IT Systems: Blockchain in Finance – Are Some Features of Bitcoin Transferable?

At the end of October, we celebrated 10 years since the so-called Bitcoin White Paper was released – a basic document describing the theoretical functionality of the P2P payment network, Bitcoin. What is the course of 10 years Bitcoin – and its underlying technology in the form of a blockchain database – has changed and what else can be changed?

The creator of Bitcoin, known under the pseudonym of Satoshi Nakamoto, is still surrounded by mystery. In addition to the White Paper, he also published the original Bitcoin source code at the beginning of 2009, and subsequently, he helped to correct numerous bugs which were discovered by Bitcoin enthusiasts over the years. In December 2010, however, Satoshi definitely disappeared from the scene and left Bitcoin to the global community of programmers and dreamers who dream about the world of money without an intermediary. Few people in these ancient times knew how much Satoshi’s work would influence the world in just one decade.

Bitcoin was originally conceived as a decentralized, digital alternative to state money. All previous attempts at creating digital money alternative have tragically failed – project operators such as Liberty Reserve or e-gold ended up in prison after a few years, typically for alleged money laundering and unlicensed money exchange operations. Users of these alternatives have often lost all of their resources. Bitcoin, on the other hand, has no central failure point from the beginning – The Bitcoin network is operated by a global community of volunteers who run transaction knots (nodes).

In other words, this time there is no longer anyone to be put in prison and no way how to do so, therefore, Bitcoin has been a continuous alternative to state money for 10 years. Its market capitalization jumped over a hundred billion dollars for the first time during 2017, and million-dollar transactions and businesses are traded on this decentralized network every day.

Digital scarcity

Since Bitcoin is unlikely to disappear now and even large financial players slowly begins to recognize it, questions, whether Bitcoin’s technology can be used for other purposes than just as an alternative form of money, arise more and more frequently.

Money, of course, is not the only financial instrument. Besides money, the world needs stocks, bonds, futures, bills of exchange, derivatives etc. The other major areas are tools allowing the ownership record keeping of such instruments – accountancy books, depositories and settlement tools.  

Efforts to be inspired by Bitcoin and to innovate in the traditional finance field have taken place in the form of implementation of the underlying Bitcoin database itself – the blockchain. However, these experiments are often condemned to failure because they are based on a misunderstanding of the true nature of blockchain. Blockchain as a shared accountancy book without a central administrator is meaningful if it is used to record and transfer some ownership.

In fact, Blockchain allows the existence of so-called digital scarcity. The standard way of sharing digital goods is coping – so, after all, from the beginning of the Internet, media companies are fighting with so-called pirate content that is being spread through copies. The only way to preserve the scarcity of digital goods was to make it impossible for them to interact with the Internet (which is almost impossible, as the record companies experienced).

With the existence of Bitcoin (and blockchain), however, it is possible to openly work with digital goods while preserving their scarcity. There will never be more Bitcoins than 21 million and single Bitcoins can be spent only by irreversible transfer to another address – this is ensured by a protocol over which the decentralized network of nodes watches. The operators of nodes have a financial interest in ensuring that the rules are observed (otherwise, the value of Bitcoins they hold or mine would fade away).

Besides the decentralized network of nodes, sufficient computational performance (hashrate) is required for the digital scarcity. The hashrate ensures that transactions recorded on a blockchain are unchangeable retrospectively and that no one can manipulate or stop future transactions.

Therefore, experiments in the form of so-called private blockchains or blockchains without tokens do not make sense. The blockchain is suitable for enabling digital scarcity, however, there seems to be another more efficient and cheaper database that is more suitable for other use.

 

Blockchain and tokens

Therefore, the proper use of the blockchain is the record keeping of the ownership and its changes – in a blockchain environment, the ownership is represented by a token. In the case of cryptocurrencies, the tokens are a payment instrument or money that works in their own right. In the case of traditional financial structures, the tokens mean a representation of one of the instruments mentioned above – a bond, a stock, a derivative etc.

Blockchain, in short, can replace depositaries, securities central record keeping and securities settlement instruments rather than internal databases and logistics tracking applications. Therefore, in order to play a real role (not just a pseudo-innovative gilt) in this function, it is necessary for the nodes of such a blockchain to be operated by an independent network (i.e., for example, Bitcoin blockchain or Ethereum blockchain) and to be used to record and transfer tokenized asset.

Tokenization is the process of converting a particular asset or a contractual relationship into a blockchain token. As part of the tokenization, the issuer defines what exactly the tokens express and concludes a contract (such as so-called token holder agreement) under the applicable law with the investors during token sale. Such a contractual relationship is subsequently moved forward by token transfer to new holders (e.g. when selling a token on the secondary market).

For the time being, it is not possible to tokenize all kinds of assets – the whole concept of tokenization is experimental and awaits the results of the work of the first pioneers. A very unknown is the approach of individual regulators, who often work with the fact that the security has to have the form of a document, which the token does not meet because of its nature – therefore, for example, to tokenize a share is not possible at the moment. Another obstacle is the requirement to list securities in depositories. The question is how far these requirements are sustainable in the 21st century. The role of depositories as trustworthy ownership record keeping can be held today by public blockchain with sufficient hashrate as well (or maybe even in a better way).

However, if a successful dialogue is established with the regulators and at the same time the tokenization is grasped professionally in technical and legal terms, an evolutionary step in the field of capital markets could occur. It could be then comparable to, for example, the discovery of the venture capital concept.

 

 

The tokenization brings the following benefits (assuming that other benefits will come later on):

  • global blockchain depository of securities
  • 24/7 markets
  • ownership transferability without the need for intermediaries, using the so-called peer-to-peer stock exchanges
  • automatic dividend delivery
  • continuous sending of dividends, e.g. through daily microtransactions
  • transparency of the issue
  • statistics on the holders of the tokens concerned
  • transparency of movements that discourages insider trading
  • simpler implementation into both national and global crypto stock exchanges, since tokens operate on the same technological basis, there is no origin of environment type “walled garden”
  • immediate settlement of trades

Today, many projects and companies deal with the tokenization. They start a dialogue with regulators and represent their solutions to the world gradually. Some projects (Polymath, Neufund) deal only with the regulatory and technical aspects, other (Czech XIXOIO) then strive to build a full-scale ecosystem that can lead companies interested in the tokenization through the whole process, from the assessment of the plan, the issue and the sale of the tokens, to the subscription on a regulated stock exchange and oversight of the liabilities arising from the relationship between the tokenized company and the token holder.

The first ten years of the blockchain have been marked by internet money; the next ten years, however, will be typical of an evolutionary step in the field of corporate capital – tokenization of assets.

Author: Richard Watzke

The interview was released in the IT Systems Magazine