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The following guest post is courtesy of Amir Vaknin, CEO at SpotOption.
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In 2009, a person or group of persons working under the pseudonym, Satoshi Nakamoto, released the world’s first cryptocurrency, called Bitcoin. While the idea of a currency beholden to no nation or bank was exciting enough, the entire online trading industry soon realized that the underlying creation – called blockchain technology – held the power to be a game-changer across industries and could create cause and effect ripples of such magnitude that it is probably impossible to predict the ultimate impact on our politics, economics, and society in general. For now, the focus is on how it will change the trading game.
Understanding the Blockchain
Blockchain. It’s a weird word with serious implications, but what exactly is it and how does it work? To understand that, first think about how financial transactions with banks have traditionally been handled. The process has remained basically unchanged since the ancient Egyptians started scratching records on papyrus about 5,000 years ago. For the majority of that time transactions were recorded and updated in the pages of first scrolls and then journals, which acted as the forerunner of what is known today as a database.
The invention of the computer allowed a bank to digitize all that information and enter it into a database that was stored on a private computer network at the banking facility. The idea of blockchain technology turns these thousands of years on its head with the idea of a decentralized, distributed database in which a copy sits on every “node” and is continually reconciled with each transaction. These nodes are represented by individual computer users spread around the globe.
The immediate advantage traders will appreciate is security. Theoretically, a trading platform powered by a blockchain technology would be unhackable. The amount of resources needed to attack even one piece of information makes the idea laughable for all practical purposes using current technology.
Testing Blockchain Technology with Cryptocurrency
Mr. Nakamoto decided to put the theories posited in a 2008 paper he wrote about his idea of a distributed database to the test in 2009 with Bitcoin. Whether you call it cryptocurrency or digital cash doesn’t matter. The idea is that there is now close to a decade of real-world evidence that his ideas work. It’s secure, transparent, and there are around 100,000 retailers and vendors around the world who have taken the step of accepting Bitcoin as legal tender.
So what exactly is a cryptocurrency?
A cryptocurrency like Bitcoin (and its newer cousins like Litecoin, Etherium, and Dash) has a few distinctive features to keep in mind:
No Intrinsic Value: Some economists would argue that the world’s reserve currency, the American dollar, has no intrinsic value either, ever since it was taken off the gold standard in the early 1970’s. But when it comes to a digital currency, it REALLY has no commodity underpinning it to any extent.
No Physical Form: Perhaps this is self evident, but a cryptocurrency exists only as zeroes and ones on a computer network. Though Bitcoin currently has a real world value when compared to the U.S. dollar, it is a separate entity that only lives in the online world.
No Central Bank Controlled Supply: Here’s the biggie. No government, bank, or other organization (like the Federal Reserve) can tinker with the supply of a digital currency. It’s completely decentralized nature puts it beyond the reach of meddling politicians and economists.
A Disruptive Global Force
Before conducting a deeper dive into the blockchain effect on the financial services industry, and by extension online trading, it should be noted how widespread the impact of this idea of a distributed database could be eventually. Those that will likely be interested in blockchain the most are industries that handle lots of information. Healthcare is a good example, as is security. This new technology could eventually lead to the decentralization of the entire world wide web. That last is a fascinating concept for later in this article.
Security: It should be no shock to anyone that current database technology, the centralized model, leaves much to be desired. With each new high-profile data breach that puts the personal information of millions of citizens at risk, the day draws closer when you will have your own identity theft problem.
When applied to online trading, a peer-to-peer network using blockchain technology could usher in an entirely new concept of the underlying infrastructure that supports millions of transactions every day. Consider the associated costs for financial technology industry leaders like SpotOption in the eternal battle to create a secure trading platform for clients. Then imagine if this massive expense could be redirected into other technological research and development. Smart business leaders of forward-thinking companies have already invested heavily in blockchain technology; expect that to only increase in the future.
Transparency: Ever since online trading began to pick up steam in the late 1990’s, individual traders have felt themselves at the mercy of brokers and any behind-the-scene shenanigans the latter might try to pull. With present technology, traders willingly place their neck on the chopping block (figuratively) and pray their broker doesn’t decide to drop the ax. In what is still a largely unregulated industry, there may be little recourse against a broker who decides to manipulate the timing or outcome of trades. Obviously, this is a BIG problem.
A market exchange built on a blockchain could easily include security features that shut down and report attempts by anyone in the network to play “dirty.” Such a ledger is inherently designed to allow all participants full access to all records at all times. The benefit of complete transparency and trust to an industry that has borne a sometimes deserved “wild west” reputation would be incalculable.
Who Needs Middlemen?: The following reality of a blockchain world might not sit well with the middlemen of the trading industry but here goes. Anyone care to hazard a guess at a raw number of how many people stand between a trader and his trade? It would be a large one: brokers, dealers, regulators, and more. Imagine if there were suddenly no need, for example, for regulators or regulating bodies because the appropriate rules and regulations were already built into the software. That means 100% compliance with no human intervention. Traders would be required to abide by them or their trades wouldn’t go through. This would (or at least should) create a drastic reduction in transaction costs and fees.
Searching for Liquidity: The success or failure of any market tends to rise and fall with its liquidity. In other words, can a trader find enough action in any particular financial instrument to make a trade when he wants to? Blockchain technology is essentially at war with system inefficiencies. Once in place, one would suspect a particular market to be able to reduce entry barriers and other associated costs, thereby increasing liquidity.
A New Internet
In the early days of the Internet, users envisioned a decentralized network that allowed for complete control of data by the individual. It hasn’t quite worked out that way. With the rise of monolithic web platforms like Facebook, Google, and YouTube, power has begin to concentrate in the hands of a few. Does blockchain technology have the power to change that? Possibly. A company named Blockstack plans to go live in late 2017 with software built on blockchain standards that will allow users to explore the Internet while retaining more control of their personal data.
Here’s how it will work
Rather than being forced to create a separate account with any online service you want to use, you will create a single profile that you alone control. When a site needs your personal information, you either allow access or not. Think of it like this. What if, rather than forcing you to go through their process of opening an account, you could choose to grant Facebook access to your profile, but the moment you decide you don’t want to use this social media platform any longer, you simply revoke access to your digital identity and that’s that. The big benefit to this arrangement is that it would put a stop to the massive databases a company like Facebook builds with customer information and then sells to advertisers without consent. The bottom line is that blockchain technology might make that long-imagined goal of a free and private Internet a reality.
None of this should make it seem that a trader can expect to wake up tomorrow in a blockchain world. There are challenges, some of them formidable, to overcome before that happens. For example, could traders with high-end infrastructure, like the trading platforms offered by SpotOption, gain a timing advantage and get their trades to market first? With the blockchain iteration that powers Bitcoin, this very well could be the case, which creates a fairness issue. As usually happens, though, problems are meant to be solved, and when it comes to technology with the capacity to be a as revolutionary to the financial markets as anything in history, you can bet there will be plenty of resources from around the globe working hard to achieve implementation.