Ever since the emergence of blockchain technology and the birth of the first P2P digital currency Bitcoin back in 2009, cryptocurrencies have become the popular choice for fast digital asset transactions. The benefits of incorporating blockchain in pretty much any industry are so many that global businesses can no longer afford to ignore the opportunities it provides. While some integrate it faster than anticipated, as with ecommerce, others like healthcare take more time and effort to do so. Either way, a growing number of sectors are searching for more reliable and quick blockchain solutions and it’s easy to see why.
Two of the industries that could benefit the most from blockchain are finance and banking. While that may seem ironic at first, given that cryptocurrencies emerged to bypass banks in particular, there are plenty of reasons why it fits them well. In his latest book Kevin Werbach, professor of Legal Studies and Business Ethics at The Wharton School, refers to blockchain technology as the new architecture of trust: “In an era when trust in institutions of all kinds is collapsing, the blockchain offers a new hope: Shared ledgers of information that no one controls but everyone can believe”.
Many believe that blockchain will disrupt the finance sector by creating new and improved processes to help customers with a variety of services, even those that still operate on paper. But for it to become widely and rapidly adopted, companies must start seeking ways to integrate blockchain into their existing systems, instead of replacing them.
A good starting point when designing a new solution is to explore the current problems and weaknesses of any specific business or process. In the finance and banking industry in particular, these issues are many and they are often interrelated:
One of the major restrictions for many financial institutions is their limited business hours. This could often translate to slow processing of documents and transactions and become a burden to their financial operation structure.
Due to the involvement of multiple stakeholder parties in banking and financial services, each of them requires a copy of the processed data. This not only adds to the delay in verifying and communicating different versions of that data, but could also lead to conflicts and confusion.
Services such as lending, cross-country payments, and trading require the assistance of financial intermediaries in the process, which come with their associated costs and commissions. Yet, by design, the current state of those services is inefficient.
Anti-money laundering procedures like KYC/AML may take weeks to undertake and complete. They usually involve multiple parties and oftentimes require loads of manual paperwork. Additional regulations in that sector enforce more and more steps in such procedures, which makes them hard to execute and create great impediment for financial operations.
So how could blockchain help solve some of those problems?
Benefits of Blockchain
Blockchain is created as a decentralized technology. Compared to traditional financial institutions which act with a single point of governance, blockchain needs no single authority which controls the data. Since there is no central database, blockchain relies on a distributed ledger that is available to all participants in the network.
The benefits of this architecture are:
All transactions ever done in the blockchain process are public and anyone can access them.
Another positive to consider is hiding all the participant identities. This is done via complex cryptographic algorithms which prevent the direct link between customers and their corresponding transactions.
Immutability and Traceability
Blockchains are immutable, meaning that once a block element enters the chain and is accepted by all parties, no one else can tamper with or modify the transaction. That, in turn, makes the system more secure and easily traceable by all shareholders.
Trust and Accountability
Because blockchain is transparent, immutable and traceable, all parties involved can engage in mutual agreements without having to explicitly trust each other and thus avoid assuming risk.
With private or hybrid blockchain, financial institutions can operate at a much higher pace, processing hundreds of transactions per second. Even when public blockchains are used, the performance would still be higher for some services (i.e. global payments or lending).
Applying these benefits of blockchain to the existing problems within the financial and banking sector creates many opportunities for service improvements.
Popular Use Cases
A few of the popular use cases of blockchain in the finance industry include documentary fraud prevention, real-time approval of financial documents and operations, tracing ownership of goods, anti-money laundering, and smart contracts.
Traditionally, trade finance involves multiple parties, which naturally slows the blockchain process, making it heavy and inefficient. This is largely due to the lack of trust between those parties, which leads to the involvement of more intermediaries. In return, they help assume the risks or assess regulations compliance and further slow down that process. Furthermore, many of those parties operate on different platforms and suffer from duplicated data compatibility.
In contrast to these transactions, blockchain takes away the need to operate on multiple platforms and prevents data duplications. The approval process can also happen almost simultaneously, since all participants can access the same document in the network. This happens through smart contracts on previous arrangements where requirements are met, which remove the delay in trade finance.
In collaboration between several international banks in 2018, IBM launched a global trade finance platform – Batavia, to support the creation of multi-party, cross-border networks available for organizations around the world.
Another popular use case of blockchain in finance is global payments. The traditional cross-border payment process usually takes up to a week. It also includes high transaction fees due to the number of middlemen involved.
Blockchain offers a way to speed up the process and consequently lower the transaction fees by establishing a digital identity and a verification process. Settlements can also be handled with the use of smart contracts in an almost immediate manner.
In 2018 the startup Ripple proved that financial institutions can benefit from adopting the new technology when they sent the first global payment using the blockchain technology. The whole transaction lasted 20 seconds and was done in collaboration with SAP and ATB Financial.
KYC & Money Laundering
When it comes to payments, lending services, and trade finance, the KYC/AML regulations are among the most costly activities for banks and financial institutions. KYC is also the main factor for inducing delay in most financial operations.
One way blockchain helps minimize these delays is by introducing private and permissioned networks. This is done to validate and ensure participant identities within the same institution or between multiple institutions that are essentially part of the same network. Another way of utilizing blockchain strengths is by taking advantage of the relatively new concept of Self-Sovereign Identity (SSI). According to SSI every individual should own and control their identity. Instead of relying on third party verification and validation services, institutions could also ask for direct access and use a digital self-sovereign identity that is uploaded to the blockchain.
While blockchain is not the solution for every single problem in the world of finance, it offers loads of lucrative opportunities. In truth, it still suffers from scalability issues and creates great obstacles within an industry that operates with millions of transactions every second. But it is only through innovation that banks and finance institutions could improve their services and compete with the arising “disruptive” startups of today.