What is Blockchain?

In order to understand blockchain it is necessary to understand the concept of Distributed Ledger Technology (DLT). At its simplest level a distributed ledger is a virtual accounting ledger where transactions are recorded in real time and distributed among the ledger participants. All participants are connected to the ledger via a computer node. Transactions have to be agreed by the participants before the ledger can be updated and then copies of the updated ledger are distributed to every computer node. This means that every party has access to the same information. Blockchain is the most well known type of DLT and involves transactions being grouped together in blocks and signed using a cryptographic signature. Blockchain is an extremely secure technology as hackers tampering with the block will alter the signature and this will immediately become apparent to all the members of the ledger. Also the distributed nature of the technology means that any hacker attempting to corrupt the records has to access every computer node. Another great advantage is that blocks of information are also recorded permanently on the ledger with each block linked to the previous block by the cryptographic signature meaning that there is a very clear transaction audit trail. Blockchain was originally designed to process Bitcoin transactions, but has subsequently been used to process a wide range of cryptocurrencies and virtual coins.

In summary blockchain offers simplicity, security and transparency for transaction processing.

Blockchain and payments

Payments has become one of the strongest use cases for blockchain, especially cross border payments. Processing these payments can be both slow and costly with a potentially lengthy chain of intermediaries being involved including banks and clearing houses, each one taking a fee. Hence the attraction of a blockchain platform where payment providers can settle with each other directly saving both time and money. In addition the consensus nature of Blockchain means that payment providers could achieve substantial back office efficiencies and costs. This is because today players can often make errors when recording transactions with each other leading to reconciliation breaks which then have to be investigated. On Blockchain platforms all transactions are agreed upfront and hence there is no scope for error. Finally there will be a complete and transparent audit trail of all transactions which regulators will find particularly attractive in terms of fraud and sanctions monitoring.

Challenges

• While there are any number of blockchain driven payments initiatives (see next section) none of them have yet achieved scale. The major payment players continue to use the traditional infrastructures although a number of them have their own blockchain initiatives.
• There are a plethora of Blockchain platforms in the market, but for the most part they are not interoperable with each other. This makes it very difficult for companies to exchange payments with each other unless they are on the same platform. Various standard bodies are attempting to address this issue.
• While payment providers can exchange crypto and tokenised payments with each other these payments have to be funded in the real world. Typically this means that a provider has to fund a bank account with cash and then translate that into a crypto coin/token.
• Blockchain platforms will often have to be integrated into legacy back office platforms. Transactions will have to be recorded on those platforms as well.

Blockchain payments use cases

• Ripple is a blockchain payments provider that has over 300 clients and can offer payment services in 40 plus currencies. Using their “Ripple Net” platform payment providers can exchange payments with each other in seconds. Liquidity is either sourced by the payments provider from their bank account or they can use “XRP” which is the cryptocurrency that Ripple has created.  Payment providers would simply exchange their own currency for XRP.
• Composed of around 20 banks and exchanges, Fnality has created its own virtual coin known as “Utility Settlement Coin’ (USC). The members will use the coin to settle FX and other transactions with one another, each coin being fully backed by cash at the respective member’s central bank account. This is a good example of a so-called “stablecoin” where the virtual coin derives its value from a “real” asset such as cash or securities. Fnality is looking to go live in 2020 with five initial currencies.
• Also a stablecoin Libra was created by Facebook in the first instance to provide a payments service for the unbanked. Based on a blockchain platform Libra allows individuals to open virtual wallets which can be used to hold Libra virtual coins. The coins are obtained via exchange from a local currency and users can hold the wallet on their smartphones from where they can make Libra coin payments to other users. Facebook Itself ensures that all stablecoins can always be redeemable by backing them up by a reserve of cash and short term securities in each national jurisdiction.
• Central Bank Digital Currencies (CBDCs). This new development can be seen as the ultimate stablecoin . A number of the world’s central banks are contemplating the issue of a digital version of their local currency which amongst other functions could act as an alternative to cash. A number of factors are driving this including the reduction of cash in certain countries, the perceived threat from private stablecoin initiatives and the inefficiencies of cross border payments. While no CBDC has yet been launched, a 2020 survey of 66 central banks by the BIS found that 80% of them had launched CBDC projects. The launch of a CBDC would have a major impact on both domestic and cross border payments infrastructures.

While Blockchain as a concept has not yet reached scale the number of initiatives in both the public and private sector is growing. It is likely to be a strong factor in the payments landscape over the next few years and here at Authoripay we would be very happy to discuss the implications of this with our clients in greater detail.