Blockchain technology has the power to lower costs, prevent fraud and reduce time to settlement.
Read on to find out more about the innovation that the major banks are investing in now to help them adhere to regulation and provide a better service for their clients.
Origins of Blockchain Technology, the real innovation of Bitcoin
Blockchain is the technology behind the much debated Bitcoin currency. Bringing together cryptography, game theory and peer-to-peer networking, the key innovation behind the digital currency is a distributed ledger which allows a payment system to operate in an entirely decentralised way, without any intermediaries.
Transactions are verified by Bitcoin ‘Miners’, who compete to decode the participants’ encrypted keys. The transaction is then broadcast to the network, together with the Miner’s ‘proof-of-work’, that is, the computing power used to break the encryption.
Combat Money Laundering
With Blockchain technology creating the visibility to view the full transaction history of every event throughout the chain, vendors have already shown how anti-money laundering (AML) services can be developed. By giving greater transparency and enhancing compliance to regulations, the technology can aid in the identification of any activity that is suspicious or non-compliant.
Blockchain technologies can aid industry participants to adhere to a number of regulations including AML and T+2 Settlement.
In an intermediated banking set up there are three main types of risk: credit, liquidity and operational risk. In the traditional banking system, because there is a centralised point in the network which all transactions must pass through, there is a single target for attackers.
Current distributed payment systems remove the credit and liquidity risks by eliminating intermediaries: payments are made directly between the payer and the payee. To confirm this, users need to have confidence that for any distributed system they use, the cryptography employed has been implemented correctly.
Distributed systems should also be more resilient to systematic operational risk because the system as a whole is not dependent on a centralised third party. A distributed system effectively has as many redundant backups as there are contributors to the network. The ledger exists in multiple copies which essentially makes it more resilient than a centralised database. Historic transactions are unalterable and permanently accessible to all participants, ensuring that if an attack does occur each participant’s balance is recoverable.
Impact on intermediaries
Through better visibility between supply and demand, settlement processes will be more easily streamlined leading to reduced overheads in settlement costs including personnel to run settlement desks, reduced/non-existent buy-ins, reduction in failed trades and associated costs, to name a few. Overall the transparency allows the whole supply chain to work a lot more efficiently, reducing overall costs, through direct personal and indirect costs (buy-in, fails etc) and lead times to settlement. As the adoption of blockchain continues, we expect to see rationalisation in intermediaries, in addition to new blockchain-only entrants offering a more efficient service to clients who wish to trade directly.
Not only does Blockchain technology have the potential to completely revolutionise the traditional banking industry, it has the capacity to bring banking services to completely new markets. According to the IMF, around 50% of the World’s adult population do not access formal banking services in any form. This may be due to geographic location, lack of trust in the banking system or being ‘unbanked’ because they lack the credit worthiness financial institutions require. However, with blockchain, as long as you have an internet connection and the appropriate software you can make a transaction; furthermore, as described above, a distributed ledger removes the need for preceding trust in the participants as money cannot be double spent.