By Rob Morgan
Confused about virtual currencies and the difference between a bitcoin and blockchain? You are not the only one. You can’t read the news today without seeing a headline about a major investment being made in the area. But what is a virtual currency, how does it work and what does it mean for banks?
Virtual currenciesof which bitcoin is the most prominent–are digital representations of value. They are marketed directly to consumers and used in place of government-issued money. Meanwhile, the blockchain is the “ledger” that keeps track of virtual currency transactions and allows users to establish ownership of these virtual assets.
A virtual currency stores value, as traditional currencies have for centuries. If you think about a $20 bill in your pocket, it has little more intrinsic value than the paper it is printed on. Despite this, it has a recognized value that you can use to exchange for real goods and services.
Virtual currencies operate in much the same way. Although there are few merchants that accept them, there is a market value for these currencies based on demand and a limited supply. Owning a virtual currency today is much like owning a foreign currency. There is an exchange rate (often volatile) and you can trade your virtual currency for dollars.
Ownership of a digital asset is different, however. To explain this, let’s use an example: your home. You do not own your home because you hold the keys to the front door. This would make hiring a housesitter an expensive proposition. You own your home because your name is the last one listed on the final deed of sale. This deed of sale is held in an official place, usually a local courthouse, where anyone can go to confirm ownership.
In virtual currency, the blockchain takes the place of this courthouse. It is the official record of all virtual currency transactions, listing the current owners of all of the currency in circulation. Unlike that local courthouse, the blockchain is a distributed ledger of ownership so there is not a sole copy of the blockchain. Instead, every participant in the system has a copy, and agrees in near-real time on this ownership record whenever a transaction is made.
So why invest in a currency that today has little transactional use and is rarely accepted as payment for goods and services? The answer lies in the blockchain. By distributing ownership of the ledger you are creating a system where ownership can be transferred (a payment!) quickly and efficiently. You do not need to go to the local courthouse or the central bank and wait for a transaction to be recorded and confirmed. Instead, it happens in real time. Moreover, the public nature of the ledger allows transparency in payments, preventing counterfeiting, fraud and double spending.
Faster settlement of funds has a real value. Settlement risks are reduced and funds can be made available to customers instantly. In fact, Banco Santander estimates that blockchain technology can save banks up to $20 billion a year by 2022.
The majority of bank investments today are in blockchain technology, not in virtual currencies such as bitcoin. More than 30 banks have joined a consortium called R3CEV, aimed at leveraging blockchain technology. Banco Santander recently made an estimated $4 million investment in Ripple, a company that facilitates payments on distributed ledgers. Neither of these companies use bitcoin; instead, they use the blockchain to facilitate the exchange of digital assets.
Bitcoin is a strong proof-of-concept that shows how blockchain technology can be leveraged to facilitate fast and efficient payments. Today the challenge lies in creating infrastructure that can leverage blockchain technology to safely facilitate real-world transactions.
