Blockchain in Banking - What Will the Future Hold

August 18, 2017 04:00 AM


Over the past year or so, major banks across the world have begun investigating what blockchain technology can offer to their business, with many use cases now being piloted.


Blockchain, or distributed ledger technology as it is sometimes called, is a database that is distributed across a network and cryptographically secured, such that records become immutable. It started out as the rails for cryptocurrencies like Bitcoin, but has evolved as a technology that can transform many legacy business paradigms in the banking sector.


There will be a range of applications that take advantage of the public, permissionless side of the blockchain spectrum, like cryptocurrencies, as well as applications that will benefit from permissioned private blockchains focused on the benefits of the distributed ledger.


Why banks are excited about blockchain


Financial institutions are exploring blockchain for its potential to reduce costs and streamline processes. But beyond this, there’s excitement about the technology’s ability to create new ways of doing business. Blockchain can unleash innovation across top line applications like loyalty and rewards, Internet of Things, marketplaces, and more – essentially any application where there is an exchange of digital assets, in addition to serving the bottom line.


A study by Business Insider Intelligence found that the most common reasons that financial services firms in the EMEA region are investing in blockchain is to create new business models or launch startups. Nearly four out of ten firms (37 percent) highlighted this as a reason for their interest in the technology.


This was followed by the promise of cost and efficiency savings (20 percent) and a desire to better understand the hype surrounding blockchain (16 percent). Smaller numbers also cited a fear of disruption and worries they will be left behind by competitors as driving forces behind their investments.


As understanding grows, banks are starting to narrow their focus and are looking for more targeted, tangible use cases for blockchain that aim to solve real problems faced by their businesses. “The most successful solutions will solve specific problems for banks and attract a large enough network to create widespread benefits,” BI Intelligence stated. For example, cross-border payments is one key area where financial institutions have a clear line of sight to create value.


The key applications for the technology


whitepaper produced by the UK-based FinTech Network in cooperation with BNY Mellon and Rabobank highlighted payments as one of the primary applications for the technology. It noted blockchain as a promising new solution for real-time, global payments settlement without the need to depend on schemes such as SWIFT.


Identity management, know your customer (KYC) processes, and anti-money laundering (AML) are other areas that can be streamlined by blockchain technology. Today these activities are both time-consuming and costly, with Thomson Reuters estimating the average national bank spends around $60 million on these activities every year. Putting KYC statements on the blockchain can allow other banks and accredited institutions – insurers, loan providers or even car rental firms – to access the information without the need to restart the process each time.


Significant savings to be made


Forecasts about medium-term cost savings of key operations are promising. One study conducted by Accenturelooking at eight of the world’s ten largest investment banks found that it could help reduce the costs of infrastructure to support their operations by as much as 30 percent.


This equates to saving between $8 billion and $12 billion a year, with benefits to be found in areas such as regulatory compliance, financial reporting and KYC activities.


For payments processing, in a speech made in April 2017, the governor of the Bank of England Mark Carney suggested it could save “tens of billions of pounds” by improving the “accuracy, efficiency and security” of payments, clearing and settlement processes.


Historically, settlement chains have involved many intermediaries, which Mr Carney noted makes them comparatively slow, as well as leaving them exposed to greater operational risk and a higher potential for fraud. Adopting blockchain technology in this area could not only reduce costs, but enhance security and efficiency.


The hurdles to be overcome


If 2015 was the year of the blockchain hype cycle and 2016 the year for experimentation and proof of concepts to learn which use cases had legs, then 2017 is the year financial institutions have started pilot programs with real customers with an eye toward production ready releases.


David Treat, managing director for Accenture’s financial services industry blockchain practice, observed: “As with any emerging technology, understanding what these investments might yield is a challenge. As we move into production implementations, bank executives will need a clear roadmap for how and where to rethink their strategies and redesign their operating models.”


One challenge is that large-scale, commercial deployments of distributed ledger technology are still in their infancy, so there are few regulatory frameworks or best practice guidelines in place to instruct businesses on the best way to proceed.


A report from BBVA Research highlighted some of the regulatory issues that will need to be addressed if blockchain is to become a mainstream banking technology. These include issues such as jurisdiction and liability in the event that something goes wrong, as distributed ledgers are, by definition, not constrained to any one location. Legal frameworks also need to be developed to establish blockchain systems as “unique and trusted sources of identity” and to be recognized as tamperproof. BBVA also noted that this must not conflict with legislation such as the EU’s ‘right to be forgotten’.


The open nature of public distributed ledgers means that privacy is a key issue, particularly when it comes to ensuring the security of customer data. FinTech Network observed this challenge is one of the inherent difficulties of the technology. It stated: “Although this can be mitigated in some way by the use of a private or permissioned blockchains with strong encryption, there will still be some cybersecurity concerns that need to be addressed before the general public will entrust their personal data to a blockchain solution.”


Despite these challenges, interest in blockchain shows no signs of abating. Blockchain is really a platform for disruptive innovation, its potential extending far beyond reshaping financial services. The World Economic Forum has written extensively on the applications of blockchain in the financial sector and beyond, and declared that “Blockchain’s ability to generate unprecedented opportunities to create and trade value in society will lead to a generational shift in the Internet’s evolution, from an Internet of Information to a new generation Internet of Value”.