Banks embrace Bitcoin technology, will ‘crypto-currency’ finally break through?

Tuesday September 15, financial tech firm R3 announced that nine major banks will form a partnership to create a framework for using block chain technology. Block chain is the underlying technology for Bitcoin. The nine banks include JP Morgan Chase, Credit Suisse and Goldman Sachs.

Banks embrace Bitcoin technology, will ‘crypto-currency’ finally break through?

Does this mean that the global financial players are finally embracing crypto-currency in favor of the common world currencies?

Technology explained

Block chain can be described as a network based general ledger, which is continuously being updated and confirmed by connected computers, or ‘nodes’. In the Bitcoin block chain, transactions are also public. It is important to realize that all historical transactions are registered in the ledger, verified and shared by the network of ‘nodes’. It’s a decentralized technology which is in essence ‘tamper-proof’. Most people are familiar with the block chain for bit coin transactions, but the technology can also be used to exchange information between parties, with no verification of a third party needed. For delicate processes, like in the financial industry, this technology offers huge advantages.

Mutual benefits

The nine banks involved, Barclays, BBVA, Commonwealth Bank of Australia, Credit Suisse, J.P. Morgan, State Street, Royal Bank of Scotland, UBS and according to sources Goldman Sachs will partner in the project led by R3. The goal is to bring the block chain technology to the global financial system. Transactions in the financial industry need to be accurate, reliable and safe. The partnership will look for solutions to find better ways to record, reconcile and report financial transactions were these criteria can be met with higher success rates. The technology could also bring significant cost reductions, since separate systems by individual banks are no longer required. The interesting thing about the project is that all players can collaborate on an equal basis. The door for other banks is explicitly open, as stated by the project leaders.

Practical application

The block chain technology sounds a bit abstract, and since the bitcoin isn’t a tangible product, it’s difficult to see it’s practical applications. To illustrate an area where the block chain technology can work, the partnership looks for issuance of commercial paper as a first use. The technology would be used for the so called post-trade process. For instance, settlements can take place under far more reliable conditions. For transactions in exchange trading or over-the-counter (OTC) it may be too soon. However, the technology could be very useful for OTC-transactions. These are transactions where no official exchange is involved. Also settlement often takes place on mutual agreements rather than the usual standards. This makes OTC-trades far more in transparent, less secure and prone to errors. A block chain technology could bring huge benefits. Also the lack of transparency which was a major problem during the financial crisis in 2008 could be tackled. A lot of derivatives where spread over the system and nobody exactly knew where the risks were. With a block chain which features a public ledger like bitcoin, this would be no longer the case.

Start of a long-term project

It’s a promising sign that the nine major banks are willing to collaborate in this partnership. This means that there is a huge incentive to make this project work. However, the technology is relatively new and it needs to be tested on processes to prove its value. But the block chain technology is certainly an interesting basis for new platforms in the financial industry. However, this stands apart from the bitcoin and we shouldn’t see the action by the major banks as an endorsement for the cryptocurrency.

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