Blockchain in Banking: A Catalyst for a Trustless, Transparent and Borderless Economy
Since its pompous arrival in 2009, blockchain brought about a slew of opportunities and advancements that promised to revamp a lengthy list of different industries. And now, with a whole decade under its belt, blockchain has set its disruptive sights on banking, a sector that’s long been hailed among the most promising blockchain use cases of them all.
For years, blockchain and banking have been commonly brought up in the same breath, and there’s a very good reason for this. Blockchain offers an opportunity to improve the banking industry by removing the need for middlemen and replacing them with trustless, transparent systems capable of operating themselves.
And, in return for embracing such a radical shift in how they operate, banks using blockchain get to push user satisfaction through the roof and establish effective, more profitable ways of conducting business.
The text below goes in-depth into explaining precisely why blockchain in banking should garner so much excitement, but it also poses a pivotal question concerning the future of our economy: will the financial industry embrace decentralized systems or will blockchain replace banks altogether? The likelihood of there being a third alternative does not seem too probable at this point. So, without further ado, let’s take a closer look at what blockchain technology in banking means both for end-users and financial entities alike.
Blockchain Technology in Banking Offers an Opportunity to Recreate the Financial World
If the value of blockchain had to be condensed to a single sentence, we’d say this technology provides a way for untrusted parties to come to an agreement on the state of a database without needing to rely on a middleman. Obviously, a wide array of industries stand to benefit from this and banking is no exception – a blockchain can provide improved variants of financial services such as payments or securitization that operate without a third party’s coordination.
But the benefits of deploying blockchain in finance do not end there; we can also automate most manual processes associated with banking. Compliance, claims processings, distributing the contents of a will, etc. – a blockchain system can turn these protocols into mere, automatic formalities.
Here’s a short list of key reasons that will help you grasp why there’s so much hype surrounding blockchain financial services:
- Top-notch security: Blockchain-based architecture can never fall victim to single points of failure, plus it reduces data exposure by taking intermediaries out of the equation.
- Total transparency: Blockchain apps feature a sole source of truth shared between all network participants, so there’s no way for misinformation to make its way into the system.
- Unconditional trust: Transparent ledgers enable different parties to collaborate without risk even if all they know about each other are their usernames.
- Automation of processes: Blockchain in financial services facilities reliable automation of business processes, brought about thanks to the creation and execution of smart contracts.
- Data owners hold all the cards: This technology allows selective sharing of information between parties while never taking control over data from its original owners.
Use Cases, Applications and Fixes: How Blockchain Improves Banking
If properly deployed, blockchain in finance can solve the most prominent issues troubling banking and financial services of our age. Here’s a more in-depth list of what decentralized networks can introduce to the banking sector:
Faster and cheaper payments
Whenever you send or receive a payment through traditional banking channels, the funds always go through a series of intermediates. Each “step” adds complexity to the process and prolongs the payment, plus every service provider expects to be compensated for playing a role in your payment. Of course, chances of something going wrong increase exponentially with every middleman that gets added to the process.
With blockchain payments, however, the needlessly complicated process is substituted with a completely peer-to-peer protocol. Nothing stands between the two individuals orchestrating the payment, so we’d have faster transactions, increased levels of security and substantially lower fees.
Significant reduction in fraud
The banking industry, although formidable in terms of security, still regularly falls victim to various forms of fraud. Luckily, blockchain technology has an incredible track record of preventing hacking, denial-of-service (DDOS) attacks, identity thefts, and other forms of fraud commonly found in the banking sector.
Typically, hackers look for a backdoor to break into a single data hub and exploit the system, which is an inherent flaw of any centralized structure. But with blockchain, there is no singular hub of information – a would-be hacker would need to enact the same changes to every single block in the system, which is practically impossible.
This is a huge aspect of all blockchain banking use cases that will certainly push deployment forward. With less fraud, the costs of doing business go down, giving decision-makers an added incentive to test out the fit between blockchain and banking.
A whole new take on Know Your Customer (KYC)
KYC, although a viable solution to the ever-present problem of identity verification, takes a huge toll on the budget. Constant updates to thousands upon thousands of users are time-consuming and expensive, plus data leakages can put all sorts of hurting to clients and banks alike.
With blockchain banking, KYC takes on a whole different look. First of all, verifying someone’s identity would be a formality as nobody apart from the user has access to his or her log-in credentials. Furthermore, all changes in client data would be automatically refreshed whenever a system member alters some of its info. And the updates would be practically instantaneous too, which is yet another way blockchain finance saves a lot of time for all involved parties.
Smart contracts save time and, by extent, money
Generally speaking, contracts exist to protect people and businesses when entering into agreements. However, due to the complicated nature of contracts, the process of creating one requires a lot of manual work from legal experts and it can certainly drain a budget.
Luckily, blockchain systems come equipped with smart contracts. They enable the automation of agreements through tamper-proof, deterministic code that supersedes legal experts. Instead of relying on a coordinated effort of specialists when performing payments, a smart contract can keep the money in escrow and only release it when certain conditions of the agreement are fulfilled.
With smart contracts, blockchain in banking allows financial institutions to automate activities that previously added cost, complexity and delays to transactions. There’s no need to constantly keep up with contracts, bills and invoices, which is all extremely time-consuming. As the old adage goes, time is money, and with blockchain payments, you save a lot of both.
A refreshed capital market
By tokenizing traditional securities (such as stocks, bonds and assets) and placing them on blockchains, we can create substantially more efficient, interoperable capital markets.
By excluding the middleman in asset rights transfers, blockchain lowers asset exchange fees while giving access to wider global markets. It also reduces the instability of the traditional securities market. It is estimated that by simply moving securities to the blockchain, banks can save somewhere between $17B to $24B per year in global trade processing costs, which is obviously another strong advocate for blockchain in banking.
Better trade finance
The use of blockchain – or any DLT (Distributed Ledger Technology) in general – supports cross-border trade transactions that would otherwise be completely uneconomical due to costs related to trade and documentation processes. What’s more, this blockchain use case can also shortens delivery times and heavily (if not totally) decreases paper use.
As approximately 80 to 90% of world trade relies on trade finance, blockchain banking adoption would be felt on a global level and throughout all industries that rely on banks to keep their funds in check.
What’s Standing in the Way of a Full-Blown Financial Upheaval
Blockchain finance deployment comes with a wide range of advantages both for banks and asset owners. However, as is usually the case with all radical changes, incorporating blockchain in financial services will not be a smooth transition.
As the fintech blockchain scene knows very well, there are severe obstacles blockchain in banking needs to settle first before we can truly start to think about completely upheaving the banking sector. Here are the most prominent difficulties that need solving sooner rather than later:
The issue of privacy
As transactions made on a blockchain are transparent and available for inspection to all participants in the system, a workaround will have to be made for blockchain in banking sector to take a full swing.
A viable banking app can not publicly broadcast every detail of every transaction as that would heavily violate privacy rights of users. Until a solution to this problem is found, full-scale adoption of blockchain in banking will remain a matter of fiction.
The double-edged sword of private keys
Private keys are an essential element of a blockchain ecosystem. They are used to verify a person’s identity and are the only way users can get access to their data. Usually a series of 10 or so words, a private key is extremely good at keeping information from falling into wrong hands, but the downside is that it can be generated only once and if you lose it, everything stored on the account is basically lost as well.
Obviously, in the context of using a blockchain banking network to allow millions of people to manage their funds, detrimental consequences of losing the private key are not exactly ideal. Some sort of compromise will have to be made, like allowing financial institutions running the blockchain to have a copy of the private key, but this might chip away at some other aforementioned benefits of blockchain in banking.<
The prevalent problem of scalability
Scalability has been a thorn in the blockchain’s side for almost a decade now. Unfortunately, any attempt at using blockchain technology in banking needs to display incredible scaling capabilities.
A decentralized financial system has to effortlessly handle new users while maintaining the speed of accessibility for the existing participants. Between that and the capacity of handling large volumes of data, we’d say scalability is currently the biggest hurdle standing in the way of massive blockchain deployment across the banking sector.
Enormous energy consumption
Extreme amounts of energy consumption would be synonymous with a large-scale, blockchain-based banking system. Blockchain networks are run by network participants who are rewarded based on how quickly they solve the equation needed to add a new block to the chain. This essential principle inherent to all blockchain systems is called mining and is the chief reason why blockchains guarantee the validity of data.
Due to excessive mining requirements, merging blockchain and banking would consume incredible amounts of energy, bringing forth a plethora of issues current financial systems simply do not have. So, if we’re going to see a full-scale deployment of blockchain in the financial industry, alternate rewarding mechanisms will certainly have to be identified.
The price of operating outside of the law’s reach
When used for cryptocurrencies, the blockchain’s isolation from laws and regulations is a fantastic quality to have. When we’re talking about massive adoption of blockchain in banking, however, this vigorous independence might do more harm than good – unless we’re going for a certain “banking on Bitcoin” compromise, which is not likely to unfold.
If and when blockchain financial services become a thing of reality, certain regulations will need to be set in place so as to avoid total chaos. Obviously, this means a lot of legal ground will have to be covered, but without it, a full-fledged decentralized system for banking purposes will never see the light of day.
Blockchain Can Completely Alter the Current Banking Landscape
While a mere mention of blockchain in banking would cause a massive pushback a few years ago, financial institutions have started to see the potential of decentralized tech and are figuring out how to invest in blockchain. Both startups and industry giants are currently conducting tests on various blockchain use cases, so we expect massive strides to be made in the years to come.
While there’s still a lot of unanswered questions and issues, the upside of deploying blockchain technology in banking outweighs its shortcomings by a huge margin. The promise of faster and cheaper peer-to-peer transactions, increased access to capital, higher data security, trustless agreements through smart contracts, boiling compliance down to a mere formality, etc. – if there ever was a tech worth investing, it’s the one that brings all of that to the table.
However, while huge steps forward are made every day, the aforementioned question still poses a crucial dilemma. Will the traditional banking industry embrace blockchains or be replaced by them? Die-hard believers in cryptocurrency believe that it will replace banks altogether, but a more unbiased opinion suggests the former is more likely.
If you ask us, that’s where we’d place our money if we were of the betting sort – chances are blockchain technology will supplement traditional financial infrastructure, making it more efficient, profitable and customer-friendly. Only time will tell to what extent these changes will go, but one thing’s for certain: changes are coming and we’d all do best to prepare for them.