What does Deloitte’s blockchain report for the central bank say?

This article is the sixth of the cover articles of the February 2016 issue of Contemporary Financiers, titled "Blockchain: Changing the Future". The original title is "Blockchain Impacts the Global Financial Industry"

Blockchain breaks the centralized and intermediary data transmission mode through distributed data storage and peer-to-peer transmission, meeting the needs of the industry. This will undoubtedly have a profound impact on the financial industry.

Trust is the foundation of the financial industry. In order to maintain trust, the development of the financial industry has spawned a large number of intermediaries, including custodians, third-party payment platforms, notaries, banks, etc. However, intermediaries rely on manual processing of information, and transaction information often needs to be transmitted through multiple intermediaries, which makes the information error rate high and inefficient. At the same time, people also generally believe that the information disclosed by authoritative agencies is socially recognized information and there is no risk of fraud. However, in practice, authoritative agencies collect various information through centralized data transmission systems, store them in central servers, and then publish them to the public. This centralized transmission mode also makes data transmission inefficient and costly. How to establish trust efficiently, conveniently, and at low cost has become a common concern in the industry.

Blockchain can be understood as a public ledger based on a computer program, which can record all transactions that occur on the blockchain. Each node in the blockchain can update the data it records to the network, and each node involved in maintenance can copy a copy of the complete database, which constitutes a decentralized distributed database. This distributed database can realize peer-to-peer transactions and interactions between people without the intervention of a third party. At the same time, once the data is written into the block, it cannot be revoked. Within 10 minutes, the information in the block will be copied to all blocks in the network to achieve synchronization of data across the entire network. Blockchain is built on the basis of the Internet, and any port connected to the Internet can access the blockchain.

On January 6, 2016, the Washington Post website pointed out that blockchain is one of the top ten most avant-garde innovative technologies that are most likely to change the path of innovation in 2016, and may be the most significant invention since the emergence of the Internet. At present, 42 well-known global financial institutions, such as Goldman Sachs, Bank of America, UBS Group, etc., have joined an organization called "R3" to jointly conduct research on blockchain; Deloitte DC3 (Deloitte Cryptocurrency Community) also published an article on the CoinDesk website at the beginning of the new year in 2016, based on a survey of European and American business communities, predicting that blockchain will leave the laboratory and become a reality in 2016.

What are the characteristics of blockchain?

Blockchain has the characteristics of reliability and availability. The design of blockchain enables it to effectively prevent failures and attacks. A blockchain is usually shared by an open user group. If a single node in the entire blockchain network fails, it will not cause the loss of information on other nodes. The remaining participants can still operate normally, and financial transactions on the blockchain will not be disturbed due to transmission problems.

Blockchain has the characteristic of transparency. Specifically, any data update will be synchronized to the entire blockchain, and any node on the blockchain network can query the data records on the entire blockchain. This improves the auditability of data on the network, and auditors can conduct a full-range audit of data in the network. At the same time, blockchain users can obtain all data in the blockchain in real time, eliminating the risks caused by information asymmetry, which increases users' trust in information in the network. HSBC analysts Anton Tonev and Davy Jose said that blockchain provides the best solution to the problem of "how to verify trust in a decentralized system". The biggest breakthrough of this technology is that two strangers no longer need a third party who they trust to achieve mutual trust.

The records stored on the blockchain are immutable. This reduces the risk of fraud in transactions. In addition, the stored records are irreversible. When new data is written into a block, the newly generated block will be copied to all blocks in the blockchain. This process is irreversible, so the blockchain is irreversible. This improves the accuracy of transactions, simplifies the data processing process, and reduces the cost of maintaining data originality and transaction traceability.

Blockchain has the characteristics of digitalization. Since almost all files or assets can be embodied in the form of code or ledger, this means that all data can be uploaded to the blockchain. By setting up the data processing program on the blockchain, smart contracts and automatic transactions can be realized on the blockchain. The "Ethereum" system created by Canadian programming genius Vitalik Buterin has realized this possibility. This feature of blockchain determines that its application prospects will be very broad.

What are the similarities and differences between blockchain and other information technologies?

Figure 1 Application of blockchain in storage, verification and workflow

Blockchain VS Internet

Blockchain runs on the Internet, but its functions are broader than the Internet. The similarities between the two technologies are mainly: in terms of data transmission, neither the Internet nor the blockchain requires a centralized intermediary; both technologies require users to access the Internet; and both technologies can be used by multiple users within an organization at the same time.

The main difference between the two is that the main purpose of Internet technology is to achieve rapid sending and receiving of information, while the main purpose of blockchain is to achieve data storage and recording; the data on the blockchain is highly tamper-resistant, while Internet data is tamper-resistant only under the premise of implementing protective measures such as encryption.

Blockchain vs. Social Networks

A social network refers to an online communication platform similar to Facebook. Like blockchain, it needs to be based on the Internet, but there are obvious differences: the main purpose of a social network is to provide a platform for people to communicate, while blockchain, in addition to sharing information, also has the function of storing information; social networks require users to publish information to a central server to achieve sharing, while sharing on the blockchain does not require a centralized server, and users communicate directly through P2P; the information on social networks has poor tamper-proof properties, while the information in the blockchain has strong tamper-proof properties; the role of social networks is to expand people's social circles in real life. The more people use it, the more dynamic the social network is, which determines that it is not suitable for use in small private circles; while blockchain can adapt to information sharing in small organizations.

Blockchain VS Traditional Database

Both traditional databases and blockchains have data storage functions, but the performance of blockchains far exceeds that of databases: traditional databases need to be established on a central server, while the distributed storage mechanism of blockchains enables each node in the network to have data from the entire network; since traditional databases are stored on a central server, the risk of data being tampered with is very high, while in blockchains, distributed storage and transparent queries greatly reduce the possibility of data tampering; traditional databases can be stored offline on a server, while blockchains require all nodes to be connected to the network. This online storage method ensures the timeliness of data.

How blockchain will be used in the financial industry

Figure 2 Typical “T+3” case in securities settlement and clearing system

Figure 3 Blockchain applied to securities settlement and clearing systems

The earliest and most popular use cases of blockchain in the financial services industry include payment, securities clearing and delivery. In the past two years, DC3 (Deloitte Cryptocurrency Community) has developed more than 50 blockchain application cases through communication and discussion with the global business community, covering finance, automobiles, hotels, chain stores, medical life, media and entertainment industries. Below, we introduce four application cases that Deloitte has recently completed in the custody industry:

● One is its application in the fields of anti-money laundering (AML) and know your customer (KYC) in financial institutions.

Deloitte’s application of blockchain in the areas of anti-money laundering (AML) and know your customer (KYC) has disrupted the existing compliance model in the financial industry.

In the field of anti-money laundering (AML), based on blockchain, each financial institution will digitize the customer information collected and verified by each financial institution and upload it to the blockchain; at the same time, the financial institution provides electronic identity information (similar to private keys) to the entities in the transaction and links the user address with its electronic identity information. Any transaction must be verified by the private key and the public key in the bank and carried out by the user address, which determines the traceability of the data on the blockchain. In this model, each financial institution shares transaction information on the blockchain, and any link of any transaction will not be out of the sight of supervision. Black money will be washed everywhere, which will greatly enhance the strength of anti-money laundering. At the same time, by setting certain rules and logic on the blockchain, the blockchain will automatically verify the compliance of transactions and users, non-compliant transactions and users will be removed, and the compliance of the entire financial enterprise will be improved.

In the field of Know Your Customer (KYC), financial institutions can also share information about transaction entities through blockchain, which will reduce a lot of repetitive work and save a lot of compliance costs for each institution. At the same time, this will greatly help financial institutions in exploring potential business opportunities and identifying risk exposure.

● The second is its application in the field of securities settlement and clearing.

Figure 4 Current transaction process involving multiple parties

The securities trading market is an area where blockchain has potential development opportunities. In traditional securities trading, after the securities owner issues a trading order, the order needs to be coordinated by four major institutions: securities brokers, asset custodians, central banks, and central registration agencies in turn to complete the transaction. The entire process is inefficient and costly, and this model creates a strong intermediary, and the rights of financial consumers are often not guaranteed. Generally speaking, it usually takes "T+3" days from the issuance of a trading order by the securities owner to the final confirmation of the transaction by the registration agency. It is estimated that the annual clearing and settlement costs required by the two major US stock exchanges are estimated to be as high as 65 billion to 85 billion US dollars, but if the "T+3" day is shortened by one day to "T+2", the annual cost will be reduced by 2.7 billion US dollars.

Using blockchain, buyers and sellers can automatically match through smart contracts, and automatically settle and clear through a distributed digital registration system. Since the data entered into the block is irreversible and can be copied to each data block in a short time, the information entered into the blockchain actually has a public effect, so there will be no dispute about the occurrence of the transaction and the confirmation of ownership. Unlike the previous transaction confirmation that required "T+3" days, on the blockchain, the completion of settlement and clearing only takes 10 minutes (that is, the time it takes to confirm the completion of a transaction on the blockchain). NASDAQ's LINQ successfully implemented this scenario for the private placement bonds issued by Overstock.com at the end of 2015. The decentralized transaction process will undoubtedly save a lot of transaction costs.

In practice, the Australian Stock Exchange (ASX) is seriously considering applying blockchain to its clearing and settlement systems. It is reported that Nasdaq OMX and the London Stock Exchange are already exploring applications in this regard.

● The third is its application in the field of proxy voting.

Figure 5 New model based on blockchain

The shareholder proxy voting mechanism currently in widespread use is composed of a set of complicated procedures. Usually, the asset manager issues voting instructions to the proxy voting broker, which is then passed to the voting distributor, who then passes the instructions to the custodian and sub-custodian. The custodian requests a notary to notarize the voting instructions, then applies to the registrar and completes the registration, and finally the voting information is summarized in the company secretariat. This is a very complex and non-standardized process, and there is a risk that the voting information will be incorrectly transmitted or lost. In addition, because the custodian and sub-custodian use different transmission systems and character recognition systems, it is very difficult to trace and confirm the vote. A research result on proxy voting conducted by a Dutch research institute pointed out that among the companies using the proxy voting system in the Netherlands, only 31% of the companies can confirm the results of their proxy voting.

Deloitte is trying to use blockchain to change this streamlined process. Asset managers only need to download the voting software, submit their identity information and complete the registration to submit their votes directly. Once the voting results are successfully submitted to the distributed digital voting registration system, they can no longer be revoked. At the same time, due to the synchronization of data on the blockchain, asset managers can quickly query the voting results. This voting process will save 50% to 60% of the cost compared to the traditional model, and it is also safe, transparent, efficient and convenient. Robert Greifeld, CEO of Nasdaq OMX, said that Nasdaq will soon launch a blockchain proxy voting application, and people will be able to vote on their mobile phones and have permanent voting records.

● Fourth, its application in the field of corporate behavior.

Figure 6: Traditional complex and highly intermediary corporate process

Like the securities clearing and settlement and proxy voting mentioned above, the business process in the corporate action field is also highly intermediary. For an instruction to be transmitted from a company investor to the initiator of the corporate action, it needs to go through multiple procedures such as fund managers (brokers), custodians, and agents. The complex and highly intermediary process makes the corporate action decision-making process cumbersome and expensive, and often leads to poor trading decisions, such as miscalculation of rights and failure of elections.

The blockchain application scenarios developed by Deloitte have also made breakthroughs in this field. Like applications using blockchain, this new corporate behavior management system eliminates highly intermediary processes and enables investors to directly participate in the management of corporate behavior. It is safe, transparent, convenient and efficient. It is reported that the blockchain company Symbiont is building the first blockchain-based smart securities trading and issuance platform, which can realize automated corporate behavior management. The platform's investors include Duncan Niederauer, former CEO of NYSE Euronext.

Special editor and author of the cover article "Blockchain: Changing the Future" of the February 2016 issue of Contemporary Financier magazine

Contributing Editor

Yang Tao, Assistant Director of the Institute of Finance, Chinese Academy of Social Sciences, Director of the China Blockchain Research Alliance, Contributing author

Wang Yongli, Vice President of LeEco Holdings (Beijing) Co., Ltd., CEO of LeEco Finance

Xiao Feng, founder of Wanxiang Blockchain Lab, deputy director of China Blockchain Research Alliance

Cao Tong, Chairman of Xiamen International Financial Technology Co., Ltd., Deputy Director of China Blockchain Research Alliance

Han Feng, PhD, Institute for Advanced Studies, Tsinghua University, Lifetime Member of Bitcoin Foundation

Qin Yi Deloitte Asia Pacific Investment Management Industry Leading Partner

Jiang Hai, PhD of the Chinese Academy of Sciences, founder of Bubi Network

Notes to Editors

When people in the financial industry ask themselves: After the emergence of blockchain technology, do you really know how it affects your organization and profoundly affects the future of the global financial industry? At the beginning of the new year, Contemporary Financiers, as a professional financial media focusing on "letting financiers see further", invited seven witnesses and leaders of the blockchain wave to record the development of this field in 2015, imagine 2016 and the future, express their insights on the operation innovation and market ecology of blockchain, and fully reproduce and interpret the special blockchain report in the hands of the central bank. Dr. Yang Tao, Assistant Director of the Institute of Finance of the Chinese Academy of Social Sciences and Director of the China Blockchain Research Alliance, served as the special editor-in-chief of the cover article of this series of this magazine. Wang Yongli, Cao Tong and other six experts collectively spoke here (including entrepreneurs with practical experience in blockchain technology and business practice and senior international investors who have made blockchain research reports for the People's Bank of China). The seven articles present a panoramic view of what happened in the blockchain market and what will happen! ! !