Blockchain – an earthquake, a tsunami, a revolution for fintech

Paul Schulte will be a keynote speaker at the upcoming Global Payment Summit (GPS), an international event designed to provide payment & transaction professionals and consultants from around the world with a unique, networking and educational experience. Delegates will learn directly from industry experts and peers about the latest thinking and developments in the ‘transaction space’.

“The unstoppable force of blockchain is barreling down on the entrenched, regulated and ossified infrastructure of modern finance. Their collision will shape the landscape of finance for decades to come”.
-- Don Tapscott, Blockchain Revolution

Tsunamis are moved by earthquakes. And the tsunami that is blockchain has certainly been caused by a massive quake – the GFC. The GFC tremor exposed massive fraud, collusion and misdeeds throughout the western financial system – in banks, brokers, ratings agencies and regulators. And no one went to jail. So, it is no surprise that bitcoin was born on November 4, 2008, at the crescendo of the market collapse. Since then, the practical manifestation of blockchain - which is bitcoin - has gone from a worth of exactly zero to USD 120 billion today, even after a spectacular fall from grace. Then we have ethereum, bloc.one, Telegram and more than 4,000 ICOs worth tens of billions. This evolution was indeed a big bang born out of the Great Financial Fire that was the GFC.

Let’s think of bitcoin as we do of email. It’s a vital new invention. And it does have value. It’s just hard to really put your finger on the precise value of each and every ICO. The really important part of this phenomenon, however, is the underlying delivery system of blockchain. Let’s think of blockchain as HTTP, the omnipresent protocol which drives all email traffic. It is the new application of a teenage technology which is making rapid inroads into every major sector of the financial system.

One fintech development after another keeps coming down at an astonishing speed and I always hear the same things: “Why did it take so long to develop this?” “Why did it take so long for us to realize that couples do their banking at night when banks are closed?” “Why shouldn’t we be able to hail a taxi on a smartphone without having to wait 10 minutes for a taxi dispatcher to find a taxi and then wait 15 for a taxi to arrive?” “Why has it taken so long for banks to get rid of paper?” And so on. I believe blockchain will make these questions ubiquitous throughout the financial system in a few years. Let’s take a few examples.

The chart above shows what blockchain is and how it threatens all forms of finance as we know them. I call it the BlockClock. The hours of 12 to 3 concern the accountants. In a few years, we will ask, “Why did we use to wait 4 months for an audited report to understand a company’s health?” Blockchain will make an audit a “live” event. It will hold the board of directors accountable. It will be immutable, so there is a very public record of decisions – time stamped. It will be a live traceable audit for all to see in real life – traceable, live, immutable. What will be the role of the accountant if the community performs these tasks on their behalf? Accounting firms are scrambling to maintain control of their fiefdom when they should be finding ways to make the blockchain as large as possible in order to include as many people as possible in it and make money from an enormous community. Nothing will come from trying to have a ‘private’ blockchain for each accounting firm. It’s like climbing to the second story of a building when there is a 30 foot tsunami on the way. It might provide some psychological relief but it is actually self-delusion. The advice? The blockchain is a LIVING AUDIT. Accounting firms are currently delivering an audit which is DOA. Think much bigger.

On our clock above, the hours from 3 to 6 concern the area of innovation. Blockchain has the capacity to set standards and offer precedents. In this process, it can act to digitize physical assets. It is the building block for the digitization of physical assets into electronic tradable units. Essentially, it offers identity and provenance to physical assets. And this combination turns these assets into tradable collateral. (This tradable collateral is a tradable token of value, which should not be confused with the tokens for every dubious Tom, Dick and Harry ICO). This is true digital banking. It can be done without a bank and without all the onerous ID paperwork that banks force us to endure. Lastly, something emerges from this which is vitally important and game-changing. The nodes (tokens) which are an agreed-upon representation of physical assets (and therefore turn ID and provenance into assured ownership) are a “third” part of the balance sheet. These nodes are both physical representation of assets (inventories) as well as financial representations of assets (receivables) and can, therefore, be seen as a triple entry dynamic. This has profound implications for banks, as any blockchain entity can conceivably take away working capital from a banks. And it can also do a much better job on quantifying risk when it comes to insuring physical assets. Get used to triple entry bookkeeping.

This brings us to the bottom of the hour with our blockclock. The hours of 6 to 9 concern insurance. Essentially, this speaks to the issue of openness. Blockchain can connect a whole array of physical assets which were hitherto structurally disconnected. Examples of this range from a string of test results for one person, which are lying all over the place to a string of hospitals with disconnected data sources lying about. Zhong An and Ping An are pioneers in this attempt to use blockchain to integrate hospitals, clinics and pharmacies to the journey of healing for each individual – from clinic to post-op. Blockchain also holds promise for improving the integrity of healthcare information systems, something which is a hot topic given the rise in hacking of national data bases. Lastly, the world of blockchain is most useful in the insuring of physical assets because we will soon have an explosion of sensor data (the price of sensors has collapsed) on physical activity which needs to be given a digital representation so that they can be sorted and understood. Only a tiny amount of physical data has a sensor and only a tiny portion of this sensor data is analyzed. Insurance companies need to get with the program on this pronto. This physical data includes our biometrics, oil rigs, factories, ships, cars, and more.

Lastly, the period from 9 to 12 on this clock is for the feature of blockchain which offers efficiency. This goes for many historical cartels which have become lazy and inefficient. It speaks on many of the questions that we have about legacy systems and which have not been upgraded in decades. “Why does it still take three days to settle a stock?” “And more than 20 days to actually completely settle the financial transaction around a stock from start to finish?” “Why is the world beholden to SWIFT and why is it considered anathema to even ask this question?” “Why do these inefficient entities get a cut on all bond and equity trades in the custody process?” The middlemen are in trouble here as blockchain enters and can radically lower costs and also increase efficiency.

In conclusion, I have read the riveting book Blockchain Revolution (Tapscott) in a few sittings and was mesmerized by its theme that the revolution we see in front of us is a desire to get away from entrenched cartels. I never thought about it, but every part of the financial system in the West is a cartel of dubious quality and character. Three companies control ratings. Four banks control the retail and corporate banking system in the US. Three banks control investment banking. Two banks control settlement and clearing. Five firms control the bulk of asset management. And decisions by the few banks which control SWIFT can make or break a country overnight. Blockchain is a way to escape the high cost, suffocating inefficiency, problematic self-interest, endemic corruption, elitist lending and the political straight jacket of the current financial system. Because blockchain is virtually free, inclusive, standard-setting, decentralized and offers new forms of provenance and collateralization, I believe blockchain will only grow and spread. Incumbents need to stop fighting a rear guard action of protecting cartels and start finding ways to integrate blockchain into their models. There is no third way.

About Paul Schulte

Paul Schulte is founder of Schulte Research, set up in 2012 researching financial institutions and financial technology. He has spent 3 decades in research on financials. He has worked for all 3 branches of US government, including the NSC at the White House. He currently teaches in 3 universities, has written 3 books and authored hundreds of articles. He has worked for the Number 1 investment bank from US, UK, Japan, China & Switzerland starting in 1990. He has taught on 4 continents. His focus is technological change in banks & insurance. He has been a source for the WSJ, NYT, Bloomberg, Nikkei, FT, Economist, Barron’s and Forbes. His clients include some of the largest sovereign, pension, mutual and hedge funds globally.