BBVA, a multinational banking group and the second largest bank in Spain, has issued a new report in which it says that blockchain technology has the potential to cause the “biggest disruption to date” in the banking and financial sector.

Untitled ‘Blockchain Technology: The Ultimate Disruption in the Financial System,’ the short report published by BBVA on July 10, explains how blockchain technology allows “massive simplification of banking processes and significantly [reducing] costs.” However, in order for the technology to be widely spread, there are still risks and challenges that need to be addressed.

According to Nathaniel Karp, chief economist for BBVA Compass, the first major disruption would be in the payments space where digital distributed ledger technology allows transactions to occur directly between the buyer and the seller, eliminating the need of any intermediary.

“This would result in significant infrastructure savings for banks by allowing them to bypass payment networks that are oftentimes slow, cumbersome, and expensive,” Karp wrote.

However, the biggest potential impact may extend beyond the payments space. In the same lines as Blythe Masters, a former JP Morgan executive and a credit default swap pioneer, said so at Exponential Finance 2015 back in June, distributed ledgers can be programmed to record anything of value, including bonds, equities, derivatives and loans.

Given that these financial assets are already electronic, “it may be possible that someday the entire system is replaced by a decentralized structure,” Karp said.

He explained:

“The latest innovations are using tokens to store and trade assets like shares, bonds, cars, houses and commodities.

“These so-called ‘colored coins’ attach additional information on the asset, generating ‘smart property’ or the ability to record and transact these assets using ‘smart contracts’, which are enforced by complex algorithms, through distributed platforms without a centralized register, thereby increasing efficiency.”

In this environment, Karp believes that financial institutions and banks would replace their current centralized models and move towards a fully decentralized financial system.

But until digital distributed ledgers become mainstream, there are concerns that need to be addressed, notably in terms of trust and protection, Karp argued.

“The system would have to possess a massive amount of computer power and efficiently cope with the enormous energy consumption required to support it,” he said. “In addition, it is not clear how this system would deal with legal and regulatory concerns, as well as with matters of national security, such as money laundering, fraud, tax evasion or terrorism.”

Furthermore, digital currencies can also be subject to crashes. In the event that their usage reaches substantial levels, “these shocks could generate systemic risk and severe economic downturns.”

Overall, improvements in blockchain technology could overcome these obstacles and lead to broader acceptance, Karp said.

Suggesting that blockchain technology will eventually become widely use some day, he concluded:

“The key question is not how, but when the disruption will become far-reaching. As other industries that have been transformed by new technologies and digitization, blockchain technology could reshape the financial industry well beyond the payments system.”

Image credit: BBVA Compass

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