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Meenakshi Doppas profile image
By: Meenakshi Doppa
August 20, 2020

Risks and Promises of Blockchain Technology

By: Meenakshi Doppa
August 20, 2020
Meenakshi Doppas profile image
By: Meenakshi Doppa
August 20, 2020

What is Blockchain?

The name derives from its structure, in which individual documents, known as blocks, connect to form a chain of blocks; these blocks can contain any type of information. Blockchains are used to record cryptocurrency transactions, including Bitcoin, and have many other applications.

Every transaction added to a blockchain is validated over the Internet by multiple computers. These systems form a peer-to-peer network, configured to monitor specific types of blockchain transactions. They work together to make sure every transaction is legitimate before adding it to the blockchain. This decentralized computer network guarantees that no machine can add invalid blocks to the chain.

Risks of Blockchain Technology

Financial risk

Traditionally, financial intermediaries mitigate the financial risk of the possibility of a counterparty refusing to meet their commitments by accepting the risk on their behalf through settlement assurances and other mechanisms, such as collateral posting criteria. Blockchain would allow settlement of transactions in real-time or near-real-time, decreasing credit risk and removing liquidity that would otherwise be tied up as collateral. The net shift to credit and liquidity will eventually depend on the application of the blockchain, how smart contracts are implemented, and the actions of the involved parties.

Legal risk

The constitutional structure that supports payments, clearing, and settlements (PCS) has been designed to suit an individual's particular position or procedure. When an individual bears the legal burden of arbitration and could be removed with blockchain, laws, and regulations that have a history of slowing behind innovation would have to respond accordingly. One of the key factors impacting blockchain adoption's speed and method is the legal and technical mismatch.

Key management risk

The strategy for handling digital assets on blockchains is private key management, securing a digital signature. In this context, property ownership is specified by private key ownership. End-users may now select absolute liability and ownership of digital properties, or somewhere between options that never before existed. Under the conventional financial model, the liability and custody of assets on behalf of shareholders is exercised by third-party financial institutions. Key management failure is the possibility that an end-user does not control his or her keys, resulting in a complete and permanent loss of those properties.

Code and cryptography risk

Whatever might be the degree of trust in them, any new technology can be checked to obtain assurance that the systems operate as expected. A reasonable level of assurance requires a high degree of technical competence, which is currently scarce. Blockchain projects must search for bugs before, during, and after implementation of their code. The risk of using a poor encryption method, without a sufficient amount of randomness to establish the desired degree of protection, will result in exploitation. Another threat is that developers do not inspect the underlying code properly. As the Decentralised Autonomous Organisation (DAO) hack showed, the failure to check the code and the haste to enforce it can lead to a serious loss of funds.

 
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Forks and chain-split risks

Blockchain developers undertake software updates by introducing hard forks or soft forks, usually including several nodes to agree on effective implementation. For certain cases, a minority of nodes may prefer and continue to support the old chain, which may lead to a permanent splitting of the original chain into two chains of two separate coins. Ethereum (ETH), for instance, is split further into Ethereum Classic (ETC), and both chains exist today. It is often important to update wallet software, or coin-splitting tools are created to help separate the coins into various wallets. During this time of uncertainty, the company's liquidity may be affected, especially if a large part of its assets are linked to a specific coin. Forking and chain-splitting risk will adversely affect participants' properties, liquidity, and solvency due to the time and energy needed to work through the transition. The new field of risks associated with blockchains must be expected and hedged by finance professionals.

Consensus and governance risks

The consensus is a method of accepting one continuous version of blockchain. Governance is the ongoing management of protocols and modification of code. The consensus and administration function together and benefit from a diverse group of people and the execution of the code. Both consensus and uncertainty of governance are the threats that developers or other responsible parties can not decide on timely protocol changes, or protocol changes are introduced that are counterproductive to a party similar to fork blockchain. This also entails the risk that settlement will not become legally established, due to the likelihood of potentially reprocessing a transaction, transaction block, or a blockchain ledger.

Promises of blockchain technology

Data Privacy

Regulatory measures such as the European Union's General Data Protection Regulation (GDPR) require businesses to reconsider how personal data are handled. These concerns are great on boardroom agendas, particularly for Non-EU firms, with the prospect of substantial fines for non-compliance. Although the safety aspects of blockchain technology are powerful, there are issues to be tackled, including permanent data retention and inter-jurisdictional transition.

Insurance

Blockchain innovations are being developed in insurance and reinsurance to streamline, among other uses, payment and claim handling. Blockchain applications in this sector should, however, ensure that they take account of particular industry regulatory issues, such as customer security and financial insurance regulations. Committing with government authorities to blockchain applications would be a crucial step towards wider recognition of insurance blockchains, and early adopted regulators have been encouraged to do so.

Supply Chain

Blockchain technologies are being used to tackle supply chain issues related to provenance (source (origin claims) import admissibility (forced labor)). Initiatives like Maersk-IBM, which brings daily records into the blockchain, or Singapore's use for import record processing, show that Distributed Ledger Technology (DLT) moves into the mainstream. In contrast, various early implementations centered on high-quality commodities like diamonds. However, users of the supply chains should note that, currently, DLT will not replace inspections on-site and ensure that audits are still available.

Initial Coin Offerings

Most blockchain companies collect funds through the selling of blockchain-tracked assets' "Initial Coin Offerings" (ICOs). The "coins" issued through an ICO constitute the right to use the services of a startup or to process distributed applications. The majority of issuers view that their coins are not governed in compliance with securities, commodities, or money transfer laws. The Securities and Exchange Commission (SEC) has also spoken about being governed by virtual coins. ICO businesses should be conscious that consumer protection authorities will investigate token sales and that governments are attempting to enforce their regulations.

Health Care

Blockchain solutions are under consideration to solve the major issues associated with the currently siloed health data management. There are interoperability issues at all rates, but blockchain solutions display expected applications such as contact and duration records, management of wearable and patient-generated data, patient consent management, patient-focused research, and quality testing results as patient identity management. However, companies should realize that health data's particular legal and regulatory issues must also be tackled in such a spirited procedure.

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