Blockchain : A Potential Disruption For Financial Services
Blockchain : A Potential Disruption For Financial Services
Blockchain is evidently one of the most important and innovative technologies that have gained popularity in recent years (Peters and Panayi 2016; Pilkington 2016; PricewaterhouseCoopers [PwC] 2015; Swan 2015a). Although still in its infancy, the technology is starting to prove its value by reducing trading costs, increasing transaction settlement speed, reducing fraud risk, improving the auditability of transactions, and increasing the effectiveness of monitoring. With financial services companies also adopting the technology, is the technology still a threat or an opportunity to incumbents?
Blockchain?aims to reduce trading costs, increase transaction settlement speed, reduce fraud risk, improve the auditability of transactions, and increase the effectiveness of monitoring??–Swan,?Fanning and?Centers,?Pilkington,?Yermack
In case you are relatively new to blockchain, let us first provide you with a bit of an overview of it. Initially utilised for Bitcoin trading, blockchain is derived from a decentralised public ledger that provides a secure infrastructure for transactions among unfamiliar parties without a central authority. In a Blockchain Ledger, blocks represent each financial transaction are arranged in linear, chronological order within a shared network (Fanning and Centers 2016; Peters and Panayi 2016; Swan 2015a; Yermack 2017). The three main features of the blockchain are decentralisation, strong authentication, and tamper resistance.
However, in practice, a?complete decentralised network is undesirable because it can risk the company’s confidential information,?i.e.,?corporate secrets. In many cases, such as the use of?blockchain?within a business or a group of companies, the read and write permissions should be restricted to?specific?stakeholders such as regulators and entities in its supply chain. Such systems, known as private blockchains (Pilkington 2016), involve a limited number of participants. The advantage of a private blockchain is that information stored in the chain is only accessible to?predetermined?parties (e.g., companies only need to share certain accounting records among departments within the organisations or with their?suppliers and customers).?Thus, such?a?design will protect the privacy and confidentiality of business data.??
In a private blockchain, the information stored in the chain is only?accessible to predetermined parties,?and this design protects?the privacy and confidentiality of business data
As shown in figure 1,?the?Blockchain market size in financial services is expected to?grow exponentially over the coming years as more and more banks invest in this?technology. A recent report by IBM found that over 91% of banks had already?invested in?blockchain?by 2018.??
91% of banks had already invested in blockchain by 2018
One of the most significant advantages of using blockchain would be increased transparency among financial institutions and improved regulatory reporting and monitoring by central banks if the regulators also have access to the blockchain network. In addition, economic benefits would arise from automated, more efficient processes that will result in reduced infrastructure, operational and transactional costs for banks. For example, SWIFT today facilities over $1.5 Trillion per day in payments globally (FT, 2021) by enabling banks to dispatch messages that credit/debit their accounts. It is acting as an intermediary involving transaction costs, ironically due to slow and costly payments. With blockchain, such costs can be reduced to zero due to automated and real-time transacting, as mentioned previously. Not only start-ups but also the established firms are investing heavily into this technology. Examples of JP Morgan and SWIFT evidence this. JP Morgan has developed its in-house blockchain-based system called “Onyx” that is operating at “billions per day”, according to an article in Financial Times (2021). At the same time, SWIFT has also tested its application of blockchain technology in the financial industry (SWIFT, 2021).
Next to this, when using smart contracts, contractual term performance is improved because smart contracts are designed to execute automatically once specific predetermined prerequisites have been met.
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With blockchain,?transaction?costs can be reduced to zero due to automated and real-time transacting
Moreover, when such transactions in a smart contract are settled near-instantly, the risk that the counter-party defaults its obligations can be substantially reduced, which could be costly for banks and financial institutions. A lot of back-office work can also be eliminated, saving banks a lot of time and money in the long run. This can improve the efficiency of execution and service in the loan ecosystem by using smart contracts to govern contractual terms and conditions, distributed ledger technology to solve communication and transaction tracking, transparency and immutable data to eliminate time-consuming reconciliations and erroneous payments (EY, 2021). Other examples of smart contract applications could range from peer-to-peer ride-sharing to self-issuing bonds or crowdfunding with the promise of future dividends (Jacynycz, Calvo, Hassan, and Sanchez-Ruiz 2016; Yuan and Wang 2016).
A key feature of blockchain is that any data recorded is perpetual, i.e., any transaction recorded on a blockchain can be tracked in real-time, leaving a very detailed audit trail. As such, it eliminates error handling, fraud and reconciliation. Furthermore, this tamper-resistance can reduce the risk of management manipulation of records, thereby preserving the integrity of the transactions. Lastly, blockchain and cryptocurrencies being mutually dependant will result in widespread adoption of this technology, especially by financial institutions should they want to embrace the digitisation of their services through stable or regulated cryptocurrencies.
Any transaction that is recorded on a blockchain can be tracked in real-time, leaving a very detailed audit trail. This makes?blockchain temper resistant?and?eliminates error handling, fraud and reconciliation
Therefore, blockchain has the potential to disrupt the financial industry fundamentally, as mentioned above. That being said, this technology is still in the development phase, with early adopters working out ways to deploy this technology on a full scale. Moreover, the technology or infrastructure of both regulatory bodies and companies to sustain this technology is still unknown, primarily in relation to the confidentiality and privacy issues with public blockchain networks, as mentioned previously. This would be a crucial challenge to overcome in the following years for blockchain to fully become a mainstream distributed ledger technology. Overall, blockchain coupled with associated smart contracts and IoT technologies has the opportunity to advance society towards a more automated, flexible, and efficient economy.??
Blockchain?in combination with?associated smart contracts and IoT technologies has the opportunity to advance society towards a more automated, flexible, and efficient economy
To know more about how blockchain can transform your business, please feel free to?contact us.
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