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How The Shadow Banking System Plans To Create A Global Currency With Blockchain

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 titanic1    244


It doesn’t feel like a revolutionary moment. A member of a small team from the Swiss bank UBS, holed up on the 42nd floor of London’s Canary Wharf, taps a screen and a bond is sold by a company called ABC to an investor called XYZ.

It is the type of transaction executed millions of times a day by banks globally but this dummy transfer is different. It was completed via an internal blockchain, the shared database technology that gained notoriety as the platform for the crypto currency bitcoin. Banks are now racing to harness the power of the blockchain technology, in a belief that it could cut up to $20bn off costs and transform the way the industry works.

UBS is not alone. Its skyscraper laboratory is part of a huge experiment taking place across several industries that is most pronounced in the finance world. Banks, insurers and companies ranging from IBM to PwC are trying to work out how they can adapt the technology that, in its simplest form, allows consumers and suppliers to connect directly and form online networks, removing the need for middlemen.

For the financial services sector it offers the opportunity to overhaul existing banking infrastructure, speed settlements and streamline stock exchanges, although regulators will want to be assured that it can be done securely. The developments potentially combine two of the most dynamic industries: the computing hub of Silicon Valley and the money management of Wall Street and the City of London.

“We could go the way that file transfer technology changed music, allowing new businesses like iTunes to emerge,” says Michael Harte, chief operations and technology officer at Barclays. “That is why there is such feverish activity at the moment.”

No central authority

Blockchain has been hailed by admirers as holding the revolutionary promise that the internet did two decades ago. Business figures from Microsoft’s Bill Gates to Richard Branson, the founder of the Virgin Group, have extolled its potential; on a trade mission to Asia in August, David Cameron, the UK prime minister, included a blockchain expert among his entourage.

Evangelists say the possibilities are limitless. Applications range from storing client identities to handling cross-border payments, clearing and settling bond or equity trades to smart contracts that are self-executing, such as a credit derivative that pays out automatically if a company goes bust or a bond that regularly pays interest to the holder.

Some go as far as to suggest that the technology even offers the potential to disrupt companies that have forged reputations as “disrupters”, such as Uber and Airbnb.

At its core, blockchain is a network of computers, all of which must approve a transaction has taken place before it is recorded, in a “chain” of computer code. As with bitcoin — the first application of the technology, applied to money — cryptography is used to keep transactions secure and costs are shared among those in the network. The details of the transfer are recorded on a public ledger that anyone on the network can see.

In the present system a central ledger is likely to act as the custodian of that information. But on a blockchain the information is transparently held in a shared database, without a single body acting as middleman. Advocates argue that trust is increased among the parties, as there is no possibility for abuse by someone in a dominant position.

The lack of a central authority is the very feature of bitcoin that provoked consternation among traditional financial institutions, most of whom gave it a wide berth. The wisdom of that seemed to be borne out when the crypto currency became bogged down in scandals ranging from its links to drugs money in the now-defunct black market website Silk Road to the disappearance of client assets at the collapsed bitcoin exchange Mt Gox.

Yet almost every big financial services institution has now overcome that initial suspicion. And the technology has swung from being a weapon wielded against the banks to being heralded as their ultimate back-office makeover, a bitter blow to the libertarians who conceived the idea of the blockchain to circumvent the global banking system.


As the hype and pessimism around blockchain technology converge toward reality over the next several years, one certainty emerging among Wall Street and Main Street traders is that advancements in platform technology will profoundly change how commonly used securities known as derivative contracts will be traded. The distributed ledgers inconceivable just a couple of years ago are on the precipice of ushering in a new era of innovative financial engineering and precision in risk management.

Wall Street firms are beginning to tinker with blockchain and smart contract technology that will allow buyers, sellers and central clearing houses of derivative trades to share information, such as KYC (Know Your Customer), in real time across various distributed ledger platforms unleashing incredible efficiencies.

Last month it was reported that Barclays tested a blockchain platform called Corda, developed by the bank consortium R3. Electronic documents that served as derivative contracts were pre-populated with standardized values, which, one day, will allow the contracts to be hashed out between counterparties, traded on an exchange across multiple banks and then cleared and settled instantaneously.  

Derivative contracts are financial instruments that derive their value from some underlying asset, such as stocks, bonds, commodities or even interest rates. Derivative contracts have become increasingly fundamental in effectively managing financial risk and creating synthetic exposures to asset classes. For example, airlines use future contracts, a form of derivative, to hedge against fluctuating oil prices. Hedge funds use options, another form of derivatives, to speculate in questionable company stock without baring the cost of purchasing a large number of shares. Derivative contracts typically have shelf lives of 30-day increments.



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