What is blockchain and how does it work?

The blockchain is a relatively new concept related to the financial world. It has caught the attention of advisors and investors because it focuses on security, transparency and efficiency in transactions that are conducted digitally.

For investment professionals, financial advisors, and the banking sector, it is essential to grasp the fundamentals of blockchain and its functionality. Thus, we will provide a detailed explanation of the key aspects of this technology.

What is blockchain?

The blockchain is a technology that is based on a decentralized and public blockchain of transactions. 

It generates a database and shared technologies that allow the transfer of a value or asset from one place to another without intermediaries. All its participants have access to them, being able to track every transaction they have made.

It can be understood as a very large ledger written by different computers simultaneously, which cannot be modified and is shared. 

How blockchain works

The blockchain is a record of all transactions stored and shared publicly, where the so-called “miners” are in charge of verifying each one of them. Once verified, they are added to the chain and shared with the nodes that form the network.

For this process, it is necessary to be clear about the elements that make up the blockchain:

1. Blocks

Blocks are made up of a set of transactions. Each one is part of the blockchain.

They are all connected by a unique code called hash and each block contains the hash of the previous block in the chain.

2. Miners

These are computers or chips whose function is to verify all transactions that take place.

Their role is to create new blocks and verify the blocks that are added to the chain.

3. Nodes

These are computers that are connected to the Bitcoin network and are responsible for storing and distributing updated copies of the blockchain.

Therefore, each new block that is confirmed is added to the blockchain and to the copy that each node stores. 

Blockchain fundamentals

Blockchain technology is emerging as a transformative pillar in today's financial landscape, based on the concept of distributed ledger technology (DLT). 

This system represents a significant evolution over traditional methods of recording and verifying transactions.

The fundamental characteristics that define the robustness and potential of the blockchain are as follows:

1. Decentralization

Unlike traditional centralized systems, the blockchain operates without a single controlling authority. 

This distribution of validation power among multiple network participants not only increases security but also minimizes the risk of manipulation. For the financial sector, this represents an opportunity to redesign processes and reduce dependence on intermediaries.

2. Immutability

Once a transaction is recorded on the blockchain, it becomes virtually unchangeable. This feature is achieved through complex cryptographic algorithms and the chained structure of the information blocks. 

Immutability provides an unprecedented level of data integrity, crucial for audits, regulatory compliance and fraud prevention in the financial arena.

3. Transparency 

The blockchain offers a very high level of transparency in financial transactions. Although the identity of participants can be kept pseudonymous, all transactions are visible to network members. 

This transparency fosters trust among stakeholders and facilitates more efficient oversight, critical aspects in a highly regulated industry such as finance.

Implementing these fundamental features of blockchain in the financial sector promises several tangible benefits. These include streamlining reconciliation processes, reducing operational costs associated with intermediation, and improving the speed and security of cross-border transactions.

Types of Blockchain

There are different types of blockchain thanks to the evolution of this technology. Let's take a look at the two main ones according to how it is executed and who has access to it.

Public blockchain

They are accessible to any user anywhere in the world; they only require a computer or device and internet access.

It's important to note that because it is open, its security management needs to be significantly more robust. This is where consensus protocols and security measures become crucial, which we will explore further.

Some examples of public blockchain are Bitcoin and Ethereum.

Private blockchain

It is characterized by the fact that access depends on a central unit, whether it is a company, organization or individual. 

The elements are the same as in the public blockchain, but their access and control are in the hands of a group of companies or individuals, known as a blockchain consortium.

An example of this type is the Hyperledger network. 

Consensus protocols and blockchain nodes

One of the biggest challenges of these distributed networks is that they are susceptible to hacks, to introduce false transaction data.

To avoid this, some security measures must be taken, among which consensus protocols stand out.

This mechanism coordinates the simultaneous approval of blocks by nodes, ensuring their integration into the blockchain. 

Blockchain in the financial sector

This technology is being utilized across various sectors, with banking being one of the most significant.

According to IBM, 91% of banks have invested in blockchain solutions as of 2018, as these types of solutions provide transparency and efficiency for each transaction.

BBVA and Santander are two large banks that have invested heavily in blockchain technology, to improve the security of their processes. This is due to different reasons:

Impact on banking operations

The implementation of blockchain in banking operations is generating unprecedented operational efficiency. Processes that traditionally required days, such as international transfers, can now be completed in a matter of minutes. 

This not only reduces significant operational costs but also improves the customer experience.

In addition, it is key because it makes it possible to:

Cross-border payments

Enables faster and cheaper international transactions, eliminating intermediaries and reducing commissions. 

Clearing and settlement

Clearing and settlement processes, which used to take days, can now be performed in near real-time, reducing counterparty risk and freeing up capital that was previously tied up during these processes.

Identity management

Blockchain technology offers robust solutions for identity verification and KYC (Know Your Customer) processes, which not only improves security but also simplifies new customer onboarding and reduces costs associated with regulatory compliance.

Innovation in financial products and services

The blockchain is catalyzing the creation of new financial products and services, expanding the capabilities of traditional institutions and giving rise to new business models.

This is thanks to the fact that it helps in different tasks and actions, such as:

Smart contracts

These self-executing contracts are transforming areas such as lending, insurance and financial derivatives. 

This is because they automate the fulfillment of contractual conditions, reducing the risk and costs associated with intermediation and compliance.

Asset tokenization

The ability to represent real-world assets as digital tokens on a blockchain is opening up new investment and liquidity possibilities. From real estate to artwork, tokenization enables fractional ownership and facilitates the trading of traditionally illiquid assets.

Decentralized financing

Although still in its early stages, DeFi represents a shift in how financial services can be offered without traditional intermediaries, including peer-to-peer lending, decentralized exchanges and blockchain-based savings products.

Risk management and compliance

The blockchain offers new tools for risk management and compliance, critical areas in the financial sector, such as:

Traceability and auditing

The immutable and transparent nature of blockchain facilitates the traceability of transactions and simplifies auditing processes, which is particularly valuable for compliance with certain regulations.

Fraud prevention

The advanced cryptography and decentralized structure of the blockchain make it extremely difficult to manipulate data, significantly reducing opportunities for fraud.

Regulatory reporting

The ability to provide real-time access to regulators can simplify and streamline reporting processes, reducing the administrative burden for financial institutions.

Implement blockchain in your company and boost your results with the help of London Consulting Group

If you want to get all the benefits that blockchain offers, London Consulting Group can help you. Through experts, we ensure that your organization can meet the market challenges and consolidate digital banking. 

This, through different actions, such as:

• Digital banking consolidation: we develop and implement strategies together with your company's leaders to respond to emerging market challenges.

• Banking and financial inclusion: we develop banking products that allow broader access to the population.

• Use of new technologies: through AI, processes and decision-making can be improved.

• Interactive and omnichannel marketing: we develop and implement tools to provide a personalized customer experience through different platforms.

• Security and cybersecurity: we implement robust measures to protect data and transactions.

• Product review and commercial strategy: we review and update the product portfolio to define the ideal strategy based on supply and demand.

• Commercial, operational and financial efficiency: we drive efficiency in commercial processes to increase sales. 

• Regulatory compliance: it is important to keep abreast of regulatory changes in the sector to generate plans that comply with them.

• Team development: we work to build high-performance teams, increase competencies and keep abreast of industry trends to adapt quickly.

• Innovation and information management: product innovation is encouraged to stay current. 

If you want to know more about how we can work together, contact us!