Block Chains in The Financial Sector Should Benefit Consumers

While consumers are unlikely to have direct contact with a “block chain,” the advantage that these public ledgers deliver to businesses will be felt in higher security and lower costs for consumers.  The use of block chains in the financial sector is still under development so it may be poorly understood.

Block chains have long been the public record associated with the pseudo currency named Bitcoin.  All Bitcoin transactions are included in its block chain and anyone can study that block chain to see some details of transactions.  In Bitcoin’s block chain, each transaction is linked by a complex mathematical progression to the transaction that preceded it.  That chain of linkages and public visibility makes it nearly impossible to erase or alter Bitcoin’s records without leaving an obvious mess, and therefore it is nearly impossible to “cook the books” to obscure traces of fraud.

The financial sector has a different set of needs than do Bitcoin users, so financial companies are adopting a block chain with attributes suited to their needs.  Only certain kinds of transactions would be recorded in the financial block chain.  A serious transaction — such as the sale and purchase of customers’ stock and the commitments to send and receive the cash to balance that transaction — would be recorded in the block chain, but banks are unlikely to use block chains to record the nickels and dimes of interest payments paid on small deposit accounts.  In the financial sector, sometimes a lot of complex information is needed to clarify a transaction to the satisfaction of the parties.  For that reason, financial sector block chains can include standardized legal terminology that identifies conditions which are an integral part of the transaction.

In the financial sector, the privacy of customer’s information and transactions must be maintained, so only the parties involved with a transaction would be allowed to see the transaction details recorded in the block chain.  The need for privacy is most obvious in the context of large stock trades.  There, it is important to prevent a competitor’s surveillance from discovering the intent to trade and “front running” the trade, i.e. doing the trade first thereby stealing the opportunity.  That would be equivalent to insider trading.

Clearly, the financial sector’s need for privacy is incompatible with the wide open public visibility and only the parties to a transaction can verify and “see” the transaction details in the financial block chain.  All other parties would be unable to identify where in the block chain the transaction was located and if they stumbled onto it, it would appear as gibberish.  Unlike in the Bitcoin block chain, the financial sector block chain has no “supervisory users” with universal access.  If needed, a regulator’s access to specific transactions in the financial block chain is arranged through a transaction between the regulator and one of the principals to the targeted transaction.

Of those block chains under development, about 50 banks and related businesses collaborate in a group called “R3” where they articulated financial sector needs and funded the related software development.  Several other groups are developing financial block chains, but divergence in the standards used by the developments cannot persist because businesses will be unwilling to support more than one standard approach for recording transactions with other businesses.  The strong motivation to coalesce around one good design is likely to come from the US Treasury when it picks the version of block chain it prefers.

The financial sector expects block chains to result in less coordination costs, lower regulatory compliance costs, and lower costs caused by fraud and security breaches.  The collaborative approach to developing a block chain seems well suited to the industry’s needs.  Consumers should benefit from these lower costs and fewer security disruptions.

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