The Potential of Blockchain Technology in Financial Services – FinSMEs
Blockchain is a powerful technology that is set to transform many industries, and create new applications in various fields. It is one of the emerging technologies that is driving the digital transformation of companies around the world.
Blockchain, or Distributed Ledger Technology (DLT), consists of an expanding collection of records that contain the cryptographic hash of the previous record, transactional data and a timestamp. The technology is usually held on a peer-to-peer network that is completely decentralised. The records cannot be altered and therefore offer a high standard in security, as well as transparency. Blockchain networks are more commonly public, but private networks have also been developed.
Blockchain has been one of the leading trends of finance in recent decades, with more financial firms keen on exploring the possibilities of the technology. New blockchain technologies have been rapidly increasing and taking the form of different solutions. The technology still has challenges to overcome, such as interoperability, before adoption is widespread, but the inexorable rise of blockchain cannot be refuted.
For London-based companies that are interested to know about the technologies that can drive business growth, a reliable IT company in London can help to develop a new IT strategy for more scaled and productive operations.
Smart contracts mean that an action will only be performed if the pre-established conditions are met. They will always be executed when these conditions are met, and this cannot be changed. The ‘oracle’ is the term for the third-party information source that allows the smart contract to access data that is not already on the blockchain. Chainlink is an example of a decentralised oracle network that can provide access to external data, APIs and traditional banking systems.
Smart contracts can increase the speed of financial transactions and simplify an otherwise complex process. They can verify the accuracy of all information and eradicate the possibility of errors.
An example of the use of smart contracts is we.trade, which is a digital platform built on the IBM blockchain. This employs smart contracts that deliver payments when the terms of an agreement are met. It also features Know-Your-Customer (KYC) checks.
We.trade is partnered with 13 major banks, including HSBC, Santander, CaixaBank and Nordea. The corporate customers of these banks are able to use the network to trade across 14 European countries.
Smart contracts are also being considered for derivatives, as a way of trading without any counterparty risk. The International Swaps and Derivatives Association (ISDA) produced a set of standards for introducing interoperability, as well as a blockchain network and smart contracts aimed at reducing costs and improving efficiency.
Cross-border transfers through traditional banking systems do not only take up to five days before they are completed, but they are also expensive. The World Bank found that banks charged an average fee of 11 percent in the first quarter of 2019. Post offices are slightly less costly, with average fees of 7 percent.
This is set to change with mobile, or e- wallets that are powered by blockchain technology. Examples of these include InstaReM, Everex, Moin, Inc or Velmie.
DLT offers the security that transactions are distributed, and not owned by one company or bank. In addition to this, transactions are immutable and once they have been recorded they cannot be reversed or adjusted. The networks operate around the clock, and they can offer somewhere between an instant to a next-day transfer of funds. The process also eliminates multiple intermediaries. But the main attraction for customers are the fees, which are on average between 2 and 3 percent.
With all these added benefits, blockchain-powered e-wallets are certain to rapidly expand.
Business-to-business blockchain payments increased to the figure of $171 billion in 2019, and are predicted by Juniper Research to reach $4.4 trillion by 2024.
Following the economic crisis of 2007/8, loans and mortgages have needed to work hard to regain trust. Blockchain technology offers the opportunity to ease the lending process at a higher level of security. Not only does this remove the reliance on traditional banks, but there is also no need for any third-party intermediaries.
With reduced operational costs, data duplication and chances for manual error, loans that use blockchain enabled loans are significantly faster. While the average syndicated loan can take around 19 days for banks to clear and approve, loans using the digital ledger can be available in less than 48 hours.
The traditional system of loans processes a lot of sensitive personal data in a central location. Certain factors are evaluated, such as credit scores and debt-to-income ratios, though these can be erroneous. This also poses a greater security risk as the data is vulnerable to attacks. The Equifax data breach of 2017 exposed the data of hundreds of millions of individuals.
In 2018, the Spanish bank BBVA began to issue corporate loans on the Hyperledger platform. This was the first of its kind to make use of blockchain technology, for a €75 loan that was completed with Spanish technology consultancy firm, Indra. BBVA claims these loans improve efficiency and transparency.
Know Your Customer (KYC)
Banks and financial institutions are required to perform identity verification checks that can be expensive and time consuming. This could include compliance with Know Your Customer (KYC) guidelines, which on average take between 30 and 50 days to review. This period is necessary due to the various checks and reviews that the KTC process involves. Additional costs are incurred and time spent on compliance with Anti-money laundering (AML) regulations. A recent survey by Thomson Reuters found that the average bank spends $60 million annually on KYC, some banks spend as much as $500 on compliance with KYC and Customer Due Diligence (CDD).
Blockchain technology offers the potential to radically transform these costly and time-consuming processes. The KYC Registry, developed by SWIFT, is currently used by over 5,500 financial institutions. This is a private blockchain network that aims to secure and render more efficient the KYC process, as well as CDD and AML.
For security reasons, users can only be granted permission on a temporary basis and only when access is strictly necessary. Checks can be returned immediately, and according to a Goldman Sachs report the adoption can lead to a 10 percent headcount reduction that is equal to $160 million in annual savings.
Digital identity verification
Many financial transactions cannot be completed without identity verification. This could involve facial recognition, authorisation or authentication. All the different stages that are in place for a verification also need to be carried out by each new service provider in a system to maintain the highest levels of security. A study by Forgerock showed that personally identifiable information is targeted in 97 percent of all data breaches in 2018.
The beneficial qualities of blockchain technology mean that the verification process can be completed much more quickly for both organisations and individual users. Systems that are powered by blockchain can also offer extra reassurances with respect to security.
Zero Knowledge Proof (ZKP) is a new innovation that has become popular among governments and organisations. This is a principle that allows one party to prove to another party that they have certain information, without revealing anything about that information. This has an immediate application in identity verification.
Zcash is a cryptocurrency platform that uses a version of zero knowledge proofs known as zk-SNARKS to ensure transactions remain encrypted before they are verified. ING bank has developed their own ZKP solution called Zero-Knowledge Range Proof (ZKRP), and EY announced the third generation of their ZKP technology on the Ethereum blockchain in December 2019.
Blockchain is undoubtedly having a revolutionary impact on the world of finance, though this has yet to be fully realised. Leaders in financial institutions and fintech firms are making DLT a priority, and preparing to adapt to a business world in which blockchain is ubiquitous. For now, we should educate ourselves in the potential in blockchain, and get ready for some momentous changes.
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