that improves operating efficiency, creates inclusive services, networks a large number of manual financial service processes, shortens transaction time, and reduces transaction costs. However, the direct problem facing blockchain banks is how to support the transformation of the traditional model with the meager income of the simple financial service paradigm. Therefore, commercial banks need to actively develop a large number of new customer groups who cannot obtain bank accounts but can connect through the Internet, so as to increase the income of intermediary business with the meager income from huge low-cost small payment transactions during the development of blockchain technology. In terms of cost control, commercial banks can use their licensed advantages to innovate the research and development of blockchain technology, take advantage of consumer trust, improve traditional centralized banking systems, optimize back-end infrastructure, etc., to reduce financial innovation and regulatory costs.

From the perspective of blockchain bank development models, there are three models: the first is that commercial banks set up blockchain laboratories, such as Citibank, UBS, Bank of New York Mellon, etc., to test the application of blockchain in payment, digital currency and settlement models. The second is that commercial banks invest in financial technology start-ups and enter the blockchain field in the form of venture capital, such as Goldman Sachs and BBVA. The third is that commercial banks cooperate with start-ups, such as Barclays Bank and Commonwealth Bank of Australia.

At present, blockchain banking services include: 1. P2P cross-border payments and remittances, trade settlements, and securities, futures, and financial derivatives contracts. 2. Registration. Blockchain has a reliable database to record various information, and the stored anti-money laundering customer identity information and transaction records are credible and traceable. 3. Confirmation of rights. Procedures such as the recognition of rights in registration and transfer matters in the equity law system can be achieved through blockchain technology. 4. Intelligent management. Since the "smart contract" has the ability to automatically detect validity and meet the procedural conditions, the contract automatically handles interest and dividend payments, avoiding the risk of credit default caused by human intervention.

Since the essence of blockchain technology is to use the Internet's standardized basic service protocols to build consensus data layer service rules, and then generate service scenarios at the financial application layer, such as Internet finance and inclusive finance, transaction banks, and cross-border e-commerce, the application scenarios built by standard protocols build a series of financial products at the application layer for digital asset targets, such as bonds, equity, foreign exchange, paper gold, etc., and only need to modify and adjust the application scenarios and consensus rules appropriately to build a set of basic protocols and services that can be applied to multiple financial products, laying the foundation for the expansion of blockchain in the financial field. At the same time, it also provides new tools to curb the credit risk drawbacks of Internet finance.

3. Challenges faced by blockchain banks

Commercial banks are in urgent need of reserving a team of compound talents that integrate technology and finance, and actively participate in the formulation of blockchain banking standards. At the digital currency seminar at the beginning of the year, the central bank pointed out that at present, payment methods have undergone tremendous changes worldwide, and the development of digital currency is bringing new opportunities and challenges to the central bank's currency issuance and monetary policy. In this regard, driven by the joint innovation of large global financial institutions, my country's banking industry should pay close attention to the latest innovation trends of international peers, join the ranks of researching and developing blockchain products as soon as possible, and adjust development strategies in a timely manner to adapt to the business operation model of Internet finance under the new situation.

Financial regulators should continue to pay attention to the development of the latest Internet technologies and prepare for responses. Since the "decentralization" of blockchain technology is a programmatic organization achieved through transparency, it breaks through privileges and human manipulation, allowing computer algorithms to achieve "credit freedom notarization". In view of the lessons learned from the speculation and money laundering risks of Bitcoin's digital currency transactions, if blockchain technology is to become a new channel for capital circulation, regulatory standards are needed to protect the interests of all parties in the market. In this regard, regulatory authorities should actively participate in the formulation of protocol rules organized by R3 to ensure the rational use of financial innovation products. At the same time, they need the support of centralized rules of procedures, use the convenience of financial technology to improve and perfect regulatory means, actively embrace new Internet financial technologies, and provide certain support for the steady development of blockchain banking business.

Author: Shao Wei, Training Center of Bank of China Shanghai Branch