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Akash Karmakar

Akash Karmakar is a lawyer specializing in fintech and data privacy. He assists fintech companies structure products, and navigate regulatory challenges. An associate with Veritas Legal, he has assisted various banks, financial institutions and technology companies launch digital and app-based products.

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Blockchain Technology Promises to Redefine Business Transactions in the Next Decade

As the name suggests, blockchains provide a network of individuals, time stamped records transactions such as peer to peer transfers in a continuous cryptographic chain that cannot be modified or tampered.

Photo Credit : GECKO Governance,

Blockchain

Blockchains, which are based on distributed ledger technology (DLT), is arguably the most disruptive technological invention since the World Wide Web. The DLT that is the backbone of blockchains shows immense potential to be deployed in industries which require settlement and reconciliation of transactions. In the near future, blockchains are likely to facilitate transactions without any intermediary thereby rendering traditional reconciliation and settlement systems redundant.

As the name suggests, blockchains provide a network of individuals, time stamped records transactions such as peer to peer transfers in a continuous cryptographic chain that cannot be modified or tampered. Owing to the fact that the blockchain ensures all participants on the network simultaneously have access to the chain, each participant can verify the cryptographic sequence to validate that the chain was not tampered with.

To de-jargonize the technology, albeit at the risk of over simplification, one could compare a blockchain to a stack of cards, each bearing a unique number. Every time the stack is transferred from one person to another within a defined group, a uniquely numbered card or ‘block’ is added to the stack and every member of the group is notified that a card was added to the stack along with its number. Since all group members are notified every time the stack changes hands and a card is added, each group member possesses identical records or ‘ledgers’ and can verify the number of transactions by matching each card number to their records, analogous to matching each block comprising the chain to their records. While DLT and blockchain is often used interchangeably, all blockchains based on distributed ledgers, while not all distributed ledgers are blockchains.

DLT, its purest form is a peer-to-peer network that uses pre-defined parameters to form a consensus based validation mechanism to prevent modification a sequence of time-stamped records that forms a sequence. This allows transactions to be tokenized and represented as a blockchain which is accessible and verifiable by all members of the network, thereby making them ‘distributed ledgers’. This feature of DLT ensures that blockchains are tamper proof and ‘incorruptible’ since they are recorded identically in ledgers with each member of the network which is updated in real time. This also eliminates the lengthy reconciliation process followed in traditional systems and has led private sector banks to experiment with the use of block chains to eliminate the reconciliation process for inter-bank payments and foreign exchange businesses.

Since blockchains offer avenues to create an incorruptible digital ledger and can be deployed to transfer digital property, DLT will precipitate significant changes to the way business and commerce functions today. The most significant ramifications of deployment of DLT in the form of blockchains may be in securities markets, where today’s clearance and settlement is only possible by relying on numerous clearing houses, custodians, exchanges and fiduciaries. Each of these intermediaries adds a layer of complexity, cost and delay that this new technology can eliminate.

While major stock exchanges are already exploring the use of blockchains to register equity issued by corporations, the use of blockchains to track the generation and consumption of complex derivatives, such as carbon credits that need to be monitored, remains entirely unexplored. The convergence of existing carbon markets into a consolidated global carbon market lends a second avenue for deployment of the blockchain’s decentralized infrastructure, which could be deployed to validate and track the trade in carbon credits and prevent the mingling of dubious carbon credits with questionable underlying assets which have been labelled as “sub-prime carbon”. Perhaps the deployment of this technology to match derivatives and their underlying assets may have resulted in the early detection of the sub-prime crisis.

Blockchain technology also finds favour amongst proponents of digital currencies. Since counterfeiting virtual currencies is a major risk factor to the industry, blockchains could be used to tokenize each unit of virtual currency and trace each transfer to reduce the changes of counterfeiting. Unfortunately there has been a significant amount of rhetoric surrounding the technology, on account of bitcoins being blockchain technology’s most ubiquitous use case model. Bitcoins have been labelled as a crypto-currency but exhibits no features of a currency and although synonymous with blockchains, merely uses blockchain technology to records transfer of ownership. Bitcoins are neither recognized nor backed by a government and its price is prone to speculation induced volatility which makes the Bitcoin unsuitable to be called a currency.

There are also associated challenges since the trade in Bitcoins could be construed as a violation of exchange control regulation in India. If bitcoins were to be substituted with government issued virtual currency, the same model could be refined to form a tamper proof system to track transactions using digital currency. Countries such as Ecuador, Sweden, Germany and Netherlands have already begun planning for blockchain based digital currencies. With respect to tracking digital currencies, blockchain technology also offers the unique ability of being able to track transactions, without needing to track the ownership of an instrument, a feature which can anonymize the beneficial owners while tracking each transfer.

Perhaps the most pervasive and tangible change which would be brought about by blockchains are ‘smart contracts’, which will automatically trigger transactions such as a payment or refund as mandated by the terms of the contract, without any external intervention. These are likely to be initially deployed in the futures and options market and then trickle down to every sphere. Today, when a document is generated and shared over electronic media, the author retains a copy. When a transfer is done using a blockchain, the recipient does not obtain the original copy since a block is added to the chain once it is transferred to the recipient thereby distinguishing the contract from the original copy with the author. Blockchains also allow the transfer of digital property securely while tracking the transfer of digital assets, such as a document, from one person to another, while also tracking alterations made by each person to such a document. Theoretically a blockchain can record an infinite number of transactions. This would allow tracing ownership of property and maintaining property registries to be done using blockchain which is already being deployed in the Honduras. While this eliminates title fraud an inherent limitation of blockchain technology is that for the system to be considered reliable, every transfer of property must be recorded and tracked using a blockchain. This necessitates a legal framework which prescribes that certain classes of transactions need to be tracked using blockchain technology to be considered as valid in law. Without legal sanction, transfers conducted outside the blockchain would render the blockchain incomplete and thereby frustrating efforts to track sequential person to person transfers in a verifiable manner.

What remains to be seen is whether regulators in India warm up to the concept of using blockchain technology to validate transactions. While the Institute for Development & Research in Banking Technology has partnered with the National Payments Corporation of India and certain banks to build a trade finance application to test the blockchain heuristic, the Reserve Bank of India’s has not officially accorded its sanction to banks using blockchains to automate their processes. Similarly in the securities markets regulatory involvement has been conspicuous by the absence of any formal acknowledgement of the technology by the Securities and Exchange Board of India. While it may be premature to expect a regulatory framework for blockchain technology, for approvals from the respective regulators would go a long way in bolstering the confidence of market participants to explore new avenues for use of this technology.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house


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