How blockchain will change the world of banking
For centuries the world of banking has relied on trusted intermediaries. Their importance soared when money moved from coins, bills or printed ownership certificates to electronic ledgers. While physical money can be handed over from one person to another, with electronic entries into databases the process becomes tricky. How do you ensure money or another asset disappears from the initial owner when being sent? During the last decades the answer has been to build a complex, multi-layered system of intermediaries, whether it is payment processors, brokers or clearing houses.
When in 2009 an innovation called bitcoin claimed to have solved this problem completely via algorithms, commentators cheered at the prospect of trusted third parties becoming obsolete. The initial enthusiasm of the first cryptographers quickly spread to early adopters, then the media, and eventually reached the incumbents of the very industry it set out to disrupt. Already back in 2015 in a study done by Greenwich Associates, 94% of all Wall Street bankers attested to the blockchain the potential to change finance forever. It is hard to get 94% of respondents to agree on anything, let alone on such a contentious and hyped technology. Yet the results of the study were corroborated time and time again.
But rather than fretting about it, bankers are embracing blockchain technology. Earlier this year 90% of finance executives say it will have a positive effect on the payments industry. And this does not come as a surprise, given that estimates of the potential operational savings usually hover around 20bn USD annually, starting with 2022. But what are the major use cases? After all, blockchain applications are said to revolutionize everything – from democratic elections to land registers. Even finance applications there are aplenty. Three stand out.
One of them is the management and trading of securities and assets. The largest custody banks each oversee trillions of dollars worth of assets. Besides their sheer size, assets and securities are so crucial because of the unrivaled complexity of intermediation, including often multiple layers. Tokenizing assets such as stocks, debts, or commodities would allow for a simple and transparent way of keeping track of who owns what, what dividends accrue and how certificates are exchanged. Tests abound in this realm. The Australian Securities Exchange has joined forces with Digital Asset Holdings to replace its existing post-trade settlement with distributed ledger technology. This field, however, faces serious regulatory hurdles, especially with cross-border trade as it requires regulatory compatibility between jurisdictions. The potential is vast, but the road ahead is long.
Trade finance is the second big area to be transformed by the blockchain, not least because of its volume. It underpins 90% of world trade and is ripe for an overhaul. Bills of lading or letters of credit are often still physical papers and they are still sent by mail or even fax. In this setup the time between issuing a letter of credit and approval can reach up to 10 days or more, whereas a blockchain-based model can cut this down to a matter of hours. The technology can thus free up unprecedented volumes of capital and lubricate global trade. It is no wonder that banking behemoths have in most cases joined not one but multiple consortia. Most of the big ones are led either by the banking-backed blockchain-startup R3 (e.g. Voltron, Marco Polo) or by IBM (e.g. Batavia, we.Trade, HKTFP).
And then there is the movement of money – whether payments in the end-customer realm or clearance and settlement between companies. This is the very cradle of the blockchain mechanism, and it will be the major point of attack for new market entrants. It is the arena where banks need to fight off market disruption.
But the blockchain is also one of the carrier technologies of the digital age. As such, it pushes banking from the previous era in which paper-based process- and business-logic prevailed into a digitalized one. On the one hand this means processes get more efficient, as we have seen with the major use cases, but on the other it means blockchain can enable banks to expand their offerings. The infrastructure that generates trust can be used to manage not just wealth, but also non-material valuables. One such use case is for banks to use their blockchain mechanisms to safeguard medical health records or to authenticate university degrees. On top, each radical innovation also has the power to alter business models. With cloud computing the selling of high-valued IT-equipment gave way to renting out server resources and managed services. The blockchain can give rise to new ways of making money too. Compared to the potential this could unlock, the 20bn USD in operational savings will look puny.
Igor Pejic, author of new book Blockchain Babel: The Crypto-Craze and the Challenge to Business