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Basics of blockchain technology and use cases

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As digital technology advances, accounting and tax professionals keep hearing new terms such as blockchain technology, cryptocurrency, crypto tokens, DeFi, DAO, NFTs, and smart contracts. All these terms have tremendous significance in the financial sector.

These buzzwords are growing to dominate many financial processes. This article will hep you understand the essential elements of blockchain technology and the innovative use cases being developed today.

Understanding the basics of blockchain technology and cryptocurrency

Blockchain technology is a digital ledger that is programmable, distributed across centralized or decentralized networks, time-stamped, immutable, secure, and coded to be public, private, or hybrid. In essence, it’s a digital third-party record-keeper and verifier of transactions across the internet. 

Information is the core of any business transaction. Therefore, the quicker and more accurate the information handling, the better it is for the business in terms of market competitiveness and financial security. 

Blockchain technology provides immediate, transparent, and shared information stored in an immutable ledger that no unauthorized members can access, significantly decreasing errors, omissions, mistakes, and fraud. 

Depending on how it’s coded, public vs. private, blockchain’s transparency allows authorized users to view the details of all transactions, making it easy to audit, track, and manage assets. 

It’s this foundation which cryptocurrencies such as Bitcoin, Ethereum, and altcoins are built upon. They’re like individual operating systems, similar to Apple iOS or Windows PC. 

According to CoinMarket Cap, there are over 21,000 cryptocurrencies, including blockchain operating systems, as of October 2022, with Bitcoin being the most adopted to date. 

A cryptocurrency is simply a means of exchange using blockchain technology. Over the past decade, the value of this exchange has fluctuated from pennies to thousands of dollars. Cryptocurrencies can make payments, payroll, tracking orders, inventory, logistics, production, identity verification, insurance, real estate, and energy management more efficient, faster, and verifiable.

Key blockchain characteristics

The key blockchain characteristics that make it so disruptive, revolutionary, and innovative are: 

Immutability: The beauty of blockchain technology is that no one can alter or tamper with a transaction after it’s authorized by consensus. This immutability makes blockchain unique. 

Consensus: The consensus mechanism enhances reliability and trust in the blockchain. Instead of a central authority governing the system, the network’s peers (computer nodes across the globe) agree on the present state of the data in the network and validate it. 

Distributed ledger technology (DLT): The blockchain ledger’s distributed nature makes it easy for anyone authorized to validate transactions because it allows simultaneous access from different computer nodes across various geographic locations. 

Security: Blockchain leverages encryption to cipher (encode) the transaction data. The data, once encrypted, can only be accessed by the authorized person who holds the encryption key (similar to passwords). Every transaction block is linked to its previous one. Hence, altering one requires changing every block in the chain, which is practically impossible without affecting the integrity of the entire network. 

Unanimity: Blockchain transactions are validated and added to the chain only if all the validators agree to the genuineness of the transaction. This kind of unanimity of the blockchain makes it highly reliable and enhances its security. 

Faster settlements: Blockchain technology does not have an intermediary or a central controlling authority (such as a bank or financial institution). Hence, the transactions are P2P, or peer-to-peer (each adjacent compute node in the network is referred to as a “peer”). It reduces the reliance on third-party intermediaries and makes settlements faster in the network. For some blockchains that means nanoseconds, and for others within minutes.

Use cases of blockchain and cryptocurrency in finance 

Blockchain and cryptocurrency have utilities in almost every industrial sector, such as finance, supply chain management, healthcare, Al, loT, telecommunications, retail, government, media and advertising, and many more. However, the discussion in this chapter focuses on the financial industry. 

Payments and remittances-domestic and international 

Blockchain is a decentralized technology that functions without the intervention of banking, payment processors, and clearinghouse intermediaries-making it ideal for fast cross-border and domestic retail P2P payments.

Blockchain technology allows for the use of different payment types, such as cryptocurrency (Bitcoin), tokenized fiat (digital dollar, euro), and stablecoins (USDC). 

Currently, remittances through regular banking channels involve exchange rate fluctuations and costly service fees, in addition to the time delay it takes to transfer money. In contrast, blockchain technology with cryptocurrency eliminates all these obstacles, ensures immediate settlement, and reduces costs significantly. 

As an added benefit, blockchain technology can digitize KYC/AML compliance and offer real-time authentication to reduce fraud risks.

Insurance-claims processing and disbursements 

Insurance claim processing and disbursements require collecting and verifying critical data. Hence, they are prone to fraud and are time intensive. Blockchain technology can streamline the verification process and reduce processing time, making claim processing and disbursements easier. 

The use of smart contracts helps in automated claim processing. Authenticated documentation and digitized KYC/AML facilitate claim assessments and reduce fraud. Tokenized reinsurance markets are poised to replace the traditional broker relationship-based models in the insurance sector. 

Investments-capital markets, asset management 

Raising capital is always challenging for businesses, especially with stringent regulations, volatile interest rates, extended times-to-market, and liquidity risk. Blockchain technology eliminates various limitations, thanks to decentralization. It streamlines the process, reduces costs, and decreases settlement times.

In addition, the immutability offered by blockchain technology makes it convenient for businesses to manage their assets. Blockchain allows seamless stakeholder engagement with digitized assets and services. It also ensures transaction confidentiality, reduces human error, improves governance, and enables efficient cap table management with automated fund administration and transfer agency in asset management. 

Banking—CBDC, credit prediction, and scoring 

Banking involves a great deal of data processing and energy. Blockchain technology enables core banking solutions, authenticated documentation, KYC/AML compilation, and conformance. Besides that, it reduces operational risks by enabling real-time financial document verification. Blockchain also enables streamlined credit scoring and prediction based on user activity. 

The technology facilitates underwriting, syndicate formation, and fund disbursement, thereby reducing costs, delays, and friction. Tracking assets and managing them in real-time is possible through code. The global acceptance of cryptocurrencies has led to many governments contemplating issuing central bank digital currencies (CBDCs).

Real estate-purchase and sale of real estate 

Blockchain’s immutability makes it a promising technology for maintaining real estate transaction records. It becomes convenient for real estate market participants to verify the genuineness of titles to properties, thereby reducing fraud. In addition, it becomes convenient to verify mortgages and other encumbrances on the property. Blockchain offers the highest security and discourages illegal tampering with property records to protect the interests of genuine sellers and purchasers.

Loans-trade finance, letters of credit, and bill of lading 

Trade finance hugely depends on the documentation process, which is susceptible to fraud and other security vulnerabilities. Besides, instruments like letters of credit and bill of lading take time to process. Blockchain technology digitizes the entire trade finance structure and enhances security and efficiency. In addition to decreasing processing times, this technology provides transparency, lowers capital requirements, and reduces human error and fraud.

Editor’s note: This is an excerpt from Sonia Dumas’ Cryptocurrency Guide. Download the guide here.

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