What Are The Real Risks Of Blockchain?

February 25th, 2019

blockchain-2-25-19.pngIn the landscape of innovative disruption, the public’s attention is often focused on bitcoin’s impact on financing and investment options. However, it is important to understand that blockchain, the underlying technology often conflated with bitcoin, carries an even greater potential to disrupt many industries worldwide.

The attraction of blockchain technology is its promise to provide an immutable digital ledger of transactions. As such, it is this underlying technology—an open, distributed ledger—that makes monetary and other transactions work.

These transactions can include bitcoin, but they may also include records of ownership, marriage certificates and other instances where the order and permanence of the transaction is important. A blockchain is a secure, permanent record of each transaction that cannot be reversed.

But with all the positive hype about its potential implications, what are the risks to banks?

The Risk With Fintech
One of the most disruptive effects of blockchain will be in financial services. Between building cryptocurrency exchanges and writing digital assets to a blockchain, the innovation that is occurring today will have a lasting effect on the industry.

One of the principles of blockchain technology is the removal of intermediaries. In fintech, the primary intermediary is a bank or other financially regulated entity. If blockchain becomes used widely, that could pose a risk for banks because the regulatory body that works to protect the consumer with regulatory requirements is taken out of the equation.

This disintermediation has a dramatic effect on how fintech companies build their products, and ultimately requires them to take on a greater regulatory burden.

The Risk With Compliance
The first regulatory burden to consider concerns an often-forgotten practice that banks perform on a daily basis known as KYC, or Know Your Customer. Every bank must follow anti-money laundering (AML) laws and regulations to help limit the risk of being conduits to launder money or fund terrorism.

Remove the bank intermediary, however, and this important process now must occur before allowing customers to use the platform.

While some banks may choose to outsource this to a third party, it is critical to remember that while a third party can perform the process, the institution still owns the risk.

There are a myriad of regulations that should be considered as the technology is designed. The General Data Protection Regulation (GDPR), the European Union’s online privacy law, is a good example of how regulations apply differently on a blockchain.

One of the GDPR rules is the so-called right to be forgotten. Since transactions are immutable and cannot be erased or edited, companies need to ensure that data they write to a blockchain doesn’t violate these regulatory frameworks.

Finally, while blockchains are sometimes considered “self-auditing,” that does not mean the role of an auditor disappears.

For example, revenue recorded on a blockchain can support a financial statement or balance sheet audit. While there is assurance that the number recorded has not been modified, auditors still need to understand and validate how revenue is recognized.

What’s Ahead
The use of blockchain technology has the potential to generate great disruption in the marketplace. Successful implementation will come to those who consider the risks up front while embracing the existing regulatory framework.

There has already been massive innovation, and this is only the beginning of a massive journey of change.

jschulman

Jay Schulman is a principal based out of RSM’s Chicago office. He is the national leader of blockchain and cryptocurrency services for RSM US LLP.