The financial services industry is undergoing a tremendous amount of change. Some of the trends are so foundational that it is hard to predict how it will look in the next 5-10 years. The fintech revolution is forcing the traditional players to find new ways to stay relevant. The regulatory uncertainty, globalization, changing demographics, evolving buying behavior, and emerging technologies are all creating a new urgency to transform the way they operate. This includes finding new approaches to:
- Compete with an entirely new set of competitors
- Become more nimble and make decisions faster
- Eliminate inefficiencies in existing processes to become more cost-effective
- Reach new buyers who are used to completely different channels
- Provide better service to buyers who put social media, mobile and the cloud first
The most innovative companies are increasingly turning to technology for a much-needed competitive edge in this dynamic marketplace. Emerging technologies like artificial intelligence, machine learning, automation, big data, analytics, and blockchain are finding their respective place in boardroom strategy discussions. The opportunities to leverage technology to leapfrog the competition are significant and could be the differentiators for winners and losers in future.
In the spirit of keeping up with the technologies, we looked at the overview of blockchain in the previous two posts (Part 1 , Part 2). In this post we will discuss whether blockchain will help transform financial applications.
Take a deep breath and ignore the screaming headlines about Bitcoin and “how to get rich quick”. While we have seen the “what goes up must come down” principle before (and we might very well see it with Bitcoin), the underlying implication of Bitcoin’s meteoric rise in the mainstream consciousness is quite noteworthy. Just as Internet and Telecom bubble in early part of 21st century and aggressive investment to build connectivity paved a way for the ubiquitous internet and mobile app revolution, Bitcoin’s rapid ascent (and potential fall) may well pave the way for blockchain technology to mature and become a foundational element to enable currency and payment applications.
While Bitcoin has received the most attention there are several other variations of the digital-currency (or crypto-currency as the popular media likes to call it) use case. The basic idea is same for all models: a currency is traded on a single global network, unregulated by any sovereign government or regulatory authority. As long as there is a network of parties willing to be part of this network and transact, the currency has value. Examples are Bitcoin, Bitcoin Cash, Ethereum, Ripple, Dash, and many others.
It should be noted that there are still a myriad of technical, legal, regulatory, and economic issues that will need to be resolved before these currencies are adopted to conduct day-to-day business transactions but it is worth keeping a keen eye on them to see the impact on future payment systems.
Trading and Settlement Networks
As we saw in the previous posts, one of the key capabilities of blockchain is the “distributed ledger”. The distributed ledger makes it possible to have “shared visibility” without the need of a central clearinghouse. The fact that transactions are fully visible to all parties at all times provides an immediate benefit for trading, settlement networks, cross-border payments, trade finance, and many other financial use cases.
In addition, the technology provides a way to implement “smart contracts” so that actions can be automatically triggered at certain thresholds. This lets us build the business logic that can trigger actions (e.g., transfer of funds) when a condition (e.g., delivery of goods) is met.
Another way to look at it is from your experience with Uber. From the order of (transportation) service to delivery (reaching your destination), the real-time tracking of the vehicle to the measure of your customer satisfaction (and tips), the experience is seamlessly integrated via an app. This is possible because the consumer, provider, and the backend system all have a shared visibility and trust in the system. Now imagine that this visibility is scaled to a shipload of goods across the ocean. As long as the predetermined conditions are met (arrival at the port, inspection, transfer of ownership) and tracking information is available on a shared network visible to all parties, the payment transactions can be automatically initiated and settled through smart contracts.
Just as it is hard to imagine life before Uber’s seamless transactions, in a few years it will be hard for us to imagine life before seamless, transparent trade or payments. The implementation is not going to happen overnight but the benefits of cost reduction, speed of business transactions, and improvement in user experience are too important to overlook.
Traditional lenders are understandably facing tremendous pressure. The threat from non-traditional lenders poses a great challenge as they are fast, nimble, built on modern technology and less regulated than the banking industry. The non-banking lenders are able to assess risk more quickly, make lending decisions faster and have more competitive rates. A traditional lender can take more than twenty days to approve and fund a loan $1M or higher.
In addition to the distributed ledger and smart contracts, there are other concepts that promise to improve lending workflows. Blockchain can also make the due diligence and risk assessment much faster with the new “KYC” (know your customer) implementation. As the information about businesses and their corporate information moves from the paper and Web (stored in government and other corporate records) to the blockchain, it will be much faster to conduct the search for business names and corporate profiles including outstanding liens and any adverse records. This will help the lenders conduct the due diligence much faster than they do today.
Similarly, the concept of “provenance” or ability to track an asset through the life cycle will greatly benefit lenders. They can design their loan products in a way that they can adjust the contracts based on near real-time information about the secured asset. An example would be a lease of an automobile where the lender is able to track the asset on a regular basis. Things like miles driven, maintenance alerts, or damage reports could be valuable inputs into managing risk of the loan.
Compliance management and reporting:
In addition to helping with due diligence, blockchain technology also promises to help lenders with compliance management. As information about borrowers becomes available online in blockchain networks, the lenders can leverage it across their workflows. This information can be used to help with their own risk management as well as with compliance with the anti-money laundering (AML) regulations. The mandatory reporting can also be automated by building the tracking and alerting logic within reporting.
As seen with the recent announcements in Delaware, Arizona, and others, state governments have started looking at blockchain as a way to reduce costs and improve transparency for their regulatory filings and public data. It is only a matter of time until banks and other financial institutions will be able to leverage public information like UCC and corporate charter information, land records, and motor vehicle titles to make lending decisions faster and also monitor the risk to their loans through tracking services.
Blockchain can help build “smart UCCs” that automate the entire life cycle of filings. The process may not require any manual action for the filing as long as the business logic can be embedded in the filing itself through blockchain’s smart contract mechanism. This would automate any future actions for the filing including amendments, continuations, and terminations. The operational cost savings would, in theory, be quite significant.
Blockchain technology has a lot of promise to streamline and even revolutionize the processes in various financial applications. As the technology continues to evolve, I wish to leave you with a couple of guiding thoughts.
Look for the broader trends where blockchain may create disruption in your market. Pay special attention to the “network effect” where a given consortium or network attracts large number of consumers (and providers). Once that happens, the barriers to entry go up and companies who are not participating can be left out in the cold.
Blockchain can also streamline many of internal processes. One way to experiment would be to look for “small wins” where the technology can be tested and deployed to improve processes within an organization. This will validate the technology in your own environment, create expertise within the organization, and become a showcase for other projects.
The possibilities are endless, and this is just the beginning.