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Aon Retirement and Investment Blog

The Blockchain Future

If you utilize a checking account offered by your local bank, you are likely familiar with the world’s financial system. Your account is reconciled on a “closed ledger system” that is run by your banking institution. But what really happens behind the scenes? In this technology age that we live in, why does it take so long for checks to clear? Why does trading a stock take three days to settle? Why are banks still susceptible to data breaches? If only there were alternatives… enter the “open ledger system.”
 
An open ledger system, called a “blockchain,” is a public ledger of all addresses, balances, and transactions. Thousands of powerful computers work around the clock to reconcile, update, and maintain the blockchain. Perhaps the most well-known blockchain is the one that Bitcoins utilize. This blog entry is not about Bitcoin as a currency or investment, but about the blockchain technology behind its transaction processing, which could find its way into the mainstream financial system.
 
There are some important distinctions to make between a closed ledger system like the one utilized by your banking institution and an open ledger system.

  • The blockchain is open source: It is being modified by developers 24 hours a day. This allows for continuous advancement of the code, significant fraud protection, and nearly instant transactional reconciliations.
  • The blockchain is decentralized, peer-to-peer: There is no centralized entity to regulate the ledger. In the Bitcoin example, its value is solely determined by market supply and demand and cannot be influenced or manipulated by any regulatory entity like the Federal Reserve.
  • The blockchain is an open network: The ledger is open and available to anyone at all times. The entire blockchain can be fully audited for every transaction that has ever occurred.
Blockchain Benefits
 
One of the largest benefits to using an open ledger blockchain is the transparency it provides. Each and every transaction is available for everyone to see, including the date and the amount of the transaction. Personal information, however, is not revealed. The blockchain provides a complete and accurate audit trail for all parties, which reduces the risk of default.
 
Improved security is another major benefit of the blockchain system. There is no third party or clearing house for blockchain transactions since they are all peer-to-peer; therefore, it significantly reduces the risk of a breach. Furthermore, powerful computers are constantly working to reconcile the ledger so the blockchain protocols cannot be manipulated by individuals, organizations, or even governments. This process makes it nearly impossible for certain types of fraudulent activities to occur.
 
Another inherent advantage to an open ledger system is the speed at which transactions settle. When you deposit a check into your bank account, depending on the time of day, it could take several business days for that check to clear. Stocks that are traded on an exchange take up to three business days to settle. In the Bitcoin example, transactions are often settled within 10 minutes. As open ledger systems continue to be developed, the settlement window may be reduced to nearly instantaneous. The implications for large institutional entities that trade securities on a regular basis are incredible.
 
The potential for lower fees associated with transactions may be significantly increased by using a blockchain. For starters, reducing defaults and fraud immediately lead to lower recovery costs. Additionally, cutting out all of the extra levels of authentication eliminates the need for extra layers of fees.
 
Blockchain Limitations
 
Perhaps the largest obstacle for open ledger systems is the lack of awareness and understanding of how they work. Blockchains are still developing and there is no standard protocol. In order for an open ledger system to be utilized as the backbone for transactions, there first needs to be greater acceptance among the global population.
 
Some of the benefits of blockchains can also be drawbacks, such as security and transparency. While the transactions themselves are secure and transparent, the parties involved in the transactions have added responsibilities. Since no personal information is attached to the transaction, each party must maintain and manage the unique codes associated with each transaction. If these codes are lost, stolen, or destroyed, so is the ownership of the transacted item. The most well-known example of this is when the Bitcoin exchange Mt. Gox was hacked and more than $470 million of Bitcoins were stolen.[1] The blockchain system didn’t fail, but rather the unsecure exchange platform (Mt. Gox) that allowed people to buy, sell, and manage their Bitcoins.
 
While there are other benefits and limitations beyond what’s discussed above, the future implications for both retail and institutional investors may be significant. Banks and other financial institutions have begun to explore ways to use blockchains. On December 31, 2015 the Nasdaq executed a private securities transaction through an open ledger system. Other entities including Overstock.com have experimented with blockchain transactions over the past year as well.
 
Open ledger systems have the potential to enhance the transparency, improve the security, and increase the speed of transactions. There may be additional cost benefits, as well. Furthermore, the implications are not necessarily limited to financial transactions, but may include other transfers of information including copyrights, patents, deeds, and different forms of licensing. While it is unlikely that open ledger systems will ever fully replace our current financial system, there may be practical applications for it in the future.
 
Jon Salett is a senior consultant and Aon Hewitt’s Chicago office. 

The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs.Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case, nor should it be treated as investment advice. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal or investment advice. Please consult with your independent professional for any such advice. The blog content is intended for professional investors only.


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