By Julie Stackhouse, Executive Vice President
This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, appears at least once each month.
This blog post is the fifth and final in a series about fintech and how it is affecting the banking industry. Last month, we looked at how digital, or mobile, wallets work. This month, we examine distributed ledger technology.
It has been a decade since the digital currency called Bitcoin was introduced. At the time, the concept of a virtual medium of exchange was largely unknown—and even frightening—to many in the general public.
Today, CoinMarketCapCoinMarketCap tracks most of the alternative coin systems that have hit the market, including Bitcoin. It shows users the current value in dollars and bitcoins for each coin. tracks more than 1,600 digital currencies. And common to all of the currencies is the use of a digital accounting system: a shared, consensus-based system called distributed ledger technology (DLT).Bitcoin uses a particular type of DLT called blockchain. Every blockchain is a distributed ledger, but not every distributed ledger is a blockchain.
Over the past decade, numerous types of distributed ledgers have been introduced, all offering a secure way to transfer assets. To qualify as a distributed ledger, three key elements must be present:
Not all ledgers have the same access rights. Access to a ledger may be unpermissioned or permissioned. An unpermissioned public shared ledger has no single owner and is open to all to view and participate. Bitcoin’s blockchain ledger is an example of an unpermissioned public shared ledger. Participants both initiate and validate transactions.
Alternatively, a permissioned public shared ledger can have one or many owners, who limit participation to trusted users. Anyone can view this type of ledger, but only trusted users can initiate or validate transactions. Permissioned private shared ledgers also have one or many owners, who limit visibility and participation to trusted participants. Traditional financial institutions would gravitate toward this type of ledger.
DLT offers a number of promising applications for financial institutions, including foreign exchange transactions, international money transfers, securities clearing and settlement, collateral management, derivatives, and data management. Proponents of DLT in financial services and other industries tout numerous benefits of the technology, including:
While distributed ledgers hold promise, their potential for clearing and settlement of financial transactions presently faces challenges. Importantly, both real and perceived security concerns must be overcome.
Moreover, interest in adopting the technology must become far more widespread than it is today. In addition, the technology must be proven to “scale” for high-volume transactions, especially with permissioned private shared ledgers. And finally, global legal and regulatory minefields must be traversed.
1 CoinMarketCap tracks most of the alternative coin systems that have hit the market, including Bitcoin. It shows users the current value in dollars and bitcoins for each coin.
2 Bitcoin uses a particular type of DLT called blockchain. Every blockchain is a distributed ledger, but not every distributed ledger is a blockchain.