Could blockchain make the financial services sector irrelevant?
Zoe Wyatt, Partner at Andersen Tax UK, discusses the inevitability of blockchain, whilst exploring banks’ attitudes towards the emergence of new financial technologies, and highlighting how the two can, in fact, work hand in hand.
Zoe’s article was published in Finance Monthly, 30 January 2020, and can be found here.
The first industrial revolution in 1780 began with mechanisation. It was followed by electrification in 1870, automation in 1970 and globalisation in the 1980s. Today, we have digitalisation of the industrial process and tomorrow there will be ‘personalisation’ (industrial revolution 5.0): the cooperation of humans and machines through artificial intelligence (AI) whereby human intelligence works hand-in-hand with cognitive computing to personalise industrial processes. This might involve the creation of bespoke artificial organs operated by computers talking to one another, automation of the manufacturing process, or self-executing contracts (smart contracts), and so on.
John Straw, a disruptive technology expert involved in developing the 5.0 model, recently claimed that blockchain could render the financial services industry irrelevant, thereby killing off the City of London and constricting the tax revenues that fund the NHS. Straw makes some headline grabbing comments, but do they have any substance?
Blockchain is the technology that underlies cryptocurrencies, such as Bitcoin, and whilst it has existed for approximately ten years, it remains relatively new.
In simple terms, blockchain is a digital archive of information pertaining to an asset, individual and/or organisation. But this is no ordinary digital ledger. Its technology features:
- the ability to validate data entered on the blockchain as correct and complete at the time of creation;
- data that cannot be changed; new blocks of data are added sequentially and chained to the last block. The story the data tells can be added to, but its past cannot be modified;
- multiple parties must consent by a majority or pre-defined basis on the validity of additions to the blockchain;
- multiple copies of the data, in encrypted form, are stored on the computer systems of numerous globally disseminated individuals/organisations participating in a particular blockchain network;
- respecting the privacy of that data;
- although there is potential for a malicious attack on a specific computer to successfully change data held on its copy of the blockchain, other participants in the blockchain network would be alerted and the true blockchain restored. In this sense, the blockchain is immutable
- an accessible audit trail.
These characteristics diminish the role of intermediaries who are traditionally used to validate data and ensure that it is kept safe. Therefore, Blockchain has myriad potential applications: investment in blockchain start-ups, which are developing solutions for the financial services sector, is staggering.
Technical issues exist in overcoming scalability, transaction speed, and energy consumption. However, these will be resolved in the near future as companies develop ways in which the blockchain can be stored ‘off-chain’. This will ensure that it does not need to be downloaded entirely by a node to verify a transaction using AI, amongst other tech, to guarantee that the immutability of blockchain is not undermined. It also creates scalability and reduces energy to such a degree that even the idle computer in a car or mobile phone can be used to verify transactions.
Blockchain technology can be deployed by the financial services sector to:
- Assist with almost real time settlement and reconciliation of transactions as the intermediaries used to verify and authenticate parties to a transaction and the source of funds are removed
- Program self-executing commercial agreements
- Trade stocks and shares in real time
- Reduce costs for financial transactions through efficiency gains
- Remove time limits and payment failures
- Track financial transactions, preventing fraud and money laundering
- Diminish exposure to currency movement
- Minimise risk of inflation or currency depreciation where it is separate from the state and/or bank.
Although blockchain technology has the power to change the entire traditional banking system, it does not represent disaster for the City of London. Although traceability of transactions and, therefore, tax evasion cannot yet be mitigated entirely, blockchain can indeed help to resolve some critical tax evasion and avoidance issues.
HM Treasury has already developed a proof of concept for VAT using blockchain technology. This should eliminate large swathes of VAT fraud. Given the advent of digital identity, tighter anti-money laundering (AML) procedures administered on blockchain and a widely adopted digital currency, tax evaders will have nowhere to hide.
Blockchain and smart contracts have the capacity to completely transform the audit and tax industries, including multinational corporations’ in-house CFO/finance functions. When coupled with AI technologies, this will enable the digital preparation of accounts and tax return, and the performance of audits. In turn, this facilitates absolute tax transparency, making it easier for tax authorities to raise and conclude enquiries more efficiently into, for example, transfer pricing on intra-group transactions.
Most importantly, the tax and regulatory systems need to evolve somewhat faster than we have so far seen on other new business models and supply chains.
To realise these benefits, seamless interoperability of different technologies is required, together with cooperation between multiple parties, as opposed to a single banking system. This will allow for comprehensive management of the risks that Straw prophesises.