Hong Kong’s central bank, the Hong Kong Monetary Authority (HKMA) published a white paper or information document on the concept of Distributed Ledger Technology (DLT). This is a reliable guide or report informing the public regarding complex concerns about the subject. It also presents the institution’s viewpoint on the topic.
HKMA produced the treatise in collaboration with the Hong Kong Applied Science and Technology Research Institute (ASTRI). This Institute was established by the Government’s Special Administrative Region in 2000. ASTRI’s mission is to enhance the country’s competitiveness in technology-based industries by means of practical research. The four disciplines of applications are the following:
- Financial Technologies
- Next Generation Networks
- Intelligence Manufacturing
Collaboration on Blockchain Technology
For the last two months, the two independent entities have been working on blockchain platforms. In fact, HK banks are striving to create a structure that can facilitate sharing of mortgage valuations. HKMA is one of the more aggressive central banks like their counterparts in the United Kingdom, Canada and Russian Federation looking at and testing other applications. These monetary boards have engaged in the testing usage for digital currency and confirmation of documents.
The White Paper establishes an extensive idea of the technology and introduces blockchain as a tool with massive promise based on the function. Some central banks, regulatory agencies and the financial technology industry in general see the DLT as a way of transmitting and updating information efficiently and securely.
According to government officials in Hong Kong privy to the matter, the release of said white paper is only the first part of a more complex procedure. There will be additional research and another report will be published sometime in 2017.
DLT and the Financial Sector
Innovative technologies started to modify banking processes and payment services. DLT or blockchain is the technology supporting different systems of databases that allows users to produce, store and distribute information minus security risks. Through the Distributed Ledger Technology, the databases can run smoothly without controls from any central party. It is known to and trusted by participants.
The primary goal of this research is to conduct a neutral and detailed review of DLT/Bitcoin. It includes probe of potentials, risks and regulatory repercussions. The Paper also seeks to point out DLT applications pertinent to banking services through the proof of work model. A second stage is expected to generate more exhaustive results from the proof of work theory. Aforementioned networks will be available for scrutiny.
Data history is tracked down from the time a piece of information was made. It is practically impossible to implement unauthorized alterations to such information. In short, Distributed Ledger Technology functions were designed so information conveyed through the networks has maximum level of dependability. Users within the network can look at the information simultaneously. In terms of structure, the blockchain is a sequence of blocks of data connected together firmly.
It is possible to keep digital records of assets in the block. New blocks are created each time participants create or change information regarding assets. Some examples include transaction documentation, new market prices, changes in status, or new business owners. All other blocks produced after the initial block is attached to the previous set. The process guarantees legitimacy and builds a reliable audit trail. The DLT design has advantages over conventional technologies. The downside is changing technology causes risks if certain issues are not handled correctly. These include governance or authority; deployment; risk management; and, compliance with regulations.
Distributed Ledger Technology entails common policies notwithstanding its decentralized approach. All participants must adhere to these guidelines to ascertain accuracy as well as trustworthiness. The decentralized system creates challenges if it is necessary to introduce changes or update said rules. These changes must be acceptable to everyone so DLT will work without fail. Framework for governance is crucial to implementation and sustainable functions of said technology. It must consider supervision, monitoring, policy-setting, acknowledgment, and management of change controls.
DLT platforms are Permissioned and Un-Permissioned. The first includes authorized nodes which work faster. These are safer and cost-efficient transactions. The Corda or Coin Desk R3 is one such platform. These platforms have their respective distinct attributes. Some of them are made for specific applications while others are intended for general purposes. For example, sharing of exclusive ledger information in Corda is restricted to parties on a need to know basis. This is not the case for other programs. The second is accessible to all and maintained by public nodes. Bitcoin is a classic example of this particular platform. It works as a digital resource and payment system. Bitcoin has hastened the development of DLT designs.
Success of new technologies depends on the implementation. For Distributed Ledger Technology, the following have an effect on financial services:
- Processing of Transactions
- Validation or Confirmation
- Detection of Fraudulent Activities
Likewise, efforts are required to guarantee the capability to work together between multiple DLT networks, ledgers within one network, and non-DLT systems. These must not be taken too lightly and studied well prior to deployment.
The emergence of new technology is another risk. This applies also to Distributed Ledger Technology. Computer-generated security issues apply to the technology despite the digital certificate, digital signature, and other measures. Denial of Access attacks can be launched against this platform and cause failure of operations.
The unspecified characteristics in certain applications specifically Bitcoin may lead to issues such as money laundering, sale of prohibited commodities, and Ransomware. The last is a variety of computer malware that is installed clandestinely on the user’s desktop, executes a crypto-virology onslaught and asks for a ransom. Problems may be dealt with if DLT is employed in a so-called “permissioned” network. However, it is important to check this technique carefully before execution.
Symmetric Key Cryptography is the key used for encryption and decryption of data. This enables a user to personally encode information and prevent unauthorized individuals from discovering any confidential information. One well-known example of this type of cryptography is the Advanced Encryption Standard. AES is appropriate for Internet communications and business transactions. It safeguards the privacy of information traded over public networks. There are multiple key sizes with longer dimensions for more security. Longer keys make it difficult for strangers to speculate. Majority of online banking transactions are secured using AES codes.
Distributed Ledger Technology can bring unique efficiencies to the banking and payment sectors. This is based on the primary strong points such as:
- Capability to establish trust in a distributed system.
- Efficiency in releasing information in a fast and secure gateway.
- Ability to monitor records and transactions.
- Possibility of reducing operational costs along with potential for better resiliency.
Stakeholders need to figure out if the present DLT is ready to accomplish requirements of the financial markets. It must determine the type of features DLT should have for integration so it can be used by banks and payment companies. This is a prerequisite before deciding that the technology is the most appropriate solution for all concerns and problems related to banking and settlement.
Current Situation for Merchants and Consumers
In this modern age of Internet Technology and Electronic Commerce, merchants and consumers meet and transact through the world-wide web. There is no need to meet physically especially if the parties involved come from different regions or countries. What is the catch here? Banks might alleviate the risks between unidentified vendors and buyers. Banks must establish partnerships, agreements and networks with their counterparts worldwide to facilitate international commerce and moderate risks.
It will not be advisable and cost-effective even for multinational banking corporations to maintain high-profile status in all markets. Setting up these conduits and pacts globally with other banking institutions governed by different laws and ensuring regulatory conformity in local countries are costly and complicated. As a result, most banks collaborate only with the biggest players in every location. Small banks are compelled to direct trade financing through correspondent banks which in turn forwards transactions to major banking corporations in that geography. This concludes the end to end process.
When the number of intermediate banks grows, overall transaction expenditures increase for both exporters and importers. In this case, blockchain technology is utilized to build an international trade finance market. This reduces the costs because a cost-effective trust channel is set up between the banks of importers and exporters. There are a minimum number of go-betweens or mediators.
The blockchain market helps banks and financial firms of various sizes to become part of this marketplace and offer their key services. Said technology determines the most convenient trust corridor between transacting banks. Each entity within that network circulates fees and contract terms. The blockchain protocol selects these institutions once terms and conditions agree with one another. This limits transaction costs to a bare minimum. Banks provide trust as well as liquidity for business finance and serve as market-makers for global trade financing.