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Blockchain has the power to shape 21st century

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The following commentary was originally written by Aditya Shanker, Vice President of Trading Products with BMO Capital Markets and published in The Economic Times. Aditya was the lead architect of the blockchain platform that mirrored the first fixed-income issuance transaction in Canada, in partnership with leading pension fund investor Ontario Teachers’ Pension Plan. He is a member of the Blockchain Center of Excellence at BMO Capital Markets.

Even as Bitcoin worried regulators, blockchain has firmly captured the imagination of cryptonerds, programmers, researchers, boardrooms, central bankers and politicians. It’s the technology that underlies Bitcoin, other cryptocurrencies and an entirely new genre of computer applications known as decentralized applications.

The creator(s) of Bitcoin devised a mechanism to issue and track ownership of digital money entirely through computer code running on a distributed network of computers. In a very subtle way, this idea was a eureka moment for humanity because it proved that facts, such as monetary ownership, could be digitally recorded and seamlessly trusted onto a computer network run by the people of the world without the need for large intermediaries.

By design, it’s a distributed decentralized secure ledger of records. It offers a way to digitize real world entities, such as information and assets, and ensure that those entities will be exactly as entered into the system without relying on guarantees from central institutions. It should be apparent at this point that blockchain technology takes a direct shot at facilitating peer-to-peer transactions without the need for middle service providers — which could dramatically cut transaction costs.

Finance and capital markets offer the “no-brainer” use cases for applying blockchain technology. Bitcoin has proven to be successful in creating digital money and tracking ownership of the same. Today, there exist hundreds if not thousands of cryptocurrencies. However, as any astute economist will tell you, for an entity to serve as a currency it must serve three functions: store of value, medium of exchange and unit of account. Contemporary cryptocurrencies are too volatile to serve as a store of value or as a medium of exchange. Stablecoin is one idea that is looking to tackle this problem by proposing to develop low volatility cryptocurrencies pegged to the US dollar or any other index. Such stable cryptocurrencies could possibly be the first killer app that blockchain technology has been waiting for in order to facilitate mass adoption.

New frontiers

Platforms such as Ethereum allow for the creation of smart contracts, digital entities with ingrained computer code that can execute contractual agreements based on future events. These entities could represent currency, financial instruments, land ownership, etc. In essence, platforms such as Ethereum enable programmable digital assets, a notion that could single handedly revolutionize asset issuance and ownership in various domains. A municipal government wanting to raise money through a bond issuance from its citizens or investors could do so by simply deploying a bond issuance smart contract on the Ethereum platform. Investors would send in their investments through a stable cryptocurrency to the municipal government. The Ethereum smart contract would issue tokens representing the bond to each of the investors. Each investor holding such bonds would be able to directly withdraw their coupon payments and the principal at maturity from the smart contract itself. Because the investors would hold digital token representations of the issued bond on a blockchain, they would be able to seamlessly trade these bonds with other prospective investors, just as Bitcoin holders can seamlessly transfer ownership of their digital bonds to another person or entity. Note that there would be minimal human intervention in the steps discussed here. In such a scenario, bond defaults could also be monitored and acted upon in real time — unlike the toxic papers which slipped undetected until 2008.

I do envision a future where raising capital through debt or equity issuance would be as easy as a few clicks on a blockchain powered digital portal. The health of the global financial system will be monitored in real time through such a portal. After all, there was a time when buying goods on a website or hailing a cab through an app sounded ridiculous.

A brave new world

The unit economics, convenience and efficiency of online platforms proved to be better than brick and mortar businesses. In art, a digital token representing ownership of an expensive Van Gogh work would make investments in art ownership a lot more liquid than they are today where most paintings can only be traded through the secondary markets such as art auction houses. Such blockchain-based digital asset tokens could also revolutionize ownership of land and real estate and provide greater liquidity to those markets. Private equity and venture capital also stand to be influenced by the democratization in financing ushered in by blockchain based tokens. The challenge that remains to be solved with tokenizing real world assets and offering such tokens as “asset backed securities” is how does the issuer of such tokens ensure that only one unit of token is issued for each unit of the underlying assets? For example, an issuer of such a token could easily cheat by issuing hundreds of tokens representing a unit of a gold bar when he or she only has a single unit in possession.

While one could argue that honesty will prevail and token issuers will not cheat, a major incentive of developing decentralized blockchain applications is to eliminate such risk. Blockchain projects should strive to design their protocols in a manner such that participants in that system are incentivized to maximize the value of the system as a whole; in other words, it is more profitable to secure and make the blockchain ecosystem more valuable than it is to cheat and profit for oneself. This idea was the essence of the protocol underlying Bitcoin’s blockchain.

Blockchains have opened up a brave new world to create, hold, and distribute digital value. Some have heralded blockchain as the next wave of technology revolution, others have dismissed it as a passing fad that will be limited to the underworld of “crypto cyber criminals.” Some see an analogy between current blockchain technology and the Internet of the early 90s. Others who are more first principles driven argue for the gains in the unit economics of executing transactions more efficiently from reduced friction enabled by the design of blockchains. Only time will tell. Perhaps you will be buying your coffee using cryptocurrency in the future and owning digital tokens for all the wonderful art work in your house. Or perhaps the world will have moved on to the next big thing.

Either way, a number of blockchain advancements will be explored over the next decade, allowing for real-world problems to be solved and new businesses and business models to emerge in the process.

 

BMO Capital Markets is a trade name used by BMO Financial Group for the wholesale banking businesses of Bank of Montreal, BMO Harris Bank N.A. (member FDIC), Bank of Montreal Ireland p.l.c., and Bank of Montreal (China) Co. Ltd and the institutional broker dealer businesses of BMO Capital Markets Corp. (Member FINRA and SIPC) in the U.S., BMO Nesbitt Burns Inc. (Member Investment Industry Regulatory Organization of Canada and Member Canadian Investor Protection Fund) in Canada and Asia and BMO Capital Markets Limited (authorised and regulated by the Financial Conduct Authority) in Europe and Australia. “Nesbitt Burns” is a registered trademark of BMO Nesbitt Burns Inc., used under license. “BMO Capital Markets” is a trademark of Bank of Montreal, used under license. “BMO (M-Bar roundel symbol)” is a registered trademark of Bank of Montreal, used under license. The views and opinions expressed do not necessarily reflect the views or positions of BMO Financial Group.

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