ComplianceJanuary 27, 2020

Blockchain: A promising future

(Published in Scotsman Guide Residential Edition, January 2020)

The financial services industry has been hearing about the promise of blockchain for several years now. Blockchain technology has the potential to streamline, and possibly even revolutionize, the workflows in various financial applications.

With the meteoric rise and subsequent fall in the valuations of blockchain based cryptocurrencies like Bitcoin in the last two years, critics have understandably questioned the hype around blockchain. According to the 2019 “Hype Cycle for Emerging Technologies” report by Gartner, blockchain has shifted from the high point of the hype curve to the edge of the “trough of disillusionment” phase in the cycle. The good news is that Gartner also predicts that as the technology continues to evolve and mature, it will likely reach the “plateau of productivity” within the next 10 years.

From the financial services and compliance industry’s perspective, blockchain technology could be a game-changer when it comes to how digital payments are processed, trades are executed, loans are issued, and assets are tracked. Banks, brokerages, insurers, regulators, and others continue to actively test ways to harness the benefits of blockchain. So, it’s no surprise that even after the recent setbacks, most large banks and financial companies have a strong interest in seeing blockchain succeed, and have active initiatives to explore and implement it.

Let’s recap: What is blockchain?

To use IBM’s definition, “Blockchain is a secure transaction ledger database shared by all parties in a distributed network, which records and stores every transaction that occurs in the network, creating an irrevocable and auditable transaction history.”

Simply put, blockchain is really just a new way to handle information. Blockchain offers a more advanced method of sharing electronic information across multiple, distributed parties. There are several features that make blockchain unique, including:

  • It is a distributed network – the information is not stored in one location
  • It is shared – the information is not owned by any single party
  • It is secure – the security and access policy is proactively built into the blocks of information
  • It is immutable – the information once finalized and written cannot be tampered with

To illustrate, blockchain applies the same “shared” concept as Google Docs (or any similar online collaboration software), but on a much wider business scale. Any business application, such as financial transactions, contracts, settlements, stock trades and regulatory filings, can be stored in a globally shared, distributed network. The information is not locked in a private or proprietary database as it is with Google’s systems.

Because blockchain’s distributed ledger technology is decentralized, each user receives a copy of the ledger, and its integrity does not need to be maintained by a central source of authority. Updates are recorded and downloaded automatically, so everyone has the same information at all times.

As a result, multiple parties can collaborate and update the data in a secure and irrevocable fashion. The possibilities (and the ramifications) of this technology are enormous, and that is the reason most financial institutions, corporations, technology vendors and regulatory agencies are paying close attention to blockchain’s evolution. It may not be too far-fetched to say that the technology has similar potential as Internet connectivity or cloud computing to transform modern-day business applications.

For lenders, blockchain can help establish veracity, transparency and security, enabling critical business functions across the lending landscape. It has the ability to solve the key challenges in lending and titling and make them more secure and efficient. But is it still something that is really going to be adopted by the largest players?

From bitcoin to blockchain

If it wasn’t for the advent of Bitcoin, blockchain might just be another interesting concept that never came to fruition. Bitcoin helped revolutionize the concept of a global, decentralized digital currency model with no central authority or regulatory body. While Bitcoin (and other blockchain offerings) will continue to evolve, it has already helped establish blockchain as one of the most important technologies to watch in the financial industry.

Traditional lenders are 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. Non-banking lenders are able to assess risk more quickly, make lending decisions faster, and offer more competitive rates, whereas a traditional lender can take over 20 days to approve and fund a loan $1 million or higher.

Blockchain could change all of that for traditional lenders. According to a recent study from Juniper Research, financial institutions that integrate blockchain will not only achieve cost reductions in payment processing and reconciliation, but also in treasury operations and compliance. The research found that when it comes to compliance, automation of identity/money-laundering checks, and the capability of the blockchain to verify the digital identity of an individual, the technology could enable savings of up to 50 percent of the existing costs base within a few years.

Changing the way banks work

Blockchain technology has the potential to disrupt the financial services industry as we know it. Although there are still several hurdles to overcome before that happens, blockchain’s potential is so appealing that many major financial institutions are investing millions in resources to research how best to implement it. In fact, a recent survey by Accenture indicates that nine out of 10 executives are evaluating the use of blockchain in their banks.

While financial institutions initially began exploring blockchain technology for its cost savings and efficiency benefits, there are so many potential applications for the technology, including:

Trading and settlement networks:
 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. Additionally, the technology provides a way to implement smart contracts so that actions can be automatically triggered at certain thresholds. This capability enables financial institutions to build business logic that can trigger actions (e.g. transfer of funds) when a condition (e.g. delivery of goods) is met.

Lending workflows:
Blockchain will help lay the groundwork for greater visibility into lending environments. The concept of “provenance” or the ability to track an asset through its lifecycle will greatly benefit lenders, enabling them to design their loan products so contracts can be adjusted 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. Criteria such as 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 assist lenders with compliance management. As information about borrowers becomes available online in blockchain networks, 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 anti-money laundering (AML) regulations. The mandatory reporting can also be automated by building the tracking and alert logic within the reporting functionality.

Regulatory filings:
It is likely only a matter of time until financial institutions can leverage public information, such as UCC and corporate charter information, land records, and motor vehicle titles, to make lending decisions faster while also monitoring the risk to their loans through tracking services. Blockchain can help build “Smart UCCs” that automate the entire lifecycle 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, renewals and terminations. The operational cost savings would, in theory, be quite significant.

Conclusion

The financial services industry is undergoing a tremendous amount of change. The fintech revolution has created a new sense of urgency with how traditional players respond to ongoing challenges that include regulatory uncertainties, globalization, changing demographics, evolving buying behaviors, and emerging technologies.

The most innovative companies are increasingly turning to technology to address these issues, as well as to gain a much-needed competitive edge. For many in the financial services industry, blockchain has become one of the most promising inventions of the 21st century. The opportunities to leverage this technology to leapfrog the competition are significant and may just be the differentiators for winners and losers in future

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