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Myth of distributed ledger technology democratizing financial services market

Blog: Ilkka Huikko

Decentralisation of data and data processing via use of distributed ledger technology (such as Blockchain) is often regarded a profoundly good thing that enables us to (1) create a world where a single consumer is empowered (2) avoid risk of data residing in a central data base being hacked or corrupted (3) eliminate redundant intermediaries, i.e. middle men and (4) create a world where less regulation is applied. These expectations are often presented by crypto currency enthusiasts, digital visionaries, start-ups, independent consultants and even people like me, consultants working for big brands.

Let me start by stating that I believe in distributed ledger technology’s potential to change the way financial services are created, processed and distributed. But while I genuinely believe there is true merit in distributed ledger technology, especially in the space of private Blockchain, I think that some of the expectations for the future of public Blockchain are more than a bit too high.

So let’s explore these expectations briefly:

Point #1. Create a world where a single consumer is empowered.
Those that were around in the 1990’s surely remember that the Internet was first seen as a vehicle for freeing consumers from constraints of the limited offering of, e.g., large news and media corporations. What happened? It is true that certain aspects of free information and service flow have been realised that benefit each of us. And this has meant the decline or collapse of many formerly established businesses. It is also true that another level of existence has emerged via social media. We now live in a world where it is possible to be heard and seen more than ever before, but either in a self-censored or moderated way. This development has increased the power of platforms enabling the flow of ideas. The consequence: even larger corporations emerged after two decades of the initial expectations – and we currently take this for granted. We also need to observe that many of the earlier media corporations (and retailers) still exist, partly due to the fact that many of us appreciate and see value in the effort these players are putting in to creating offerings – either media content or retail offerings in front of us.

Point #2. Avoid risk of data residing in a central data base being hacked or corrupted.
Many Blockchain proof-of-concepts suggest that the most feasible way to implement a Blockchain is not to include all the data in the Blockchain itself but rather in one or more data storages that are accessed from the Blockchain process. If this emerging best practice prevails, there still is a “central data base”. In fact, the distributed database itself is not the main component of Blockchain but the effective and efficient way of creating distributed processing and complex transactions. Some specialists say it is substantially easier and faster to create these processes using Blockchain. This is due to the fact that the protocol itself includes the parts that were, and still are, quite hard to implement using more traditional technology. The productivity factor is said to be 3–4 times in favour of Blockchain. And this is exactly why I think a major change will be evident over time. This is also why I think the private Blockchain implementations combined will be of a larger impact than the public ones.

Point #3. Eliminate redundant intermediaries - i.e. middle men.
Blockchain enthusiasts often omit a key value-added attribute of these intermediaries. They act as a reliable counterparty and sort out any errors or other messy situations. If there is no such counterparty, one is at the mercy of a random one-time transaction partner, even if the identity of this party is known. This most likely is fine when the interest in question is of small value (or at very least: the loss is bearable). But when the interest is one of the most significant things in a person’s life, the situation is different. On a more philosophical level, people tend to believe in ideas, but trust other people. Therefore, while we all might believe in the idea of the Blockchain, only some of us will trust this idea to take care of our needs unless there is a party or instance backing up this idea. Just consider religions and draw parallels. As a side note related to Point #2, if there are central data bases, there still needs to be a party maintaining them.

Point #4. Create a world where less regulation is applied.
There are two sub arguments:
First, many people say there should be no regulation at all. For some reason, regulation is often seen as a bad thing and it is easy to see why. Implementing functions and activities required by regulation is a tedious and costly task. Not all regulations are thought through when it comes to these practical consequences. Still, regulation typically exists because there is view that something or someone is worth protecting. As long as a majority of people share this view in any particular case, the regulation should be regarded as legitimate.

The second claim is that a regulator or jurisdiction can only control people, not software. So, if the Blockchain is genuinely decentralized, there is no way any jurisdiction can control exchanges in this Blockchain. It is only a piece of software written once and published to be freely used. But wouldn’t it be people who create these Blockchains and wouldn’t it be people using them? People, by definition, are subject to jurisdictions. And, as said above, it is likely that there will be a party maintaining the central data base. This party would be subject to the laws of at least one jurisdiction.


If the reasoning above is even close to correct, where does this leave us? Here is what I think might be a realistic scenario on public distributed ledger domains:

New solutions based on distributed ledger will emerge in any case. Looking at the payments domain alone, there is a lot of disruptive potential – e.g. cross-border payments are most natural target for disruption (high fees and slow process). Incumbents are, or at least should be, quite busy in renewing their services and related cost structure in order to compete with new emerging solutions. The tricky part is that they should – in cooperation with each other – be able to agree on a new architecture of industry standard procedures. This is not at all fast, nor easy.

Some of these new solutions (or similar solutions created by incumbents) may turn out to be the new standard – and therefore gradually pull a vast volume into the new service, replacing the services currently provided by the incumbents. A key indicator of change in financial markets is the trust in large corporate clients. When some of them take the first steps towards emerging solutions and then replace part of their existing banking relationships, the volume will move fast. Corporations are, however, conservative. They run their risk management drills and are therefore hesitant to trust any solution or service without a proper responsible party. Consumers may act differently, assuming they only have a low amount of interest in play, as said above. In any case, it is likely that there is a party administering the solution (or at the very least, one or more data storage concept and solution related to it).

As soon as the volume reaches a certain threshold, states and regulators will increase their attention – and will introduce new rules and mechanisms to enforce these new rules. At the same time, the potentially global nature of the new services will – even more drastically than today – exceed the limits of nation states’ jurisdictions. Therefore, the new services will trigger more global harmonization and potentially also simplification of regulations. While I believe this direction will be gradually realized in any case, it is highly likely that there would need to be one or more bubbles bursting that disturb the overall economy and/or increase public interest before the need for regulation is widely accepted. As I write this, the value of Bitcoin has hugely increased in a very short time. During the transition period, it is likely that we will see different progress in different geographies. Europe, North America, Asia and African countries will handle the change in different manners. Some services may be banned in some countries or regions. There will be messy processes both when amending laws and when pursuing interests in courts. Remember the effect of Uber – they still have plenty of outstanding lawsuits all over the world, but a certain amount of harmonization has occurred already.

In the end, the most efficient structures will prevail. And it is almost certain that these will be Blockchain (or equivalent) solutions. It is still unlikely that these solutions would profoundly democratize financial services. They will simply provision services more efficiently.

Some of the remaining players are likely to become huge corporations that orchestrate vast global eco-systems. They provision service with a tiny margin but will become insanely profitable. The only remaining question is – will they be controlled by current financial service institutions or new players? And just as in any boom/gold rush/dot.com era, many players – both financial institutions and new players – will be out of business, either closed down or merged with other institutions.

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