Every day, people around the world transfer billions of dollars. These transactions are heavily reliant on paper although most people send money digitally. In financial environments, bankers still keep financial ledgers. But, what if there was a database that had the qualities of a ledger that can instantly log transactions and monitor and register changes in real-time? What if this system doesn’t require time-consuming third-party verification? That is exactly what Blockchain technology offers and the technology is creeping into the financial sector.
Blockchain offers banks a decentralized ledger. All the transactions of a financial institution are stored in multiple controlled-access computers creating a trail that no one can edit or delete. When a financial institution adopts Blockchain, the technology takes over most of the company’s workflows including record keeping, equity management, debts management, and cybersecurity.
When Did Blockchain Enter the Financial Sector?
Blockchain and Bitcoin (CRYPTO: BTC) came at almost the same time. Financial institutions were not ready to jump into the bandwagon but they later did. In 2015, NASDAQ conducted Blockchain share trading using their platform, Linq. This first trade made it possible for financial institutions to trust Blockchain and find ways to hop into the technology. Using the system, the NASDAQ opened doors for banks and financial institutions to use the ever-accessible Blockchain technology. Using Blockchain will reduce the operational costs of banks by more than 25 percent.
After NASDAQ, several banks adopted Blockchain including:
- JP Morgan Chase (NYSE:JPM) – Their platform, Quorum, is dedicated to Blockchain R&D. This system handles a range of transactions and services including share trading and smart contracting.
- Goldman Sachs (CRYPTO:GS) – The Goldman Sachs’ Circle is a project that explores the use cases of digital currency and Goldman Sachs’ Circle technology. Goldman Sachs seeks to decrease the volatility of cryptocurrency and make more people accept the digital currency.
- Bank of America (NYSE:BAC) – The bank created a Blockchain-centered network that keeps all the banking records and authenticates data from businesses and individual customers. Only authorized people have access to the ledger and its recorded entries.
How are Financial Institutions Using Blockchain?
Cross-Border Transactions
Blockchain is actually capable of disrupting the whole banking system that we follow currently. Though not fully implemented by banks worldwide, some of the banks have started using Blockchain to complete transactions and perform cross-border payments now. In the past, cross-border payments have been a preserve of Swift and Western Union but now banks can use Blockchain to send money anywhere in the world.
When using Blockchain, remittance costs are between 2 and 3 percent of the total costs of the transactions. This is way cheaper than what traditional third parties charge, between 5 and 20 percent of the total cost. Because Blockchain doesn’t require third-party verification, the transactions are faster.
Major banks are already using Blockchain to make cross-border transactions. In 2016, for instance, Westpac and NAB (two of the largest banks in Australia) partnered with Ripple (a Blockchain solution for global payments) to make international payments easy and affordable.
In 2015, the Commonwealth Bank of Australia had plans to partner with Ripple (CRYPTO: XRP) to make global transactions a reality. Later, in 2016, the U.S. Federal Reserve formed a partnership with IBM (CRYPTO:IBM) to create a digital payment system based on Blockchain. There are so many other banks that have adopted Blockchain to make cross-border transactions easy. These banks include Barclays Bank, BNP Paribas, and Deutsche Bank.
Removing Third-Parties from Stock Exchange and Share Trading
The traditional process of a stock exchange is long with so many third-parties involved. This process can take more than 2 business days. With Blockchain, the unnecessary intermediaries do not have to be there as buyers and sellers can access trading from their computer anywhere in the world.
Using Blockchain in stock exchanges can reduce information redundancy thereby enhancing the flow of transactions. Blockchain handles transactions between smaller groups of traders and only registers the final transaction. In 2017, NASDAQ partnered with Citigroup to create a Chain Blockchain ledger. This ledger records all transactions and changes in ownership. Once implemented fully, this is going to be a game-changer for the trading industry, as it can reduce a lot of procedures in between transactions and make the procedure a lot simpler and quicker.
Digital Identity Verification
Identity verification involves many steps and takes some time to complete. Before a transaction goes through, the bank needs to perform either face-to-face verification through an online video call or at the counter, authentication after logging into a service, and authorization. Customers have to take all these steps for every financial service they use. However, with Blockchain, customers can re-use their identity across different platforms.
With Blockchain, once a user registers their identity, they do not need to repeat the registration whenever they need to use a new service as long as those services are powered by Blockchain. Users only need to ensure they limit the private information they share with different services.
There are several companies using Blockchain-based customer identification systems. Companies such as Tradle and Cambridge Blockchain have created systems that help financial systems identify their customers with ease. Tradle creates a system that stores verification data and gives the owner full control of the data. Another such company is ID2020 which creates digital identities for people with no paper IDs. ID2020 has the backing of Microsoft, Accenture, and Rockefeller Foundation.
Syndicated Lending
Syndicated loans involve a group of banks lending to individuals. Due to the complex nature of the process, syndicated lending takes up to 19 days when banks use traditional lending means. Such banks face the challenges of customer verification. The banks also have to operate within the Bank Secrecy Act and the Anti-Money Laundering laws. As such, the bank is tasked with detecting, preventing, and reporting any money laundering-related activities.
With Blockchain, banks in a syndicate are able to share tasks like ensuring KYC, compliance, and then they link these tasks to a single block. The benefit of this is that when one bank checks the clients for compliance, other banks check other factors and they can all access the data in a single block. The banks can then exchange the information making it easier for them to process transactions. Banks will benefit from low costs of meeting regulatory requirements while users will enjoy the fast lending process.
Accounting, Auditing, and Bookkeeping
Accounting involves a lot of paperwork and the digital developments in accounting are slow. Regulatory requirements posit that financial institutions have to confirm data integrity and validity. With Blockchain, banks and other financial institutions can streamline compliance procedures and reduce cases of double entry in bookkeeping.
Companies no longer have to maintain separate records for different receipts. Instead, they can enter all transaction records in one joint register. All the records are protected cryptographically and are distributed. These records are transparent and are impossible to alter. Financial institutions can further use Blockchain smart contracts to pay invoices automatically.
Auditors can automatically audit data from financial statements in a central point to save time they’d spend browsing papers. Auditors only need to generate a fingerprint and compare it with what is on the Blockchain file. If the fingerprints are the same, then the data has not been changed.
Easy Access to Credit Reports
Through a blockchain-based system, both Businesses and individuals can receive quick loans based on their previous credit and repayment history. In the traditional method, credit scores by credit report companies aren’t always accessible for smaller companies. These traditional methods are also not ideal as it involves paying a company to access its sensitive data. Through Blockchain, borrowers can make their reports accurate, transparent, secure, and shareable.
The data owner has to register the history of their transaction and uses a private key to secure it. From here, the transaction which is fully encrypted will be stored outside the Blockchain at the same time encrypted data in hash is stored inside with metadata and timestamps.
When someone needs to access the data, they will submit criteria for the credit history. The Blockchain smart contracts will then identify and also verify the data and later filter it and return the results. This saves the data buyer the costs and the time they’d otherwise spend accessing the data.
Hedge Funds
A hedge fund is a pooled fund or an investment partnership between a group of Institutional investors and a fund manager. Hedge funds maximize returns for the investors while minimizing losses. The number of hedge funds using cryptocurrencies has increased.
Decentralized cryptocurrency hedge fund platforms allow many strategists and crypto investors to participate. This is unlike in traditional hedge funds where a fund manager in a single entity controls the funds.
Other Areas Where Blockchain is Used:
Financial institutions also apply Blockchain in crowdfunding, peer-to-peer transfers, and in trade finance. More and more financial institutions are adopting Blockchain technology in their operations. However, some are still hesitant. The increasing number of blockchain-powered technologies will see financial institutions streamline their operations. Most of these technologies are disrupting the financial industry for good.
About the author
Rithesh Raghavan, Director at Acodez, a Digital Agency in India, and the co-founder of Acoweb.