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Blockchain Disruption: The Impact Across the Financial Sector
In Brief
- What is blockchain?
- How are cryptocurrencies changing the world of finance?
- Is it the perfect time for central banks and other financial institutions to jump on the crypto train?
Technology is shaking things up, new trends dictate new rules across all spheres of life, and the financial sector is no exception. In recent years we have witnessed a surge in the adoption of blockchain technology, with forecasts suggesting a market value of over $23.3 billion by 2023. The financial sector has been one of the most proactive when it comes to embracing the new technology, with over 60% of the market value concentred here.
The current financial system based on trusted arbitrators has been governing relations between individuals and businesses for decades. This system is not only heavily reliant on trust but also vulnerable to a variety of environmental conditions and pigeon-holed by a substantial amount of operational activity. Over time, old systems become sluggish and outdated. This is where new technologies come in and shake the fortress.
With blockchain disruption business models are transformed, allowing lower costs, faster execution of transactions, improved transparency, and auditability of operations. If you are curious about the relationship between blockchain technology and the financial sector look no further. Sit tight as we guide you through the what and the how below.
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Blockchain As a Solution
In its simplest sense, the term blockchain is what it says on the tin, a block of chains. Blockchain can be described as a public database (the ‘chain’) of digital information (the “block) that is stored across multiple computers.
In the financial sector, a blockchain takes the form of a distributed, secure, and transparent system that logs and shares transactions across a digital network. By using a distributed ledger, banks can trade faster, cheaper, and improve overall efficiency. According to research carried out by Jupitar Research, blockchain deployment will enable banks to attain savings of more than $27 billion annually by 2030. Also, reducing costs by 11% compared to current levels.
Cryptocurrency is the primary market that blockchain is used for, most commonly Bitcoin. Most of us will know that Bitcoin is a digital currency that uses peer-to-peer technology to allow the transfer of payments without the need for an intermediary. By enabling these contracts and direct transfers of value, it presents the potential to undermine the current system.
How Cryptocurrencies are Changing the World of Finance?
Cryptofinance technologies have been touted as the “next-big-thing” and their untapped potential can disrupt the world of finance.
It’s no doubt that cryptocurrency adoption has grown substantially in recent years. Thus, blockchain is lowering the barrier for entry and providing a seamless alternative to the current way of banking. How can the financial sector harness the power of cryptocurrencies and their underlying blockchain? Let’s dive in.
Faster Execution of Transactions
Blockchain creates the ability for instant settlements, while currently, transactions can take anything up to 5-10 working days. Traditional business transactions can increase complications and are accompanied by unwanted expenses. The fact that blockchain technology is a one-to-one affair cuts out the middleman and streamlines this process. In turn, this provides faster execution and lower fees but, the same security guarantees.
For example, the Bank of Canada’s 2018 test run, in conjunction with the TMX Group and Payments Canada. This experiment proved that blockchain is feasible for automating instantaneous securities settlements. In addition to removing a significant part of the risk associated when obligations cannot be met.
Greater Transparency
People have less control over their funds with the current system. For instance, when transferring money from one account to another the status of the transaction is less transparent. Cryptocurrencies standardize shared processes. Since all transactions take place over peer-to-peer technology and are governed by a code, it creates a single shared source of truth for all network participants.
Data Integrity & Security
Another way that blockchain can disrupt the current financial system is by offering higher levels of security. At present, the need for a middleman can bring a higher risk for data being compromised.
The use of blockchain ensures the authenticity of data by empowering modernized processes that automate data verification and reporting and digitizes Know Your Customer (KYC) procedures. Furthermore, any recorded data can be tracked in real-time and is immutable. This helps to eradicate the risk of fraud, operational risk, error handling, and reconciliation.
Increased Financial Solution in terms of Crisis
Digital currencies offer innovative solutions in times of crisis. This was evident when over $60 million worth of Bitcoin was stolen from Bitfinex, one of the world’s largest digital currency exchanges. The solution developed enabled the compensation of all customers who shared equally in the loss with a Recovery Right Token (RRT). People could exchange the token for equity, or they were bought back for $1 by the exchange giant in the instance where people were skeptical about the recovery of Bitfinex or they just wanted to make a profit. Without this pioneering technology, it is likely that Bitfinex would have sunk and customers lost all their money.
Borrow & Lending Money
Traditional financial tools restrict the means of multiplying wealth. Banks and financial institutions alike have monopolized the lending sector, enabling them to offer high interest rates and limit access to capital based on credit scores. The process of borrowing and lending can be drawn-out and incur unsolicited expenses.
Blockchain projects provide a new type of lending ecosystem, which is part of a movement called DeFi or Decentralized Finance. The aim here is to create a more accessible financial system by putting all financial applications on top of blockchains. One-to-one money lending enables users to borrow and lend funds simply, securely, and cheaply. This new system will twist the arm of financial institutions and banks although they will still be required for bigger item loans for major purchases like houses or cars.
Fundraising
Historically, start-ups or entrepreneurs looking for capital depended on external financiers such as angel investors, venture capitalists or bankers. This process can be lengthy and requires a lot of pen to paper and dotting of the i’s.
Initial Coin Offerings (ICO) and Initial Exchange Offerings (IEO), are types of funding that use cryptocurrencies to create a reduced need for banks and other financial institutions during the fund-raising process. Again, this reduces the uninvited fees charged by banks for facilitating business securitization and the Initial Public Offerings (IPO).
In saying this, ICOs do pose some perils. ICOs carry significant financial risk for investors due to the unregulated nature of the marketplace. Furthermore, the relative ease of setting up an ICO allows significant amount of funds to be raised without any concrete obligation for delivering the promise.
Asset Tokenization
The world we live in is full of untapped real-world assets. From stocks, bonds, commodities, currencies to private equity, and real estate; all of which require a synchronized effort between banks, brokers, and exchanges. Enter Tokenization – the process of issuing a blockchain token that digitally represents the ownership rights of a particular asset. Asset Tokenization will bring forth new markets and make the financial industry more accessible, cheaper, and easier. Thereby, possibly unlocking trillions of euros in currently illiquid assets and vastly increasing the volume of trades.
A new “token economy” offers the potential for a more efficient and fairer financial domain. Furthermore, it opens up new avenues for investors with limited capital by aiding them to buy fractional ownership of expensive assets.
Programmability
Protection comes at a cost and that’s the exact role contracts play, protecting the parties involved in an agreement. It is important that contracts are firmly rooted in law and comply with regulations this process may require the involvement of legal experts.
Blockchain enables the reliable automation of business processes through the use of smart contracts. The utilization of smart contracts greatly improves contractual term performance, through tamper-proof, deterministic code running on the blockchain. Money is safely kept in escrow but once certain stipulations within an agreement are fulfilled the provider will then release the money
To Blockchain or not To Blockchain
Remember when the availability of the internet to a mass audience represented a huge step in moving globalization forward? Blockchain is the new internet. The benefits listed above are proof that blockchain has huge potential to transform the current financial system.
There are still a large number of regions worldwide where citizens have limited or no access to banking services. In such regions, the adoption of cryptocurrency could be an optimal solution that reduces the dependency on centralized systems or provides a lifeline when systems controlled by the privileged fail. We have seen the introduction of new laws in recent times that are sure to change the landscape for the future. Specifically, India, South Korea and Germany read more here.
While the financial industry is very much embracing the wonderful realm of blockchain, there is still resistance from certain financial institutions and banks. However, a recent survey showed that 80% of central banks are making progress in developing their own cryptocurrencies. Most recently, JP Morgan, America’s largest bank has set the wheels in motion for issuing its own settlement-focused, digital currency, JPM Coin.
Although huge progress has been made we are yet to realize the full benefit of these technological advancements. Blockchain is very much at the beginning of its journey. Nevertheless, we cannot deny that blockchain technology is here to stay.
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