In the last part we had explained what is Fintech and Algorithmic trading. This article is independent of the last one but if you do want to know about these concepts, please click here.
In this article, we have tried to simplify the concept of blockchain and have tried to throw some light on the potential uses of blockchain in finance. AI is a lot more permeated in our lives than you think. As students or professionals of finance the tool we use the most is probably MS Excel and you may be surprised to know the latest versions of MS Excel 365 have a pinch of AI.
So, let’s dive deeper to understand what exactly is blockchain and why is it so hyped. If you follow cryptocurrencies, especially bitcoin, you must have heard this word multiple times. Because this technology was originally developed to record transactions of bitcoin. But slowly people started realising what this technology could offer. This technology can probably change everything from how you book a train ticket to how e-books and music is shared to how we maintain books and records. So, an obvious question arises what is so special about this technology? Well, we were faced with the same question and below mentioned are some of the interesting things that we found out. But before we go to that, let’s try to understand blockchain.
If you were to run a Google search on the word blockchain, you will come across the following terms in almost every definition:
- Distributed Ledger Technology:
To understand this, we’ll take a simple example of Google docs. Google docs serve as a collaborative tool to co-operative editing of documents in real time. That is, documents can be shared, opened and edited by multiple users simultaneously. Changes are automatically saved to Google’s servers, and a revision history is automatically kept so past edits may be viewed and reverted to. Blockchain uses a similar technology wherein data is not stored centrally. Instead data is made available to all the users (could be thousands or millions) in the network at the same time. Any change to the chain is to be verified by all the users.
- Cryptography:
Every block of data in a blockchain has 3 parts viz., the data, the hash and the hash of the previous block. What does a hash mean? Hash function, in cryptography, means that a message is converted into a string of letters and/or numbers using a math function. For instance, the message “Hello” will get converted into something like: EFHB3547.There are some specific features like the same message would result in the same hash. A small change in the message would result in a new hash that is completely different from the older hash such that they appear uncorrelated. (E.g. here, if the message is changed to “hello” it would result in a has like DBJK1602. Even though only the case of the first letter was changed, the resultant hash was completely different.) Also, the hash created would be fixed in length irrespective of the length of the message. For instance, the messages “Hello” and “Hello everyone” would be converted in a hash consisting of, say, 8 characters.
So, an example of a blockchain could appear like this:
As we can see from the above diagram, Block Three is connected to Block Two with the help of hash and Block Two is, in turn, connected to Block One. Since the first block cannot point to any previous block, it is called as the “Genesis Block”. Suppose you tamper with Block Two, the following will happen:
- Hash of Block Two will change
- The “Previous Hash” in Block Three will thus be different from hash of Block Two.
And thus, it can be easy to know that something was changed in block two. Now, that’s not enough because the hash of all the subsequent blocks can be regenerated in a matter of few seconds and the fact that the data was tampered with can be concealed. To mitigate this, the bitcoin blockchain has something called “Proof-of-work” which slows the process of re-working all hashes to 10 minutes.
- Timestamped:
All the blocks in the chain are timestamped i.e. the date and time of their creation / modification is recorded. Once the data is stored in a blockchain, it can never be erased. Transactions are thus stored in a chronological order. These features make it easier to audit the changes to a blockchain.
Potential Uses of Blockchain in Finance:
- Banking:
Blockchain can help banks to carry out transactions more securely. And not just the net-banking transactions. As of now, banks take a day or two for the clearing of cheques. With blockchain, this can be reduced to 10 minutes. Every cheque would be a new block in the chain. The information once verified by the receiving bank; the funds can be thus transferred.
- Trade Finance:
Trade finance includes letter of credit, bank guarantee, bill of lading, etc. Blockchain promotes transparency, security and efficiency because the data is shared with all parties to the transaction namely, the buyer, the seller and the bank.
- Transactions:
Blockchain can possibly change how transactions are done. With the help of smart contracts (a smart contract contains a set of rules under which the parties of that smart contract agree to interact with each other. If and when the predefined rules are met, the agreement is automatically enforced), blockchain can rule out intermediaries from most of the transactions as blockchain enhances transparency and thereby trust between the parties to the contract.
- Syndicated Loan:
A syndicated loan is provided by a group of lenders and is structured, arranged and administered by one or several commercial banks or investment banks. Due to the very nature of these loans, transparency becomes inevitable and blockchain can play an important role by being the single source of truth.
- Accounting:
The current financial accounting is based on a double-entry system, which was introduced in the late 1400s. In double-entry bookkeeping, every entry to an account requires a corresponding and opposite entry to a different account. However, blockchain is about to change that as it supports triple-entry accounting. This system adds another step that ensures all transactions are written to a blockchain. The triple entry is specifically for blockchain and is cryptographically sealed to protect the parties involved.
Whether these articles covered everything about AI in Finance? Certainly not. This is not the end but the beginning of your research. If our article motivates you to do your own research about AI in Finance, our objective of writing these articles will be accomplished. Thank you for reading!
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