Could Blockchain Prevent Market Crashes Like in 2008?

In 1929 the Great Depression started in the United States. The economic depression lasted until 1933, and it is marked as the longest, most profound and most widespread financial crisis of the 20th century. During this period nearly 11,000 banks failed, the unemployment rate only in the US rose above 25%. After that, governments across the world set up new laws to prevent such a crisis again. Nevertheless, there were at least two major crises across the globe after the Great Depression. And even though it was believed that the financial sector would learn from its mistakes, 2007 came and the most recent global financial crisis hit the world.

The global financial crisis was primarily caused by a lack of transparency and deregulation in the financial industry. That allowed banks to engage in hedge fund trading with derivatives. Banks then issued more mortgages to earn from the profitable sale of these derivatives. They created interest-only loans that were affordable to subprime borrowers. What they did not realize was that there were too many homeowners with questionable credit ratings. That meant that there are too many people who would never be able to pay off the debt that they took on. As a result, homeowners began to default on mortgage payments, leading to an economic crash which spread to the U.S. financial sector and other countries due to the reselling of those mortgage assets all over the world. The effects were devastating: hundreds of thousands of people lost their jobs, houses, and businesses.

So in less than a hundred years the world has suffered dramatically because of the financial crises. Does that mean that we have to prepare for another one? Or there is a way to prevent it from happening?

Blockchain offers a way to avoid the mistakes that were done decades ago

You may think that Blockchain is a buzzword that is used in today’s finance world to manipulate people to invest their money in specific projects. While this is surely not entirely false, there is a lot more to it, and it pays to look deeper. It hardly seems like a coincidence that Satoshi Nakamoto published Bitcoin whitepaper in 2008. It was done to provide a technology to prevent the current events from happening in the future.

As you already understood, the financial crisis is usually caused by a lack of transparency and greed that leads to risky decisions by financial institutions. That led Lehman Brother, an institution that was operating for 158 years and provided almost all possible financial services, to fail. Imagine there had been an opportunity to identify anomalies in trading, funding and other activities earlier. It would have allowed the bank and regulators to take the necessary precautions to avoid bankruptcy. Could blockchain have helped them back then?

One thing that blockchain does, is keep track of every transaction that is made in the chain. The technology records any possible transactions that you can imagine — from payments, purchase of stocks or derivatives and other financial activities. It would enable companies as well as regulators to use machine learning tools to identify the anomalies in financial institutions and, prevent them from escalating to a tragedy. Lehman Brothers would have been operating until this day had they identified their errors earlier — and blockchain would have indeed helped them to do so.

It sounds promising but is it possible?

In 2017 IBM predicted that 91% of the banks would be investing in blockchain solutions. In 2018, 66% of them expect to be in production and running their services with the technology. In a recent article, Business Insider reveals that 75 Banks are testing the JPMorgan IIN blockchain-based services — at the moment, almost all major banks like HSBC, Deutsche Bank, National Bank of Canada and many others are testing the technology. Financial institutions are serious about making a change in their infrastructure to avoid the mistakes that they did in the past. Also, thanks to the cooperation with innovative fintech startups such as Blockstate, the financial system will be in different shape in the coming years.

Blocksate is a company that is developing distributed ledger technologies to replace out-of-date parts of the existing infrastructure in asset management, debt, and derivatives. By removing unnecessary parts of the process and improving overall transparency, they will help prevent such errors from happening, resulting in more stable financial markets. Their infrastructure products are already being used in a live environment. A first asset management product — BlockState’s own CTF15, a digital asset index — is already running on this smart contract enabled platform, proving that the technology improves for real-life application.

The financial world as we see it now is going to change dramatically in the upcoming years. We can already see that a huge amount of efforts from financial institutions, fintechs and regulators are made to stabilize the market and prevent other crashes from happening. Blockchain is one of the tools to do so, and it is already in the game.

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