Blockchain : A Revolutionary Application in Financial Services
Efforts have already been launched by a group of financial institutions to investigate the potential opportunities that blockchain holds for their businesses. Some organizations like USAA Bank and BBVA have already put in millions of dollars in Bitcoin service providers like Coinbase and Circleto study blockchain applications. Some others like Barclays and Fidelity have created accelerators or sponsored hackathons in a bid to provide space for startups and learn from them. Some other organizations like Citi and Nasdaq contribute as beta-testing systems which are built atop the blockchain technology to explore the potential it offers.
Goldman Sachs is an organization that filed an application for a patent related to a settlement system for securities markets that would incorporate its own cryptographic currency, the SETL coin. The company is one of the 42 financial institutions (half of which are among the 100 largest revenue generating firms in the world) that joined a blockchain group launched in 2015 by a financial technology firm, R3 CEV. This consortium or group, one of the first collective efforts among major financial sector firms, is exploring opportunities to utilize blockchain technology not only in new financial products but also in their ongoing operations.
The Alte Group, a financial services research firm has reported that in 2015, US$75 million have been invested by financial institutions in blockchain technology. This amounts to more than twice the amount invested in 2014 and the firm has also predicted that about five times the amount invested in 2015 will be invested annually by the year 2019.
Financial services companies and regulators are paying great attention to the following areas and applications in blockchain.
Trade execution and settlement
Adopting blockchain technology will enhance settlement at lower costs as also lower the risk of the happening of fraud. Some organizations will put in effort towards developing some unique and powerful offerings for trade and settlement. Nasdaq’s private Linq blockchain network is one such example and its offering helps private companies that are yet to begin record keeping activities required by public listing to keep track of changes in the ownership of shares issued to founders, early investors and employees.
Likewise, Ripple has introduced a well established powerful value exchange platform where financial institutions can indulge in real-time exchange of currency, cryptocurrency, commodities and other tokens of value, without having to depend on the traditional intermediaries of the international financial system, such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT). In yet another context, Overstock.com has issued private bonds via a blockchain mechanism, and has obtained approval from the US Securities and Exchange Commission to issue and record company stock using blockchain. In each case, when there is a change in ownership, a record of the same is immediately put on the blockchain and there is a simultaneous payment and settlement of the trade.
Blockchain technology will help in the development of new exchanges that ease the trade of not only financial instruments but also of a wide variety of assets. This would involve the exchange of virtual tokens that represent underlying physical or intellectual assets. In early 2016, R3 CEV, a technology firm conducted a test that comprised exchanging tokens representing theoretical assets through a private blockchain application. The test used Ethereum, an open-source blockchain platform and was conducted over a five-day period among bank offices located in North America, Asia and Europe. Some of the banks that participated in the test were Credit Suisse, HSBC, Barclays, BMO Financial Group, Commonwealth Bank of Australia, TD Bank, Natixis, UBS, Royal Bank of Scotland, UniCredit and Wells Fargo.
Physical asset registration
The use of blockchain will regularize the process of registering assets which include real property. Inreal estate, blockchain does not warrant the requirement of title insurance to confirm the accuracy of a local government’s property registry. The current title review process is expensive and lengthy and the blockchain can be utilized to create a ledger of property ownership which is easily accessible, thus drastically reducing the time taken to transfer the real estate ownership and the associated costs.
Blockchain will also help in a faster price comparison and tracking of escrow paymentson contracts. Ubitquity, LLC and Factom are some start-ups that are designing platforms aimed towards tracking the ownership of property using notarizing functionality.
Supply chain management
Blockchain can play a very vital role in the detailed tracking of the movement of goods. It can ensure a highly safe and secure supply chain management procedure that is fool proof and protects the system against fraud. ALondon-based startup, Everledger, is concentrating on the registering and tracking of individual diamonds, documenting their provenance, tracking their owners and fighting against insurance fraud. To do this, the company focusses on the serial number of the individual stones and digitizes each diamond by maintaining all the related information on a blockchain ledger. Leanne Kemp, the founder of Everledger, foresees that this application of blockchain technology would soon encompass other luxury goods lie artwork, designer watches, designer handbags, etc. to provide a strong and secure system that would be able to track changes in ownership of these items.
Cash reserve management
The present system of multiple financial intermediaries has resulted in huge settlement time, increased costs, high risks for financial intermediaries.Blockchain has the potential todrastically reduce settlement time, which in turn, will result in the reduction of the amount of cash and collateral required to be held by financial institutions to alleviate settlement risks.
This will be prime importance in the case of international transactions which can be completed in just a few hours as opposed to days taken at present.
Smart contracts used digital technology to incorporate business rules including automated execution of contract terms, into a contract. Blockchain will be useful in customization of smart contracts on case to case basis and in streamlining of transactions without the need for counter parties and intermediaries.
Regulators will also be attracted by smart contracts because of their stronger security aspects and the reduced risks of getting hacked internally. IBM is in the process of launching a proprietary blockchain to facilitate digital contracts. The company also has plans to release an open-source version that is user friendly and can be used by anyone. Smart contracts could also prove advantageous to artists, musicians and authors to license their work and track the usage without having to depend on intermediaries.
Blockchain not only is changing the system of banking but also bank regulatory and supervisory functions.Consider for example, financial institutions could leverage existing applications to develop algorithms to identify patterns of fraud and laundering of money. The use of blockchain technology will empower banks to track the history of every transaction to make sure that there is a clear and traceable path for the origin, destination and the use of funds.Thus, the banks will be better equipped to keep track of any suspicious activities and networks.
Google’s automated ContentID system is an example of an algorithmic approach already being used by private entities to monitor and manage compliance, however, this does not rely on blockchain technology. ContentID automatically disables YouTube videos that violate copyright laws. Likewise, Fedwire is an example of blockchain technology that can be used by government agencies to empiower bank supervisors to track systemic payment risks.
What to Expect?
Blockchain is the leader for a series of technology based innovation that is already playing a vital role in the banking and financial sectors. This is analogous to the computer processing revolution of the 1980s, however, the extent of the changes will be very high than during that period. The 1980s saw the replacement of papers by computers in the offices of the financial institutions, however, the underlying processes remained and there was no change in the processes. An example of this can be seen in the steps required to complete a securities trade 50 year ago and today wherein we find that they are the same except that trading speed was increased by the computers. On the other hand, blockchain reorders the mechanics of financial transactions in a manner not envisaged until just a few years ago.
Institutions will take time in understanding the benefits and risks offered by the blockchain technology. But it is not affordable to wait for total clarity before deployment of this technology since there is going to be continuous evolution and the same is required to stay in this competitive race. The technology is going to evolve at a very rapid pace and for success, firms need to take reasonably quick decisions and act quickly based o informal experience. Thus, it is inevitably important for firms to be active participants in this cycle of innovation and disruption to fathom how technology is shaping the sector and how they are positioned in identifying the available opportunities and pursuing the same.Similarly, it will be critical to understand that aiming to develop a perfect solution will be futile since the problem itself could change before the solution arrived at is implemented.
Presently, we can predict with a limited amount of certainty a variety of changes and developments that blockchain technology will offer. However financial institutions and fintech providers could, going forward, face the challenge of identifying problems that will require new and innovative approaches rather than coming up with solutions. The most successful firms will be those that take advantage of these opportunities to harness fintech and the blockchain revolution.