What is Blockchain?
One of the risk management technologies prioritized by Council members for early investigation is ‘blockchain.’ In the simplest terms, blockchain technology is a giant spreadsheet for registering assets and accounting for transactions in real time. Blockchain technology enables investors to window into the transactions of the investment funds that they invest in and protects against fraud. It is a potentially game-changing risk management technology.
A wide range of blockchain solutions have been proposed and are being developed in the financial services industry. One representative solution called Rubix is being developed by founding Council member Deloitte.
Deloitte’s Rubix is intended to be a suite of industry specific blockchain applications that increase investment fund transparency and reduce investor risk. These applications are being built in cooperation with innovative clients and will include the following features:
- Built in real time financial auditing to eliminate fraud.
- Rule-based systems that provide detection of compliance issues including KYC/AML/CFT, conflicts of interest, custody requirements, SEC, CTFC, FINRA, and FCA regulations.
- Monitoring of trades and comparison with publically available data to constantly guard against insider trading.
How Blockchain Works
Blockchain prevents certain aspects of fraud that no other approach currently addresses. Namely, the real-time timestamping and verification services within blockchain assure that no transaction, once entered, can be subsequently altered. Further, rule-based systems guarantee that investment funds are compliant with applicable regulations at all times.
Once a transaction is posted to the blockchain, the transaction is time-stamped and irreversibly recorded in real-time, creating a globally distributed digital ledger to which all permissioned parties have access. Conventional financial audits function to reconcile accounts at a given instant in time. Auditors do not delve into an ongoing reconciliation of accounts at every instant in time. However, in the blockchain audits occur every time a transaction occurs, 24/7.
Tamper-Proof Audit Trail
At the same time that a transaction enters the blockchain, it’s also authenticated and audited. Audits occur at the time of transaction entry and are ongoing. Since there’s never any gap between audits, there’s no possibility of tampering with transaction data at a later date. And because investors have ongoing, open access to the blockchain as permissioned users, tampering with the blockchain at any time would become immediately obvious.
Detecting Regulatory Violations
In addition to its real-time auditing capabilities, Rubix also constantly monitors an investment funds’ activity to detect any compliance violations or irregularities. Rubix technology utilizes advanced algorithms to detect illegal insider trading, conflicts of interest or violations of all SEC, CTFC, FINRA, and FCA regulations.
Frequently Asked Questions
Short and simple answers on how blockchain is improving risk management.
When was blockchain technology first invented?
What is the “block” and what is the “chain” in blockchain?
How does blockchain benefit investors?
How is the blockchain managed?
How does the blockchain protect privacy for both investors and fund managers?
What is the difference between multi-party vs. single applications of blockchain and what are the implications of both applications for investment funds?
How do I investigate blockchain technology for my firm?
The concept of a blockchain was formally introduced in 2008 in a paper called: Bitcoin: A Peer-to-Peer Electronic Cash System. The paper was written by an anonymous author under the alias Satoshi Nakamoto. The first use of a blockchain was in early 2009, when bitcoin came online. While the crypto-currency has been met with mixed sentiment, the blockchain technology underlying it has been widely hailed for its wide array of potential applications across diverse fields.
A “block” is the part of the blockchain that records some or all of the recent transactions, and once completed, goes into the blockchain as a permanent database. Each time a block gets completed, a new block is generated. Blocks are linked to each other like a “chain” in linear, chronological order with every block linked to the previous block going back all the way to the original block.
Blockchain prevents certain aspects of investment fund fraud that no other approach currently addresses. Namely, the real-time timestamping and verification services within blockchain assure that no transaction, once entered, can be subsequently altered. Further, rule-based systems assure investors that investment funds are compliant with applicable regulations at all times.
The blockchain is managed by a network of distributed nodes. Every permissioned node has a copy of the entire blockchain. New nodes can come and go, synchronizing their copies of the blockchain against those of the other nodes as they join the network.
Properly permissioned blockchain networks restrict access to the blockchain to permissioned users only. In a permissioned blockchain, only approved permissioned users have the ability to input transaction data into the blockchain (fund managers) or oversee and validate the registry (investors).
Multi-party activities, including bilateral transactions such as securities trades, require both parties to subscribe to the same implementation framework for blockchain. This type of “network adoption” necessitates different parties to typical investment fund transactions adopting the technology at approximately the same rate in order to have a ready market of counterparties to work with. Multi-sides applications present a “chicken and the egg” problem: an investment fund can’t implement the technology until those they trade with do, and those they trade with can’t implement the technology until the fund does.
In contrast, investment funds can begin with a single-party approach to use of blockchain technology. This approach involves recording only the fund’s internal transactions and unilaterally using the blockchain. This way, the investment fund can make aspects of those transactions accessible to investors right away and provide them with immediate transparency.
There are a variety of papers online describing blockchain technology. An insightful yet succinct introduction can be found at http://dupress.com/articles/trends-blockchain-bitcoin-security-transparency/
On-the-ground implementations of blockchain technology at this early stage tend to be through consortia, associations or bespoke pilots with technology vendors or consultants. Participating in our Risk Management Council is one of the best ways to gain exposure to the technology, and to influence the direction it takes in the investment fund industry.