Blockchain is revolutionizing the Financial Services industry
Financial services have traditionally been a very conservative industry, where technological changes are adopted in a very conservative way, basically for two reasons:
1) it is a very highly regulated market; not so easy to become an early adopter of an emerging tech;
2) trust is critical in the relation between clients and financial services providers, so the industry needs to be risk-averse, and emerging technologies imply certain levels of risk.
With blockchain technology, a (big) revolution has arrived: the industry is turning upside down, from operational processes (before there was paperwork and analogic solutions) to different business markets and sectors like banking, payment services, real estate, insurance, asset management, crowdfunding, lending, ...
Here I’ll explore how the industry is transforming, and the major benefits of this very disrupting technology from an innovation perspective.
As for many other sectors, digital transformation remains the main challenge faced by the banking and financial services industry. According to a survey performed by Oxford Economics and Accenture, 90% of the 90 financial services executives interviewed, say they have a long-term plan and strongly invest in technological innovation, considering in most cases disruptive technologies such as artificial intelligence (AI) or blockchain; but why ?
Digital transformation processes are customer-centric, which makes customer retention necessary in a globalized environment where business models are evolving rapidly (maybe by the adoption of digital transformation, as a sort of self-fulfilling prophecy). The regulatory compliance and the fintech start-ups threats to the industry are also identified challenges. Industry players unable to address these challenges, may not be viable in the long term.
Distributed ledger technologies (DLT) provide extremely useful resources for enhancing processes in the most significant business areas: clearing and settlement, trade finance, cross border payments, insurance and anti-money laundering. A significative example is the Australian Stock Exchange, that migrated its entire financial asset management system to a DLT platform.
Regarding clearing and settlement, there is today no common agreement about which stages of the different transaction lifecycle (from pre to post trade, and from execution to settlement) can be covered by the blockchain. The benefits are clear from a technical perspective; however, from a functional perspective, there are still many gaps such as interoperability with existing legacy systems, compliance and regulatory issues, as well as assets segregation.
In the financial processing industry, DLT provide a complete set of key benefits:
Goods and assets can be tracked and monitored in real- time. Once stored in the ledger, the information cannot be modified, thus ensuring that it is the real data; its access can be granted by the participants in the system/network, without disclosing sensitive information to third parties. Furthermore, the related asset information can be relayed from or to the new owner to be used in different ways.
Commercial transparency in financial processing is a key feature that implies shortening the transactions and value chain. More transparent information about the transactions (in opposition to commercial agreements) reinforce customers’ trust.
The balance between transparency and privacy is one of the key aspects of the DLT paradigm. Identity in a blockchain is concealed behind cryptography, so the link of public key identities with individual users is particularly difficult to achieve. This fact, added to the nature of the data structure of a blockchain (where transactions are linked to public key identities), provides a level of transparency never seen before.
All transactions are stored sequentially and indefinitely in the chain of blocks. This provides an indelible audit trail for the life of an asset between parties. In traditional systems, auditability was a process performed by third parties, but it cannot be relied on by the financial processing value chain players.
Each single transaction is verified by the network using cryptographic algorithms, assuring the authenticity and immutability of the information. The users have control over their own assets and transactions using also cryptography; we can then state that blockchain is innately secure.
Of course, there are theoretical scenarios where a blockchain can be counterfeit, for example modifying one single transaction in more than the 51% of the network, but technical limitations make this scenario just hypothetical, rather than a real threat to the data integrity and immutability.
DLT allow each party to easily and securely share finance-related trade data. The level of collaboration (which information each party can share and who can access what) is determined by the configuration and topology of the network/system, so we have a very customizable solution easily adaptable to any regulatory, technical or functional requirement in almost any business case.
Transactions are completed between involved parties with no intermediaries due to the trust of the blockchain consensus algorithm. Features like smart contracts provide automatization of commercial actions, for example cutting-edge initiatives such as Etch, an automated smart-contract based platform for wage management.
Banking sector reactions
Most of the key players in the industry have reacted to the blockchain technology and are deploying DLT applications in their day-to-day operational processes and applying them to different services provided by the institutions. It includes JP Morgan Chase in the US (with the creation of the Blockchain Center of Excellence), Banco Santander in Spain (supporting initiatives such as RippleNet and Hyperledger or with We.trade trading platform deployment) or Mitsubishi UFJ in Japan (with the launch of a blockchain-based payments network by 2020).
Toward the end of traditional banking?
The implementation and deployment of fully operational trusted and authorized interaction networks among corporations, B2B networks, service providers and financial institutions are turning upside down the financial services industry. This does not announce the end of the banking industry as we know it, but the blockchain technology, in addition to digital transformation processes, provides a significant added value to the players involved. The question is whether the traditional players are going to lead this transformation or new players will emerge.