Let’s face it – there is no other sector except banking and finance that has seen as much disruption as it has, post the invention of blockchain. All the largest financial services firms, for example, are planning to/have already used blockchain and distributed ledger technologies as a record of ownership and transaction in order to avoid the time-consuming reconciliation of each internal ledger in order to create a faster and safer system. The disruptive power of this technology is very evident by the fact that blockchain has shown strong evidence in reducing effectively the costs for infrastructure attributable to cross-border payments and regulatory and security trading compliances. In some nations, the transaction costs saved in banking and finance sectors could be as high as USD 15-20 billion.
As of 2019, most Bitcoin 2.0 applications are still at the emerging stage, but they promise to improve the architecture of transaction-based industries. In addition to the traditional use in the financial space and the banking system, the open and distributed nature of blockchain seems perfectly positioned to enable new levels of collaboration across various levels of finance and thereby promote a new revolution in the banking industry, which we can already see today with new developments in banking sector happening on this front almost on a daily basis. Implementing the changes that blockchain promises will usher reduced transaction costs and create immense value for the banking system.
Let’s explore this more deeply in this article
Blockchain Applications in Banking and Finance
Here are three things you should know.
Digital Financing Platforms:
As distinguished from the traditional financial legacy systems and other old ways of banking, digital finance involves a convergence of digital banking, mobile value exchange and crypto-currency applications in a variety of forms. These are suited to different jurisdictions, market evolutions and the differentiated needs of the banked versus the underbanked worldwide. This is referred widely as the ‘internet of money’, converging with the internet of value (exchange) and the internet of things and aiming to attain a greater understanding of the opportunity in digital finance services and distributed infrastructure development.
The digital finance landscape is evolving to address these opportunities, creating huge system-wide convergence and integration, and niche players alike. At the end of the day, the users/consumers of all these offerings will decide which variations suit them best based on ease of use, access, stability, store of value, security, reduced friction, exchangeability, transferability etc. – ultimately the best user experience (UX) for the money.
In doing so, delivery platforms from every sector of the industry will prefer a stake in this lucrative business, even in those parts of the world which are overbanked to those which are underbanked. There is a great chance that cryptocurrencies could become disintermediated, as cryptocurrency technologies, business processes, and alternative currencies and protocols emerge or become adopted by existing and new players in the FinTech, digital currency and mobile payment sectors. What this implies is a union of digital finance technologies and a combination of decentralized and centralized platforms and delivery channels.
One can attribute this rise to many factors, including the ease with which digital currencies can unite global consumers and merchants: the low cost of digital currency payments, the openness of consumers to new innovations and lastly, the growing influence of technology companies.
Commercial mechanisms today rely on centralized ledgers to clear payments and to record all transactions and maintain account balances. In simple terms, the transaction is transmitted once from the transacting parties to the intermediary, checked for validity and accordingly adjusted for both accounts. However, blockchain enables transmission to all network nodes, and removes the need to trust in third-party intermediaries. The transaction is cleared as a result of verification by nodes, yet no node is required to be trusted. The entire process can be settled for a very low transaction cost, thus enabling much cheaper payments as compared to traditional mechanisms.
Given these benefits, it is quite certain that payment systems of the future will have to rely on DLT frameworks like blockchain. However, it is also important to understand that making payment systems decentralized also requires more processing power and time. Though the transaction is copied onto every member computer (i.e. nodes) by the blockchain, the entire process is slower as compared to centralized clearances. This also explains why Visa and MasterCard can clear 2,000 transactions per second while Bitcoin can at best clear only few.
Nevertheless, for any currency controlled by a central party, it will always be more efficient to record transactions centrally. What can be clearly seen is that blockchain payment applications will have to be with the blockchain’s own decentralized currency, and not with centrally controlled currencies.
One of the most commercially successful applications of blockchain technology has been the electronic cash, and in particular, Bitcoin. Payments, contracts and asset registry – thethou most common potential applications of blockchain – can only work to the extent they run using the decentralized currency of the blockchain.
Even though all blockchains without currencies have not moved from the prototype stage to commercial implementation as a result of not being able to compete with current best practice in their markets, yet their disruptive potential remains immense. The use of electronic cash, therefore, is necessary for any application of blockchain technology to make commercial sense. It would be workable only in those cases where the disintermediation of electronic cash provides economic benefits outweighing the use of regular currencies and payment channels.
Electronic cash offers significant potential to revolutionize the entire banking system, especially after the launch of Libra a few days back. However, historically speaking, before blockchain was invented, payment methods were divided into two distinct non‐overlapping categories:
- Cash payments, which are carried out in person between two parties: These payments have the convenience of being immediate and final, and require no trust on the part of either transacting party. There is no delay in the execution of the payment, and no third party can effectively intervene to stop such payments. Their main drawback is the need for the two parties to be physically present in the same place at the same time, a problem which becomes more and more pronounced as telecommunication makes it more likely for individuals to want to transact with persons who are not in their immediate vicinity.
- Intermediated payments, which require a trusted third party, and comprise cheques, credit cards, debit cards, bank wire transfers, money transfer services, and more recent innovations such as PayPal. By definition, intermediated payment involves a third party handling the money transfer between the two transacting parties.
Before the invention of Bitcoin, intermediated payments included (though not limited to) all forms of digital payment. This is why, Bitcoin is referred as the first electronic cash that allowed for digital payments to be completed without having to rely on a trusted third‐party intermediary – opening doors to various new technologies of the future.
The use of blockchain in banking and finance in future might take on many forms. However, it will hopefully break down barriers and increase access to increasingly large audiences across geographies, with different levels of income. Crypto-currency innovations initiated by the bitcoin protocol and its later derivations have opened up a range of applications and potential solutions for an increasingly globalized economy, inviting further exploration. Emerging digital finance models and technologies for financial inclusion can positively impact those who are unbanked or excluded, creating greater access, equality and efficiencies in established markets, and delivering a digital finance future that is flexible, frictionless and almost free for all.