Blockchain has the potential to disrupt every industry and Banking and Financial industry is arguably the most prominent among all. The features of Blockchain Technology such as distributed ledger, immutable records, real-time payments, transparency, and security can potentially solve various existing inefficiencies of the financial system.
Traditionally, the financial services industry is known for its legacy systems and some banks have loads of legacy systems, some of which are 20+ years old. Therefore, It becomes a necessity for the financial services industry to embrace Blockchain and improve on many of its outdated systems.
Banking giants such as Credit Suisse, JP Morgan Chase, Goldman Sachs, Citigroup, etc have caught on this trend & have started experimenting and partnering with Blockchain tech companies to automate their banking functions. In fact, R3 was the first Blockchain consortium with more than 100 bank and financial institutions as its members.
According to a MarketWatch report, total investment in blockchain in the banking and financial services sector amounted to $2.3 billion in 2018. The report also forecasts that the expenditures will reach $17.47 billion by the year 2025, with a CAGR of 33.6% for the 2019-2025 period.
Before the pandemic, the need for Blockchain was becoming increasingly evident, but afterward, it has become even more apparent. Traditionally the banks used to rely on human connection to win their customer’s trust and grow their customer base but after the pandemic, a staggering drop has been seen in the number of customers visiting their bank branches.
Now, customers prefer to manage their banking activities through digital banking from the comfort of their homes. It results in the reduction of trust among customers in their banks and banking has become more commoditized and price-driven.
To cope with the aftermath of the pandemic, to remain profitable, and to retain & grow their customer base at the same time in an ever-increasing competitive market, financial institutions must rely on blockchain technology.
Blockchain offers different types of advantages to the banking and financial sector and each advantage is capable of unlocking unique use cases for the finance industry which were previously unattainable.
In the last decade, the financial industry has made significant strides in digitization of its process. However, with increasing digitization, financial institutions have become more vulnerable to cyber-attacks. Cyberattacks are considered the biggest threat to the financial industry.
The use of blockchain technology will provide a much-needed robust security system to the financial institution. Blockchain uses its distributed ledger technology to store valuable data in various nodes present on the network instead of in a single database as done in the legacy finance systems. The community of users present on the blockchain network is able to see and verify each transaction in the ledger, thereby making the distributed ledger tamper-resistant. Hackers in order to tamper with data on the blockchain have to hack or change the data in the ledger of majority nodes. By eliminating a single point of failure in a centralized financial institution, blockchain averts security breaches.
Also, in the rare event of a node malfunction, the data doesn’t get lost as it is stored in several other nodes as well and the malfunctioned node can quickly regain all the data as soon as it is repaired.
Blockchain also provides an additional layer of protection in the form of smart contracts which enable automatic transactions when certain requirements are met.
Globally, money laundering is estimated to be worth around $2 trillion annually. Financial institutions are struggling to keep up with the compliance of safety measures such as Anti-Money Laundering & Know your Customer. This process includes compiling, tracking, and storing massive amounts of data which later have to be passed on to regulators. In addition to being a costly process, it is also a slow, fragmented, and manual process which results in delays and client dissatisfaction.
Using Blockchain for optimizing the compliance management process can help financial institutions to manage compliance in an efficient & cost-effective manner. The data recorded on Blockchain becomes immutable and remains transparent to the authorized participants on the network. In this way, regulators would get real-time access to the customer’s data which is necessary for compliance purposes.
Therefore, the compliance management process will become streamlined and render more transparency and ease in reporting the requisite data to regulators.
In the traditional banking and finance systems, there is little to no scope for interoperability and data integration between different institutions and stakeholders. The data is stored in one central database and sharing of the data with another party can only be done manually which takes time and is prone to human error.
Blockchain provides the bank or financial institution an option to share information with other stakeholders. The extent of information to be provided will be determined by the bank. It can choose to provide information that is both useful to the stakeholder and able to streamline the banking process at the same time.
This Integration of data between banks and their stakeholders can open up new use cases for banks, which could potentially reduce transaction costs and improve efficiency.
Tokenization is a process of digitally representing an existing real-world asset on the blockchain. For example, property (tangible or intangible) or financial instruments. The real-world asset is recorded on the blockchain ledger, the economic value and the legal rights of the asset are linked to its digital representation on the blockchain.
This blockchain-based tokenization process has unlocked a wide array of unique use cases and the creation of new products for financial institutions. The tokenization process is expected to provide greater liquidity to illiquid assets, ensure greater participation of retail investors, and simplify the compliance process for the underlying assets. For financial institutions, it may result in faster, cheaper, and frictionless transactions of tokenized assets.
Most of the traditional banks are still dependent on paperwork for record-keeping and this area has been relatively slow to get digitized. The global finance industry consists of trillions of bank records of everything ranging from personal account data to stock market transaction ledgers of individuals.
Blockchain provides a digital alternative to such extensive paperwork. Blockchain’s ability to store immutable records would enable auditors to automatically validate the most critical data in financial accounts, lowering costs and saving time. Any data that is recorded on a blockchain can be tracked in real-time, leaving a very detailed audit trail. This will also curtail operational risks such as frauds and human error when recording transactions & reconciliation of records.
Trust between the customer and businesses is the key component in the smooth functioning of every industry. But the trust factor becomes indispensable in the financial sector. With the growing scandals involving banking giants such as Goldman Sachs and Deutsche Bank, this element of trust between financial institutions and their customers is dwindling.
Blockchain by utilising its decentralisation feature can prove to be instrumental in restoring customer’s trust. In a traditional centralized transaction system, the central trusted agent verifies each transaction and provides access to the database. On the Blockchain, each party can access the database and check the history of the transaction anytime without the third party. The key characteristic of blockchain is that transaction data is replicated and stored over a distributed network so that all stakeholders have access to the same information. This provides the transparency which customers have yearned for a long time.
Blockchain using its real time payment technology can transform both domestic and international payment systems. However, using blockchain for international payments has greater benefits. Blockchain provides an alternate way of payment and thereby could end the dependency on SWIFT and other payment schemes. SWIFT is the most common system used for sending and receiving money internationally.
Cross-border payments generally could take 2-7 business days and up to 15 % of fees to transfer a sum of the amount. This is because there are multiple banks involved as intermediaries in the transaction and currency exchange fees along with the commission of intermediaries account for such a huge percentage of fees.
Whereas, Blockchain is a global ledger that is not constrained by borders and does not require middlemen. It enables peer-to-peer transactions in a decentralized manner, facilitating the transfer of funds directly from sender to receiver. This process eliminates the number of intermediaries in between the transaction. Elimination of intermediaries makes transactions faster, cheaper, and secure.
Some of the most established use cases in Banking and Financial Services are as follows:
The process of trading or investing via stock exchange involves a lot of intermediaries and complicated formalities. By utilizing Blockchain technology, the number of intermediaries between a transaction, the complicated formalities, and the enormous amount of math it takes to quantify stock prices in real-time could all be improved upon.
The process of trade finance in this modern age is still based on archaic practices. As a result the process of trade finance is still highly manual, takes a lot of time and deals with a voluminous amount of paperwork. Use of Blockchain could streamline the entire trade finance process by eliminating time-consuming paperwork and bureaucracy.
Most of the current digital identity verification practises are weak and outdated. Several steps are involved and the user must go through this process every time they are required to verify their identity. Using blockchain, users will only have to verify their identity once, saving them time and increasing the efficiency of the process.
One of the biggest challenges the crowdfunding market faces is preventing fraud and enhancing trust of the investors.Blockchain will provide traceability of funds, resulting in a new level of transparency that will reaffirm investor trust while helping to prevent fraud.
There are several parties involved in the transaction for a single syndicated loan. Due to the participation of so many parties the process becomes very complex, time-consuming and costly. By using Blockchain, we can fix these issues and make this process more efficient, secure, and reliable for all the parties involved.
The present methods used for cross border payment and remittances involve too many intermediaries in between. This makes the process lengthy and costly. Blockchain by eliminating the unnecessary intermediaries from the process would make it faster,cheaper and secure.
Credit reports are created by the third-party credit bureaus. Current issues in the credit reporting system are that it involves a third party, it’s insecure, lacks transparency, and prone to error. By using blockchain, consumers will not have to rely on these inefficient credit rating agencies and will have complete control over their personal data.
Accounting, Bookkeeping, and Auditing are the most integral practices of a financial institution. These processes still rely on manual workforce and include too much paperwork. By using blockchain for optimizing these processes, financial institutions can reduce costs and save time.
In a typical hedge fund the participation of investors is limited to the contribution of their capital. The decisions regarding the investment of these funds are taken by the hedge fund manager. Blockchain can empower those investors that wish to participate in the decision-making process about where their funding will be invested.
The biggest pain point for both buyer and seller in the insurance sector is the Claim and verification process. Blockchain by using smart contracts and its distributed ledger technology can speed up claims & verification process, lower costs and reduce frauds.
Innovation has always been the cornerstone for growth and prosperity of any organization. Lack of innovation has frequently caused the fall of prominent industry giants such as Nokia, Kodak, Xerox, etc. Hence, if the financial institutions also resist change and innovation then newcomers will soon disrupt their businesses.
Blockchain is the only solution for institutions that want to truly digitize and automate their processes. This, in turn, will lead to lower operational costs, general and administrative costs, while restoring customer’s trust and increasing overall efficiency of the institution. In addition, Tokenization of Assets and Decentralized Finance (DeFi) is opening up a new chapter in the Financial space.
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