Tuesday 11 August 2020 9:00 am

Blockchain can futureproof the financial services industry

How can blockchain technology transform the financial service sector at a time of turbo-charged pace of innovation?

The last decade has been defined by unprecedented technological change, most notably through the widespread adoption of smartphones and an ever-increasing reliance on digital financial services.

Throughout this time, shifting client needs and new generations of digital natives have forced legacy financial services providers to rethink the way they offer services; facing pressure to compete with neo-banking providers, whilst struggling to stay competitive in a challenging financial landscape.

Yet, despite more challenges than ever before, there is a powerful tool that financial service providers can wield to keep pace in this rapidly shifting age of digitisation—blockchain technology.

Emerging at the turn of the last decade, blockchain technology is now reaching maturity, laying the foundations for an entirely new financial operating system. So, how can financial service providers begin to leverage the power of blockchain technology throughout the next decade, and what are its key benefits?

Leveraging the power of Blockchain

It is likely that distributed ledgers will compliment today’s global financial systems. It is highly likely that there will be increased coexistence and synergy between legacy systems and decentralised infrastructure, which is the first step to scale up blockchain-based solutions and drive mass adoption.

Some of these solutions are ready-to-ship, disrupting their respective sectors and creating innovative alternatives and solutions ready for a new decade.

Cross-boarder payments

Sending or receiving money across borders, or between two different national currencies, has typically been a process fraught with complexities.

When electronic payment providers first emerged alongside e-commerce giants, it was a revolution in the way customers could send money online. International payments were typically settled in under a day, in contrast to days or weeks for traditional bank transfers, and currency exchange was processed behind the scenes. 

Nevertheless, the Bank of International Settlements recently concluded that despite innovations in cross-border payment provisions, the industry was still fraught with examples of technical hurdles and high costs¹, and bank transfers continued to be one of the preferred methods of transacting cross-border despite their limitations.

Financial service providers could leverage payment gateways built using blockchain technology to enable round-the-clock instantaneous transactions, with low fees irrespective of the value of the transaction.

In particular, stablecoins—digital assets pegged to the value of national currencies—make it simple, fast, and inexpensive to transfer value across borders.

Digital Identities

Despite the best efforts of financial service providers, identity theft is a growing issue. Not only does identity-based fraud have severe economic consequences—with losses of over US$40bn in the last two years alone according to data from PwC²—but it also impacts the user experience through the introduction of lengthy know your customer (KYC) and anti-money laundering (AML) requirements.

Instead, blockchain-based digital identities, secured using cutting-edge privacy-preserving technologies such as zero-knowledge proofs, serve as a single source of identity data and verification for seamless onboarding of new customers, while meeting the regulatory requirements of data protection.

Applicable to both private clients and entire businesses, identity information stored via distributed ledgers could help meet KYC and AML regulatory requirements more efficiently, while unifying identity information across multiple services. Users would only need to upload one set of identity documents to a blockchain-based identity solution, removing the need for financial organisations to authenticate individuals independently.

For financial service providers, a simplification of the KYC process through blockchain-based digital identities would result in less friction for new clients, reduce the time needed to build risk profiles for customers, and represent huge KYC cost savings for financial organisations—which according to professional services firm Capgemini costs as much as US$500mn per year for large companies³.

Asset Tokenization

Tokenization of securities, such as equity, is perhaps one of the most powerful use cases of blockchain technology. Share registries are particularly ripe for digitisation, and distributed ledgers would allow companies to easily issue equity-based tokens; tracking shareholders and updating share registries without maintaining a capitalisation table or arranging capital through manually intensive efforts.

By streamlining the equity issuance process using blockchain technology, companies can save both time and resources, especially useful for small to medium enterprises with limited personnel.

The wider benefits of tokenization for the trading of equity and other assets are profound. For the first time in history, tokenized assets can be transferred cross-border in minutes via blockchain-based exchanges and marketplaces, a process which would normally take days to settle, involving multiple intermediaries and complex internal processes.

Instead, blockchain-enabled exchanges and marketplaces automate the trading, execution, and settlement process. As a result, trading floors need no longer be limited by time-zones, paving the way to 24/7 trading with instant settlement times and low fees due to disintermediation.

Trade finance, credit and loans

Access to working capital is essential, and trade finance facilitates this need. However, the current process for both lender and borrower is lengthy, generating a significant paper trail through bills of lending, letters of credit, and due diligence.

There are even more friction points for companies looking to engage with multiple finance providers, as each stakeholder maintains different databases and companies must apply individually to each provider.

To solve this, blockchain technology and smart contracts could be deployed to serve as the underlying infrastructure for trade finance agreements, automating and processing loans according to pre-defined criteria, and onboarding new trade finance customers through existing digital identities.

The result would be a trade finance ecosystem where due diligence could be completed in minutes, loan agreements would require less third party oversight, and smart contracts would legally enforce agreements.

Similar efficiencies could be introduced to consumer lending using blockchain. Just like onboarding a company through digital identities, banks and lenders could easily create risk profiles for retail customers through pre-aggregated information stored on a blockchain, making loan decisions instantaneously, decreasing loan defaults, and improving the customer experience.

Alternative products

Digital assets and blockchain are also creating entirely new asset types. A recent trend to emerge from the blockchain space are alternative assets and services, which leverage evolving products such as P2P lending protocols, or focus on staking blockchain protocol tokens.

The Blockchain-complete future

Blockchain solutions are still somewhat nascent, and adoption by legacy financial providers has been measured and methodical. Nevertheless, a multitude of financial service providers are already experimenting with blockchain, developing blockchain-based MVPs, running pilots, and leveraging external blockchain solutions.

The beginning of a blockchain-complete era will occur once regulatory frameworks fully recognise blockchain technology and its associated products, which in turn will empower business decision-makers to integrate blockchain into their core processes.

In the future, it is highly likely that financial service providers will need to pivot their business models to include decentralised assets and value transfer, which will make autonomy, low fees, digital identities, and instant transactions the norm.

Hinrich Pfeifer, General Secretary of the Cardano Foundation, established in Zug, Switzerland in 2016, represented in more than 20 locations worldwide. www.CardanoFoundation.org. The above is the author’s opinion and does not constitute financial advice.