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Leaders at financial services institutions and the Nasdaq stock exchange are experimenting with the blockchain protocol for posting, clearing, and settling transactions. 

In mid-2014, the Deloitte Center for Financial Services produced a report on bitcoin, a protocol for exchanging value over the Internet without intermediaries like banks or credit card companies.  The report was spurred by a rapid rise in the value of bitcoin: Entities of various stripes were positioning themselves to develop services or products aligned to the cryptocurrency and its processing platform. 

At the time, we posited that for bitcoin to enter the mainstream as a digital currency, several conditions would need to be met.  Chiefly, it would have to exhibit greater price (or exchange rate) stability and entice merchants to accept the currency for payment through various digital and physical touch points.  In addition, all parties in the financial ecosystem (including merchants, payment processors, and banks) would need to be able to trust the veracity, stability, and security of the system itself. 

Some of these conditions continue to trouble the bitcoin ecosystem.  The value of the bitcoin itself has cooled off from its high of more than $1,000 in December 2013 to about $240, and we continue to have concerns about security in the overall ecosystem. 

But rather than focus too narrowly on the cryptocurrency itself, perhaps we should widen our scope to the blockchain, the public ledger on which all bitcoin transactions are recorded.  We wrote in our paper last year, “While the protocol and public blockchain have been used to facilitate bitcoin transactions … the features enabling digital transfer of assets could have a wide range of other applications, such as exchanging land deeds, automobile titles, or securities holdings.”  And that is precisely what appears to be happening.  What is really drawing interest among financial services institutions is the underpinnings of the bitcoin system, namely the blockchain protocol for posting, clearing, and settling transactions. 

For example, Nasdaq recently announced that it would deploy a specialized trading platform specifically for new issuance of securities as part of an initial public offering, running on the bitcoin/blockchain system and using what are called “colored coins” as a digital representation of equity shares.¹ And USAA, a financial services institution based in San Antonio, Texas, is one of a number of banks investigating blockchain technologies as a potential tool to improve internal operational efficiency.²

So will the blockchain gradually take over transaction and operational platforms in financial services?  It’s useful here to consider two often-cited precedents for the bitcoin/blockchain phenomenon: Napster and Transmission Control Protocol/Internet Protocol (TCP/IP). 

Napster, founded in 1999, was a revolutionary example of file-sharing technology applied to MP3 digital music files.  Like the bitcoin system, it was based on open-source principles.  However, after Napster experienced explosive growth, musicians successfully sued the company for copyright infringement, and Napster eventually shut down.³ It re-emerged as a paid music site, but the idea of music file-sharing had been clearly demonstrated to the public. 

TCP/IP, the communications and networking protocol that provides the foundation for the Internet, has its foundations in research conducted by the Defense Advanced Research Projects Agency (DARPA).  It was first adopted as the networking protocol for the U.S. military, and then later by large commercial organizations, eventually pushing out all other similar networking protocols.4 The richness in web browsers today owes to the development of this single protocol.  As a blogger from the Brookings Institution put it, “The blockchain is a foundational technology, like TCP/IP… And much like the Internet in the late 1990s, we don’t know exactly how the blockchain will evolve, but evolve it will. "5

These two examples suggest that distributed ledger technologies are being seriously considered, as well as deployed, to address longstanding industry problems.  And it will likely not end there: Napster showed how the technological underpinnings of a new idea were of value in the long term, and the development of TCP/IP demonstrates how a standard networking protocol was the springboard for a wide array of development.  The Nasdaq example may be the tip of the iceberg.  As “colored coins” provide an experimental way to exchange assets other than currency, brand new commercial transaction networks may arise based on this one good idea. 

—by Jim Eckenrode, executive director, Deloitte Center for Financial Services