Transforming the Finance Industry with Blockchain Innovation
Blockchain is one of the most talked about technologies in the banking industry right now. The exponential jump in the price of the Bitcoin cryptocurrency (from $300 in 2014 to almost $27,000 at the time of writing) has led the leaders of the world’s largest financial institutions, companies and organizations to seriously look at blockchain technology, a promising innovation that can seriously change the banking landscape.
Thanks to the distributed blockchain technology on which cryptocurrency is based, a whole series of breakthrough transformations in the banking industry has become possible. Many banks have already invested in developing prototypes to explore potential applications across the financial services spectrum. In the financial realm, blockchain can become what the internet has become in the information realm.
While major commercial banks and financial institutions are exploring blockchain use cases, central banks and some governments have also shown some interest in the technology. It is important to understand that blockchain technology is not a universal approach that can solve all problems. However, there are areas in which blockchain can be an indispensable solution.
Fraud Prevention
The financial industry is increasingly affected by fraud and cyber attacks. The point of vulnerability is primarily in centralized databases, when all information is stored in one place. Unauthorized intervention can bring a lot of harm to such bases. Blockchain significantly reduces the risk of interference due to the decentralization of databases.Since there is not one, but many nodes with information, it becomes much more difficult to penetrate, since it is necessary to attack them separately.
KYC and AML
Blockchain can help eliminate process inefficiencies related to user identification and anti-money laundering (KYC and AML) requirements in financial services companies. Today, this is a costly, time-consuming process that must be duplicated every time a consumer enters a new financial relationship with a service provider. Creating a centralized network registry can make the entire process of establishing and verifying an identity easier, faster and cheaper.
More than 2,000 financial institutions in more than two hundred countries around the world have already switched to the SWIFT centralized KYC storage. This is not a blockchain yet, but a direct step in that direction. In response to numerous criticisms, primarily related to the low speed of data processing, SWIFT representatives have already announced the possibility of using the blockchain. Startups like Tradle and Polycoin are also working on blockchain solutions that streamline KYC (identification) processes and even extend to AML (anti-money laundering) procedures.
But before blockchain becomes a major component of compliance technology, the key issue of blockchain’s inherent anonymity of transactions needs to be addressed, which puts regulators at odds with the technology, especially in the aforementioned areas. According to the Thomson Reuters Survey, financial institutions spend an average of more than $60 million a year on customer identification and verification. The purpose of this procedure is to keep track of who banks are dealing with and prevent potential financial terrorism and money laundering.
Another important reason for customer identification is to verify eligibility to avoid administrative penalties. Blockchain can help to significantly reduce operating costs in this direction. This can be achieved by storing information about verified customers in a blockchain node, which can be accessed by other banks, insurance companies and accredited organizations. Thanks to this approach, companies will not need to spend time identifying a client from scratch.
The rapid expansion of reporting and compliance requirements also opens up the possibility of a comprehensive blockchain-based regulatory solution that automates and simplifies the exchange of information between the financial services industry and regulators.
Instant Payments
The use of blockchain technologies to make payments between different financial institutions and customers can significantly reduce the costs of banks. In addition, it can improve the security and speed of domestic and international payments.
The blockchain trading platform Batavia, founded by the giant UBS together with the IBM corporation, has already carried out the first real cross-border transactions. During the pilot run, two operations were carried out: the sale of cars from Germany to Spain and textile raw materials from Austria to Spain. In the process, communication was established between all parties (suppliers, buyers and financial institutions) necessary to carry out transactions.
Already, digital innovation has significantly changed this area. The focus is shifting from proprietary payment services or regional partnerships to a global model that enables real-time payments anywhere in the world. Processing transactions in near real time will speed up the verification and closing of transactions.
Capital Markets
The adoption of blockchain in the capital markets is actually a matter of time. There are strong arguments for the introduction of blockchain in this area, they are associated with risks, efficiency and accuracy. A consolidated and distributed real-time data repository provides all users with a single view of all trading-related information, thereby reducing errors or inconsistencies and speeding up the resolution process.
Asset transfers and transactions can be further streamlined by implementing smart contracts, which are automatically executed based on predefined business logic.Users can share data, setting their own cost criteria with partners to better manage risk and credit exposure. Blockchain-based solutions also enable the use of currently non-tradable assets, such as invoices, to increase profits.
Trade Finance
Blockchain has the potential to revolutionize the trade finance industry, characterized by a complex network of players and manual, paper-heavy processes. Many major banks are already working on prototype projects to explore the possibilities of digitizing trade finance assets on a distributed ledger. For example, Standard Chartered and DBS are currently working on a solution based on Ripple’s blockchain technology, developing more efficient and innovative trade finance services.
Blockchain-based startup Wave, which is partnering with Barclays on trade finance, is already using the technology to control goods and documents during transit. The service replaces traditional shipping documents with electronic versions and tracks goods from point A to point B, recording transactions, executing and updating smart contracts, and even making payments at certain points.
Syndicated Lending
In syndicated lending, blockchain provides a reduction in the settlement process. This will save money by reducing transaction verification, time for calculations and information exchange, as well as the cost of the transaction as a whole.The Blockchain protocol will allow the use of a faster and more accurate methodology for the exchange of information between counterparties. Counterparties do not need to maintain and update separate registries for each party. It also simplifies inspection and audit procedures by regulators. Here, the parties can be part of the same WAN with shared access to the same ledger.
Smart Contracts
Contract terms can be programmed on the blockchain and linked to specific events. Based on the results of events and certain rules, the contract can be automatically executed and the content of the contract is transferred to the appropriate participant. This eliminates the need for third parties and intermediaries to authenticate contracts and the associated fees and charges. The leading operator offering a blockchain protocol for a reliable and transparent contract between anonymous parties is Etherium. This technology finds application in financial services in areas such as the foreign exchange market, self-financing contracts, and the like.
Hedge Funds
The hedge fund industry is adopting blockchain technology through crypto hedge funds, digital asset speculation, and direct investment in Web3 technology companies. Hedge fund funds are also exploring possibilities beyond digital coins, imagining the future of finance. Evanston Capital, a hedge fund strategy company, made the decision seven years ago to fund blockchain-focused venture capital strategies because of the broad investment opportunities they provide.
Evanston Capital started its blockchain activities in 2016, and in early 2022 established a dedicated venture capital fund of blockchain funds. The firm has raised $58 million by adhering to its investment approach of conviction and focus. The success of blockchain investments lies in understanding how startups use blockchain technology to improve existing systems or create new user experiences. Since there are about 200-300 blockchain VCs, careful screening is critical to identify startups with significant growth potential.
During the cryptocurrency bull market, many startups were fascinated by the idea of issuing tokens linked to their protocols. However, some prematurely introduced tokens without building a sustainable user base and generating revenue, leading to speculative token price action.The behavior of the market during this period contributed to the realization of the need to create a coherent economic stimulus that would not focus on speculation, but on the growth and adoption of users. The subsequent market correction and focus on due diligence are seen as positive developments for the future of the industry.
Maximizing Risk-adjusted Returns
Dchained Capital AR Fund Multi-Strategy, a newly formed hedge fund, uses a comprehensive investment approach to maximize risk-adjusted returns. The fund combines long-term value investment, short-term systematic trading and active hedging to manage risk and capture volatility. By investing in blockchain technology-related stocks across various sectors, the fund seeks to value value based on the long-term potential of blockchain rather than directly investing in digital assets. This quantitatively driven strategy has already shown solid investment returns.
ImprovingTransactions Efficiency
Blockchain technology has great potential to improve the efficiency of transactions. Quadrata, a firm that specializes in building a blockchain-based passport network for transactions, believes blockchain will revolutionize the financial industry. Quadrata applications optimize the flow of decentralized financial capital, facilitating secure and efficient transactions. With increasing momentum and widespread adoption, blockchain technology is gaining momentum in the alternative investment space, generating interest from industry leaders like BlackRock.
Tokenized Fund Offerings: Democratizing Access to Institutional Strategies
In recent years, a new trend has emerged – the offer of investment products on the blockchain. The KKR Health Care Strategic Growth Fund II made history as the firm’s first alternative investment fund to be offered on a public blockchain. This move allows individual investors access to private market institutional strategies. Other companies, including Hamilton Lane and Apollo, have also used blockchain technology to launch funds, lowering barriers and increasing accessibility for investors. Such events demonstrate the potential of the blockchain as a specialized asset class.
Banks and Blockchain: Fundamental Benefits
Banks are beginning to recognize the merits of blockchain systems. Citibank’s March 2023 Global Perspectives and Solutions report argues that “financial and real asset tokenization could be a major use case leading to blockchain disruption… In private markets, [tokenization] is expected to grow 80-fold to reach almost $4 trillion by 2030.” And by 2030, “up to $5 trillion of central bank digital currencies (CBDCs) could circulate in the world’s largest economies, half of which could be linked to distributed ledger technology.” This is approximately $6.5 trillion that will be secured and used by blockchain technology within seven years.
Meanwhile, interbank messaging system SWIFT is working with Web3 service provider Chainlink to explore the possibility of integrating traditional financial systems with blockchain technology. This will allow SWIFT messages to give instructions for transferring tokens on-chain, which will help the SWIFT network become interoperable across all blockchain environments.
The advantages of blockchain-based systems are inherent in the technology itself. In traditional financial markets, companies publish financial statements to investors once a quarter, a total of four times a year. In decentralized financial systems (DeFi) based on blockchain technology, the balance of the platform is updated every time a new batch of transactions is added to the chain. This can happen as often as every few seconds.The operation of a lending platform like Aave, which operates as a kind of DeFi native money market, is completely transparent and visible on the chain. Users can check the solvency of the platform themselves. This is built into the protocols from the very beginning; it’s just how DeFi works. Blockchain is secure and transparent at its core.
Decentralized Insurance
Tamper-resistant smart contracts open up incredible opportunities for citizens of countries that lack free and fair commercial and legal institutions. Farmers whose livelihoods depend on crops can now protect themselves and their families with decentralized insurance, which has been hailed as a godsend for small farmers facing the unpredictable effects of climate change. Only 3% of sub-Saharan African farmers have access to traditional agricultural insurance. Now 100% of farmers with an internet connection can take out a policy based on a smart contract, regardless of whether they have a bank account or relationship with an insurer. Over 7,000 Kenyan farmers did just that in the last quarter of 2022. Their deterministic nature means that the funds stored in a smart contract – whether it be an insurance policy, a money market fund, or a liquidity pool – cannot be changed contrary to the terms of the agreement. Blockchain systems do not rely on trust, they back up their promises with objective and verifiable mathematics.
Conclusion
According to a study by the Global Financial Markets Association (GFMA), the use of blockchain in the traditional financial industry will save industry participants up to $120 billion a year. In their report, which also featured the Boston Consulting Group, the analysts are asking regulators and financial industry players to take a closer look at the benefits of distributed ledger technology.
The researchers believe that the blockchain can significantly speed up and simplify the collateral processes in the derivatives and lending markets. This will save up to $100 billion. And smart contracts will automate and speed up clearing and settlement processes, which will save another $20 billion. The report provides an infographic on which areas can benefit from the implementation of blockchain and smart contracts. It is the settlement sphere that is the most promising for the introduction of technology. Although, the researchers note, introducing blockchain into existing systems can be quite difficult. According to a survey by Ripple, about 300 payment providers from 45 countries believe that blockchain and cryptocurrencies can improve traditional finance.
Both the public and private sectors are increasingly investing in experiments with blockchain technology. An additional incentive here is the possible benefits of an early transition, when, in addition to direct benefits from reducing own costs through the implementation of new technologies, it becomes possible to receive peculiar bonuses – income from the provision of services for the implementation of these technologies to other, less efficient institutions.
One thing is clear: blockchain is here for the long haul. Of course, it will be some time before all these experiments actually translate into large-scale adoption of blockchain at various levels of the financial sector. One way or another, there can hardly be any doubt about the potential of this technology to transform the financial services industry.