How is Blockchain Revolutionizing Banking and Financial Markets

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blockchain in banking

Invented back in 2008, the blockchain technology has depicted the change that it can bring in different business areas. The technology, even in its infancy, has disrupted different industries and sectors. Various features of Blockchain such as decentralization, immutability, and transparency make it appealing for business sectors and domains all across the world. One such industry that is leading the way in exploring the potential of blockchain is the banking and finance industry.

Though there are several roadblocks in the way currently, it can be surely said that Blockchain holds the potential to transform the finance and banking sectors by reducing potential costs and labor savings. According to a PwC report, 24% of financial executives from all around the world are very familiar with blockchain technology, with North Americans significantly more familiar than those from other regions. Observing the wide-reaching implications of the technology, companies are constantly researching to find out the ways of applying blockchain in multiple sectors.  

Talking specifically about the banking and finance sector, hundreds and thousands of funds are being regularly transferred from one region of the world to another within each day. This makes the global financial system one of the most popular sectors that could be benefited through the application of Blockchain. Operating on the basis of highly dependent manual networks, the banking and finance sector is prone to errors and frauds that could lead to a crippled money-management system. According to Global Fintech Report 2017, 77% of Fintech institutes expect to adopt blockchain as part of an in the production system or process by 2020.

Blockchain for Banking Industry

blockchain in banking
Source: Lina Lysenko (Dribbble)

With the basic understanding of blockchain technology and its working, the real question that pops up into our minds is Blockchain really useful for the banking sector? If yes, then how can we utilize Blockchain in the best possible way for the industry? And most importantly, is blockchain here to stay or go?

According to a claim by the Harvard Business Review, blockchain will do to banks what the internet did to media. When it comes to banks and financial organizations of this day, Blockchain has the potential to solve a lot of problems. Blockchain technology possesses all the attractive characteristics needed by a reliable technology involving money matters. It is safe, secure, decentralized, transparent as well as relatively cheaper.

Blockchain provides a very high level of safety and security when it comes to exchanging data, information, and money. It also allows users to take advantage of the transparent network infrastructure along with low operational costs with the aid of decentralization. These characteristics make blockchain reliable, promising and in-demand solution for the banking and finance industry.

Financial institutes perform the necessary function of keeping money safe and secure for people and therefore, the processes in place require a lot of mediators. The involvement of these mediators is what makes the industry more expensive. Moreover, with the involvement of too many people and manual processes, the chances of errors and frauds always increase. Blockchain technology aims to do the heavy weightlifting by securing transactions and making the overall customer experience more satisfactory and less money consuming.

Examples of Some Banks Using Blockchain

blockchain in banks
Source: Adarsh Goldar

Though the word blockchain was treated skeptically by banks and financial institutions in the early days of its adoption, the story has changed now. With the success of Blockchain in various industries, the banking sector is actively seeking new areas and applications of the Blockchain technology.

Big names like JP Morgan Chase have dedicatedly placed their faith in the future of Blockchain technology. The American multinational investment bank headquartered in New York City has started a new division called the Quorum division specifically for research and implementation of Blockchain technology. Quorum is a distributed ledger and smart contract platform for enterprises that supports speedy transactions and throughput addressing challenges for the finance industry, banks and beyond. According to resources, they have already issued a yearly deposit certificate based on a distributed registry with a variable rate.

Other than these, a major US bank, Bank of America has filed a patent document which was published by the U.S. Patent and Trademark Office. The document talks about the implementation of a permissioned blockchain for securing records as well as authenticating business and personal data.

The system would allow only authorised participants to access the data and keep a log of all the logging entries. Moreover, the proposed system will utilize blockchain technology to combine multiple existing data storage platforms into one. This secure single network will increase the overall efficiency and reduce the number of storage locations of the user’s data.

Another name in the line is Goldman Sachs, who is actively involved in research and support of the distributed registry technology. They have invested in a cryptocurrency project called Circle. The project is considered as one of the most well funded startups in the blockchain space. It aims to solve the key problem of volatility in the digital currency space thus, making the finance sector more reliable with crypto options.

Backing such a popular project, Goldman Sachs group intends to become the leader in cryptocurrency adoption among their Wall Street competitors. They are also setting up their own cryptocurrency trading desk that will exclusively handle their digital trading.

Applications of Blockchain in Finance

blockchain in banks
Source: Diana Maltseva (Quora)

With emerging use cases with each passing day, the blockchain technology has the potential to disrupt the banking and finance sector of current times. A few ways in which blockchain can change the current face of the banking industry are as follows:

Fraud Reduction

The involvement of money in any situation leads to increased chances of fraudulent activities. And for an overall sector operating on the very base model of money, security is of utmost importance. More than 40% of financial bodies and intermediaries including money transfer service providers as well as stock exchanges are susceptible to heavy losses relating to economic crimes annually.

Reason being the usage of centralized database systems for operations and money management. A centralized database system is vulnerable and highly prone to cyber attacks as the single point of failure, such systems can be exploited by hackers. Once a hacker gets access to such a system, it is a child’s play for him/her to take the money. This leads to the need for more secure systems that are strong enough to avoid such attacks.

Enter Blockchain, a secure, non-corruptible technology operating on a distributed database system. Since blockchain is distributed, there is no chance of a single point of failure. Each transaction is stored in the form of a block with a cryptographic mechanism which is extremely difficult to corrupt.

Moreover, all the blocks are linked to each other and due to this linking mechanism, if one block is breached all the other blocks on the blockchain immediately showcase the change. This, in turn, helps to track the breach and provides the hacker with no time to make changes in the overall system. With a secure Blockchain system in place, we can eliminate the cyber crimes and attacks of banking and financial sectors taking place in the current times.

Know Your Customer (KYC)

Banks and financial institutions are strictly concerned about the increasing costs that they have to bear in order to comply with AML and KYC i.e. Anti-money Laundering and Know Your Customer norms. All these processes consume a lot of time and have to be performed individually by all the banks and money based institutions.

According to a Thomson Reuters Survey, the overall estimated expenditure of these processes ranges from $60 million to $500 million yearly. These customers due diligence regulations are performed in order to reduce the money laundering as well as terrorist activities. Currently, banks need to upload the KYC data of a customer into a central registry which can be used for checking the information of an existing or new customer.

With the adoption of a blockchain system, the independent verification of each client by one bank or financial organization would be accessible for other banks to use so that the KYC process doesn’t have to be restarted again.

Meaning that the duplication of efforts would be eliminated by the aid of blockchain technology. Moreover, all the updates of clients’ will be to all financial institutions in near real-time. This would result in the reduction of administrative efforts as well as costs for compliance departments.

Smart Assets

Trade finance can become essentially challenging when transactions in the form of assets have to be recorded with a clear date and time stamp. Supply chains all around the world involve a lot many entities and components being bought and sold continuously. All paperwork involved in documenting the details of demand and supply is even more complicated. Blockchain can hold these records of smart assets in digitized form and get them updated in real-time. A smart asset system would not be limited to the entries of just objects moving from here to there but it can also have the track of where a particular item is delivered and where has it come from.

A smart asset tracking system for the banks and financial institutes competing in the current times holds a lot of scope in the competition. A bank with a rich data set can turn this data into valuable information for its clients with the aid of blockchain.

Smart Contracts

The application of smart contracts can prove particularly important in the banking and finance sector. A smart contract is a self-executable piece of code that runs when certain conditions written on it are completed.

Smart contracts, when used for financial transactions, would be helpful in increasing the speed and simplifying complex processes. This will also ensure the transfer of accurate information as the transaction will be approved only if all the written conditions of the code are met. Moreover, as these terms are visible to all the parties involved in the transactions, the chances of error at the time of execution are dropped drastically.

Trade Finance

Trade finance is considered one of the most useful applications of blockchain technology in the banking sector. All the involved parties such as a complex transaction can be on-boarded on a blockchain network and the information can be shared by exporters, importers, and banks on one common distributed ledger. Once certain specified conditions of the deal are met, the smart contracts will automatically execute themselves and the respective parties can view all the actions performed.

According to sources, an Israel-based start-up along with Barclays have successfully executed a trade transaction that would normally take 7 to 10 days in just 4 hours using Blockchain technology. When compared to the existing infrastructure, the use of blockchain can reduce costs dramatically relating to licensing, ticketing as well as other overhead charges.

Why Blockchain for Banking?

blockchain in banking

  1. The current day banking systems are highly reliable on paper and outworn process. The Need of the hour is to have an upgraded system embedded with reliable and trustable technology that could withstand frauds, scalability and security issues. The blockchain technology and its decentralized nature can give the banking systems the much-needed edge they’re on the lookout for. 
  2. Banks cannot be termed as independently operating self-sufficient entities as any transactions made through them still involve intermediaries. Moreover, the rate through which money is transferred on an international scale can still take up to 5 days along with entailing risks. With a blockchain system in place, banks would be able to make transfers real quick without even having to take the burden of risks as the system would be self-sufficient to resolve it all on its own.
  3. The world is going digital and with this progress, even small transactions and payments are happening digitally. The economic activity rate is increasing and there’s no doubt in assuming that the rate will keep picking up in the coming days. The blockchain technology will make small transfers feasible and fast along with the aid of lower fee and scalability of transactions.
  4. Financial services other than banks are constantly evolving their systems with the aid of the latest technology in order to secure the markets by providing economically available services at cheaper rates. Banking and other financial institutions should look forward to the adoption of new blockchain technology too in order to secure their place in the ecosystem.

Challenges in Adoption

Blockchain sure has its advantages in terms of adoption given its proposed features but there are some hurdles along the road as well which need to be addressed for banks and financial institutions to grow ahead with blockchain.

blockchain in banking

Interoperability: The blockchain technology is not bounded by any international rules and regulations that place a standard to it. With the increasing need for interoperability among large industries like banks, the technology needs to be compatible with different systems and should hold the potential to get adopted by the masses. The integration of existing systems with a blockchain based model is a big challenge today as the current systems and processes cannot be entirely eliminated. If the actual adoption of blockchain allows multiple systems to work together smoothly, operational feasibility can be achieved.

Privacy: Banks and financial institutions are the entities that are trusted by people for storing their funds. In order for blockchain to take their place, it is important to ensure that the data stored on the blockchain technology is kept securely and would not hamper the identity of any individual. As the transactions made on a public blockchain are publicly available, the need of exploring the potential of private blockchains for data-critical sectors is needed along with the resolution of issues like interoperability.

Encryption: Private keys are the essential elements of a blockchain as they play a significant role in securing the data of an individual on the blockchain. However, a private key generated once has to be kept very securely as once it is misplaced or lost, there’s no way to get it back. Moreover, the encryption used to store data can be compromised by finding loopholes in the network which in turn, makes the blockchain susceptible to hacker attacks.

Security: The blockchain network is secure and powerful as it is embedded with cryptography techniques. Cryptographic networks are complex to hack and thus, any kind of security breach in such networks would require a high amount of computational power in order to secure any hack. When a blockchain network is applied to any banking institution, it has to be secured with multiple security protocols. The network should be capable enough to restrict participating authorities to take control of the network only according to the access permission given to them. Depending upon the requirement, the blockchain involved in such systems or organizations could be permissioned or permissionless. People in an organization need to be handled with different levels of access permissions in order to save the overall network from malicious insiders and cyber hackers.

Scalability: Growth of existing databases is undeniable. The number of entries will keep on increasing as the number of people will continue to grow too. This poses a big challenge to the application of blockchain technology network. The network created through a blockchain should be able to handle the growing traffic while maintaining the speed of accessibility for the network participants. If the blockchain technology is applied to the current banking systems and institutions, it has to ensure the capacity of handling large volumes of data too.

Energy Consumption: Most of the current successfully running blockchain networks run on the concept of proof-of-work mechanism in which the network participants are rewarded based on how quickly they solve the equation to add a new block to the network. While this keeps the network working smoothly, it also increases the consumption of energy in enormous amounts in the form of computational work. This kind of computing power leaves massive carbon footprints which affect the environment. Before adopting Blockchain in an industry like banking, this issue needs to be resolved through alternate rewarding mechanisms.

Legal Regulations: If blockchain is applied in the banking sector, the need for international and national regulations around it will become mandatory. Currently, cryptocurrencies, the most popular application of blockchain, do not have any regulations around them which makes them susceptible to both profits and losses. However, if and when blockchain finds its place in the banking or finance sector, the regulations need to be in place so as to avoid chaos among people in case of any losses.

Conclusion

Despite the strict jurisdictions around the banking sector, the financial institutions have started to realize the potential of blockchain technology seeing the popularity of cryptocurrencies in the current markets. The big giants in the banking sector have started conducting the tests for finding out the possible use cases of this decentralized technology for their business processes.

Moreover, some of the organizations are also investing heavily in such researches and tests conducted by startups to develop blockchain based solutions. With Blockchain entering the current scenario, a lot of problems could be solved while making the system more transparent, easy to access and reliable.