What Is Blockchain—And Why Should Financial Advisors Care?

blockchain


By James P. Dowd/ Contributor

Imagine it’s the early 1990s and someone tells you, “Hey, there’s a new thing called the World Wide Web and it’s really interesting. You should install a browser and check it out.” As an investor, you could have made a ton of money backing this new technology, and some people did. Those were the investors who were able to envision the transformative power of the Internet and find ways to monetize it.

Today, many technology experts consider blockchain technology to be the next iteration of the Internet. Venture capitalists invested over $1.3 billion in blockchain technology in the first half of 2018, banking on the idea that blockchain will eventually become integral to all business. Financial advisors who wish to stay current will greatly benefit from having a basic understanding of blockchain technology and crypto digital assets.

Fundamentals: What Is Blockchain?

• Decentralized Secure Ledger:  A blockchain is a decentralized ledger system that tracks data in a massively parallel system all across the Internet. More than a just a database, it securely tracks every sequential change that has ever been made to it, including the “address” of the individual who made each change. Instead of allowing for multiple copies of the ledger with different versions, there is only one trusted version, which exists in multiple locations at the same time, authenticated by and accessible to the members of the network, with details of every transaction and every user who has ever altered it. A blockchain therefore can be viewed as a decentralized, digital public record of transactions that is unchangeable and tamper-proof—a shared, secure source of truth. In comparison, most client-server databases are centralized, hub and spoke systems. In a client-server database, the data resides in the hub and the spokes represent different ways that users tap into the data, whether via HTTP connections over the Internet, or directly through an application.

• Cryptographic Technology: Blockchains are powered by cryptography, extending themselves and storing data by solving cryptographic problems that have a unique attribute: They are extremely complex math equations that are very difficult to solve. But once solved, it is very easy to prove that the solution is correct.

The graphics cards or the computers solving these cryptographic problems are called miners, and are rewarded for their work with small amounts of the crypto currency that underlies that blockchain, e.g., Bitcoin rewards on the Bitcoin blockchain; Ether on the Ethereum blockchain. These systems rely on the concept of “proof of work”—solving the cryptographic problem, then verifying that the solution is accurate. Blockchains are massively parallel systems. Try to fool the chain by writing data that is not accurate, and all the other nodes on the chain can invalidate your entry based on the specific cryptographic solution.

• Open Source Technology: Many blockchain technologies, such as Bitcoin and Ethereum, are open source software, which means there is no license fee to use them.  When building foundational infrastructure, having a significant installed base and a set of common, open standards are key prerequisites for a successful system. Open source technology can facilitate the adoption of agreed upon, open standards, since the code base is accessible and subject to review, critique and collective enhancement from the community of users. Open standards and open source technology have been a major factor in the enormous success of the Internet. There is no need to buy expensive software or learn proprietary protocols to be able to engage in development or consume vast amounts of Internet content.

Similarly with blockchain technology, open source code has led to rapid adoption, with no single monopoly or oligopoly dictating terms to the rest of the market. I believe this is central to the value proposition of blockchain technology, and it explains why open source systems like Bitcoin and Ethereum are thriving, while “private” chains have languished.

What Is The Difference Between Bitcoin And Ethereum?

There will be numerous firms involved in providing tools and resources that capitalize on the inherent benefits of blockchain technology, the fact that it is decentralized, open and secure. But the truly unique aspect is that the technology itself incorporates a virtual currency that rewards contributors and charges for use.

The Ethereum blockchain, which is the most widely utilized blockchain technology for application development, has decoupled the application layer from the protocol layer of the blockchain itself. While the Bitcoin blockchain exists to facilitate the creation, transfer and storage of Bitcoins, Ethereum not only allows for the storage and transfer of Ether cryptocurrency, but also is used to develop smart contracts and Ethereum-based applications.

This has profound implications for financial services. One $3-$5 trillion example illustrates the point: Consider, if you will, that most non-listed private assets, such as hedge funds, private equity funds and real estate securities, do not settle through the Depository Trust Company or DTC, which handles clearing of most publicly traded U.S. stocks, ETFs and mutual funds. Instead, they settle through a manual, laborious and inefficient process consisting of paper contracts, faxes, checks and wires.

The Ethereum blockchain, which is the most widely utilized blockchain technology for application development, has decoupled the application layer from the protocol layer of the blockchain itself. While the Bitcoin blockchain exists to facilitate the creation, transfer and storage of Bitcoins, Ethereum not only allows for the storage and transfer of Ether cryptocurrency, but also is used to develop smart contracts and Ethereum-based applications.

This has profound implications for financial services. One $3-$5 trillion example illustrates the point: Consider, if you will, that most non-listed private assets, such as hedge funds, private equity funds and real estate securities, do not settle through the Depository Trust Company or DTC, which handles clearing of most publicly traded U.S. stocks, ETFs and mutual funds. Instead, they settle through a manual, laborious and inefficient process consisting of paper contracts, faxes, checks and wires.

However, some advisors may already be hearing from a few clients experiencing FOMO—the fear of missing out. Thoughtful advisors or investors who take the time to learn about this new technology and its potential impacts will be ahead of the curve and could benefit from this early stage of growth.

In the meantime, here are some things advisors can do:

• Educate yourself

• Try to distill real information from the deluge of online data

• Take time to analyze the technology and opportunity, so that you can distinguish between potential scams and real opportunities

• Listen and learn from some of the current blockchain visionaries

• Be patient, because these markets are likely to go through boom/bust cycles

• Let clients know that you are watching, listening and learning

These are interesting, exciting times in the blockchain world. You and your clients will be well served if you pay close attention, ask questions and stay alert for opportunities.


James P. Dowd, CFA, CPA, is founder and managing director of North Capital Private Securities (NCPS), North Capital Investment Technology (NCIT) and North Capital Inc.