“Leveraging blockchain can offer a significant leap forward in terms of productivity, something which financial services providers traditionally struggle to scale.”
—Robert Crozier, Allianz Technology
Not so long ago, NASDAQ partnered up with distributed ledger technology provider R3 for digitizing their assets and making them more accessible. JP Morgan introduced its new blockchain unit called Onyx. Not to forget, the innumerable applications of the blockchain technology in every field, from solving problems in real estate to even addressing the COVID-19 crisis. However, in spite of all the hype, blockchain still seems to be a nebulous, futuristic-sounding concept for many. Is it really as magical as it’s made out to be? In this blog post, we’ll demystify the blockchain technology for you — and examine its potential to revolutionize the banking and finance world, specifically the retirement plan industry.
What is blockchain?
The blockchain technology is a vast, globally distributed, public ledger running on millions of devices and capable of recording anything of value. Money, equities, bonds, titles, deeds, contracts, and virtually any kind of assets can be stored and moved privately, securely, and from peer to peer. And the biggest advantage? Blockchain is decentralized. This means, all this can be achieved without powerful intermediaries like banks and governments — thanks to network consensus, cryptography, collaboration, and coding.
In simpler terms, blockchain is a growing chain of records (or blocks) that are linked using cryptography.
Each block is linked to the previous block (forming the “chain”) through a cryptographic hash, a timestamp, and transaction data. Therefore, you cannot modify a single block without altering all subsequent blocks — which makes a blockchain record resistant to modification. This doesn’t mean blockchain records are inalterable, but it does mean blockchain is secure and immutable.
Blockchain has become synonymous with Bitcoin, the first peer-to-peer electronic cash system. Well, because, that was how the journey started: Blockchain was (and is) the technology powering cryptocurrencies. But innovators in various fields are now realizing and harnessing the many benefits of this system. And the finance industry leads the pack.
Why does the finance industry need blockchain?
The traditional financial system has a host of problems. To say the least, it’s:
- Antiquated, with a continuing reliance on some paper-based processes
- Centralized and vulnerable to failures and attacks
- Exclusionary, denying billions of people access to basic financial tools and information
To solve these problems, several key players, such as Citigroup, Goldman Sachs, Chase, and Credit Suisse, are currently enthusiastic investors in this technology. And why not? Blockchain promises and delivers:
- Greater transparency
- Safe and reliable transactions
- Distribution, eliminating the need for a central entity
- Immutability and traceability, with accurate, chronological history of transactions
- Better security
- Increased efficiency
Let’s see how.
Terms you should know to fully understand blockchain
Any information on blockchain and its impact on the financial services industry would be incomplete if we don’t dive deeper into two terms:
- Distributed ledger
- Smart contracts
A distributed ledger is a database that is accessible by multiple people. The data is consensually replicated, shared and synchronized across multiple sites, institutions, and geographies. With us so far?
This is not to be confused with a distributed database. Distributed databases require a central administrator. On the other hand, distributed ledgers contain transactions or contracts and are maintained in decentralized form across different locations and people, with inherent replication and synchronization across the various nodes of the blockchain network. This eliminates the need for a central authority to authorize, validate, or verify the transactions against manipulations. This is the technology that blockchain uses.
The information on the ledger is accurate, secure, and can be accessed with cryptographic signatures. This information is immutable. Distributed ledgers are more resistant to cyber-attack when compared to centralized ledgers: For an attack to be successful, all of the distributed copies of the ledger need to be attacked simultaneously. This difficulty in manipulating and attacking them also makes them extensively transparent.
Distributed ledgers have other advantages as well:
- Decrease operational inefficiencies
- Increase transaction speed
- Are automated, functioning 24/7
- Eliminate the possibility of fraud
Simply put, smart contracts are lines of code that automatically enact the terms of the agreement between buyer and seller. The code and agreement exist across the blockchain network.
These self-executing contracts allow trusted transactions to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement. The code controls the execution, and the transactions are irreversible and trackable.
Here’s an example: Smart contracts have great potential in automating many steps in the traditional life insurance process. With the policy terms encoded into the smart contract, the claims process will get streamlined and sped up. In the event of passing, the notarized death certificate would trigger the smart contract to auto-execute — in this case, release the payment to the beneficiaries.
When implemented correctly, smart contracts are incredibly difficult to hack. Your documents will not be stolen, because they’re encrypted and stored safely on a secured ledger. You don’t have to trust any intermediaries, because smart contracts eliminate that completely. Other advantages of smart contracts include:
- No manual processing or fees, saving time and money
The future of blockchain
One of the greatest drawbacks of blockchain has been scalability. The blockchain network is limited in its processing of transactions since records are restricted in size and frequency. And with cryptocurrencies and blockchain thriving, there’s a huge risk factor: The growing chain might become too unwieldy to handle. Even the co-founder of Ethereum admitted this in his interview.
Enterprise blockchain is proving to be a force to reckon with when it comes to tackling the scalability problem. And there’s good news for all: Gartner predicts that blockchain will become technically scalable by 2023, and will support trusted private transactions with the necessary data confidentiality. Statista forecasts that the global blockchain industry revenues will experience massive growth in the coming years: to over $39 billion by 2025. And the finance industry is leading the revolution, with over 60% of the technology’s market value concentrated in this field.
Here are some real-life use cases of blockchain technology in financial services.
- Israel’s Bank Hapoalim set up a blockchain system to manage digital bank guarantees. The bank’s customers receive security documents in a digital, automated, and secure manner. Clients no longer need to physically enter a bank to transfer the guarantee to a beneficiary or return it to the bank if not used.
- Blockchain is incredibly useful in cross-border payment systems. Usually, these are powered by SWIFT or Western Union and take 2-3 days on average. But with a blockchain network (like Ripple) involved, Deloitte estimates that the cross-border transfer process could be completed in 4-6 seconds. Plus, transaction costs could be cut down by 40-80%.
- The shipping and transport consortium Maersk uses blockchain to streamline marine insurance. Instead of navigating through a frustrating network of brokers and underwriters, shippers can manage risk much more efficiently. Claims are now paid in hours, not years, and premiums are agreed and settled in seconds.
Clearly, blockchain technology is turning the finance world upside down. So far, most bankers and other financial powerhouses have somehow managed to dodge the kind of massive revamp that is critical to economic vitality and progress. But blockchain has arrived and is here to stay — and it’s up to the finance industry to transform the inaccessible money machine into a prosperity platform for all.