Bitcoin Price Febr 2016Bitcoin may be a risky investment, but the technologies that underpin it are a safe bet to disrupt the finance sector

This is an interesting article which we picked up courtesy of the Economist.    The price of Bitcoin, the best known and most widely used example of a cryptocurrency, has followed a roller coaster trajectory in the past 18 months. This erratic behavior, combined with Bitcoin’s reputation as an enabler for criminal activity, means that serious investors may not consider cryptocurrencies to be an asset class worth considering (the price of Bitcoin reached US$420 recently).

However, the technology that underpins Bitcoin may prove highly disruptive to the way the financial services industry works. The investment community would be wise, therefore, to keep one eye trained on developments in the cryptocurrency space.

The aspect of the Bitcoin protocol that finance experts find intriguing is its distributed ledger, the Bitcoin blockchain. As Michael Jackson, general partner at VC firm Mangrove Capital Partners points out, the finance industry is built on ledgers. Most financial transactions are concerned with guaranteeing and tracking assets as they move from one ledger to another.

Bitcoin’s public ledger is distributed across millions of computers, recording every Bitcoin transaction – with little or no cost. There is growing interest in treating Bitcoin not as a currency but as a digital equivalent to a notary’s stamp: using the blockchain as a way to authenticate digital transactions, offering irrevocable proof of ownership with a traceable history.

This ability to move value across ledgers cheaply and publicly has a myriad uses. One possibility, Mr Jackson suggests, is some form of regulatory mechanism that uses the blockchain as a tool to provide improved visibility on the flow of funds between parties. This could provide unprecedented transparency and regulatory oversight in, for example, foreign exchange markets.

Bitcoin itself is just the start.  A number of projects have adapted the original Bitcoin codebase to introduce new ways of using the protocol. It’s possible that there won’t be one single blockchain in future, but many different distributed ledgers competing for users and for services. There could even be private services running behind closed doors and on secure private networks.

Claire Cockerton, CEO of London’s new financial technology industry body Innovate Finance, points to the Ethereum open source development project. Ethereum uses the blockchain as a platform for the exchange of binding “smart contracts” that replace standard business documents. By using the blockchain as a ledger, smart contracts can be tracked and used to verify business relationships and agreements without having to resort to the legal system. Tying smart documents to a blockchain would provide the functionality of key electronic data interchange (EDI) platforms such as RosettaNet, an e-business platform for the electronics industry, at a much lower cost.

Elliptic is a UK-based start-up that seeks to “bridge the gap between traditional finance and digital currencies”. Co-founder Tom Robinson says the cryptographic mechanism underlying Bitcoin could be used to authenticate the exchange of almost any abstract concept, as long as it can be treated as an asset and stored in a register.

One suggestion is to use the blockchain to manage car leases and the associated registration documents. When a car changes hands, it would be tagged with a new cryptographic signature. That signature could be used to programme keys issued to the car’s new owner so only they can open and start the car.

Evidently, the technologies that underpin Bitcoin hold enormous potential for innovation in financial services. This potential has been recognised in global financial hubs such as London, as evidenced by Innovate Finance’s avowed interest in the technology, but also smaller centres, including both the Isle of Man and Jersey. Both jurisdictions have e-gaming industries that rely heavily on trusted, electronic financial transactions, and the expertise and infrastructure they have built could be useful in developing Bitcoin-based services.

But the use of the technology in financial services could spread much further afield. According to Andy Jarrett, a director at industry accelerator Digital Jersey, Bitcoin and related technologies could be combined with SMS banking services in emerging economies to help manage and authenticate transactions, as the underlying technology is effectively free.

Bitcoin, the currency, is a risky investment. But the potential of technologies that underpin it to disrupt the finance sector is looking like a safe bet.