Blockchain technology is not just improving banking and finance but changing the way we interact with our money, data and bureaucracies. In this article, we talk about how blockchain applications are changing traditional financial institutions by offering new solutions to old money problems.
Cryptocurrency Making History
If someone offered to leverage an investment with tulips, tea, or a fresh batch of beaver pelts today, you’d think they had gone off their rocker. But travel back with me to the 17th century when flowers, oolong and fur fueled the economy and resulted in the establishment of several long-lasting institutions and sovereign nations.
In the Netherlands during the Dutch Golden Age, one tulip bulb was worth ten times the annual income of that of a skilled worker, and so tulips fueled the thriving economy of the Dutch. The Brits love of tea may be a tired stereotype, but there is good reason for it. By 1766 tea exports from Canton weighed in at six million pounds -which is why the Boston Tea Party of 1765 made such a splash.
While the Dutch flourished with flora, the British East India Company thrived under the export of their own super plant; tea from China and Assam India. The British economy was virtually completely dependent on the tea trade for several centuries.
The 17th century also saw the establishment of the Hudson’s Bay Company. The explosion of the fur trade is the reason that the beaver is Canada’s national animal. The ownership of the Canadian fur trade was the cause of a serious power struggle between the French and the British. By the 1580s beaver pelts had become a major source of international trade revenue in Europe.
Emerging Technology In the Present Day
Well, those are fun facts, but you might be wondering: what do the economics of the 17th century have to do with blockchain and cryptocurrencies. The point is, currencies, needs, and values inevitably change.
Along with changing needs so do the methods of making exchanges and determining values also change. And just as you can no longer use a bunch of tulip bulbs as collateral for your mortgage, and dumping a bunch of tea into a lake is probably no longer newsworthy, so we have begun to realize a world where cryptocurrencies can exist. The applications of blockchain technology are transforming the way we conceptualize hard currencies and the exchange of goods.
A few of the items this article discusses are:
- Speedy cross-border payments
- Reduced KYC costs
Paving the Way for the Financial Future
It is no exaggeration to say that every day the traditional financial industry becomes more and more amenable to the merits of merging traditional processes with blockchain solutions. Blockchain applications are offering profitable and sustainable solutions to our current financial needs; from services for effective applications of smart-contracts to more efficient global transactions.
Blockchain applications also offer potential solutions to many concerns about information processing and retention, as well as the expansion of global-banking capacities.
Major finance players have very recently embraced blockchain tech as seen with the JP Morgan cryptocurrency, Alberta Treasury Branch’s crypto support, and Fidelity’s crypto custody service. These companies, and many more, are demonstrating the value that blockchain applications have to offer the financial industry.
Blockchain Technology and Finance are a Happy Couple
Blockchain has much to offer in meeting the current needs of the financial world. Here are few of the benefits of pairing the two:
- Blockchain platforms are decentralized, so they may be owned by a single entity, but are dependent on concurrent networks.
- The data is cryptographically stored via a hash inside each block.
- The blockchain is immutable, so no one can tamper with the data that is inside the blockchain without this affecting the other blocks of data.
- The blockchain is transparent so one can track the data and gain access to a full history of transactions.
- Smart-contracts allow for efficient and automated contracts.
- Storing information in a blockchain is an efficient means of storing and sharing customer data safely.
What is Blockchain Technology
Basically, a blockchain is a time-stamped series of data with an immutable record. The data is managed by a collaboration of networks, rather than owned by any single entity. Each of these blocks of data is secured and bound to another using cryptographic hash functions. Within the block, there is a hash pointer. A hash pointer contains the address of the previous block as well as the hash of the data inside the previous block.
To learn more about the nuances of blockchain please read our article on; What is Blockchain Hashing.
Traditional Financial Institutions and Blockchain Disruption
Cryptocurrencies and blockchain were designed with the individual and decentralization at the heart of it. However, it is impossible for large financial institutions to ignore what they stand to gain through blockchain applications of their very own.
One of the gains to traditional financial transactions is the improvement of processes by fast and accurate documentary procedures. These are essential for credit checks and client acquisition. By using smart-contracts, collection and guarantees happen automatically and electronically. By having access to a public ledger of transactions, details of the financial history of businesses or an individual are available and accurate because it is immutable.
The outspoken critic of cryptocurrencies, Jamie Dimon CEO of JPMorgan, is now ushering in a new phase of crypto-finance applications with the launch of the first digital coin to be launched by a major American bank.
Institutional clients of JPMorgan can now exchange dollars for digital tokens, each equivalent to one US dollar. Using JP Tokens, clients can settle payments instantly (within a matter of seconds). Transactions that typically take several days to be fully processed and require several intermediaries along its way to the final destination.
To read more about JP Morgans’ cryptocurrency announcement, read on our blog JP Morgan Cryptocurrency – 7 Key Takeaways.
Public Ledgers and Transparency
By relying on shared or public ledgers, transactions that use blockchain are transparent and immutable. Relying on a shared ledger not only increases the accuracy and maintenance of transactions records. It also makes peer-to-peer transactions a functional reality increasing the diversity of exchanges and transactions while dramatically decreasing the risk.
The credited creator of Bitcoin, Satoshi Nakamoto, did not invent blockchain technology. Rather in 2008, he put into practice the cryptographically secured chain of blocks that was described in 1991 by Stuart Haber and W. Scott Stornetta. The driving idea behind Satoshi Nakamoto’s creation of the cryptocurrency bitcoin was a technology that could support safe peer-to-peer transactions and eliminate the need for a third party.
Until bitcoin, peer-to-peer transactions relied almost exclusively on the exchange of physical cash. The dependence on cash meant that making long distance transactions were difficult and risky. Blockchain applications are steadily mitigating and eliminate these obstacles and risks.
Because blockchain applications rely on public or semi-public ledgers, the risks of relying on centralized systems are being mitigated. By relying on a centralized system, a given network becomes far more vulnerable to compromised data. Because information is being held in one place, if the system fails or is held ransom, the whole network and its data are compromised. This is not the case for decentralized networks.
Centralized power also limits fair competition and potential participants, and suffers [inevitably] from corruption. Blockchain apps are often described as democratic. This is not only because of the decentralized network, but because of a public ledger of transactions that relies on the mutual agreement for their approval.
Moreover, the blockchain is democratic because it is more accessible than traditional financial institutions. That is institutions are the arbiters of who has access to what credit and controls borrowing and lending power. With a peer-to-peer system, individuals are able to make more autonomous financial decisions.
When we talk about blockchain public ledgers, one of the major appeals is a new kind of transparency. The reason blockchain is such an appealing platform is that it uses a ledger that maintains both the anonymity of the actual humans making transactions. Public ledgers simultaneously keep a public record of all of the transactions that occur on a given blockchain platform.
If you take a look at the image below you will see “from” and “to” and under those columns, you will see a random-looking collection of variables; these are addresses hidden with cryptography. Or more specifically, these are the addresses of individuals making transactions between one another.
The essence of crypto-transparency is the combination of anonymity and accountability through public access.
This is particularly valuable for customers of large financial institutions. The public ledger offers a level of transparency that was never before available to everyday folks. So when you want to know what is going on within a large institution that is using a public ledger you can call up all their transactions.
Transparency leads to accountability.
Obviously, not many traditional financial institutions are ready to adopt this exact open model. However, given the continued influence of the world of cryptocurrencies, it would come as no surprise if the public ledger became a necessity due to public demand. If a company wants clients and investors they will have to earn trust and show us what’s under the carpet; not simply hand over a bill of goods that we are simply expected to approve of.
Supply chains are steadily embracing this kind of transparency. IBM and Walmart are strong examples of companies that are particularly interested in using blockchain to do so.
Consumers and citizens alike deserve the basic tenets of transparency and accountability. In an ever expanding global economy, trust needs to be earned, not just freely given.
Ethereum’s Decentralized Applications
The gains made by Ethereum’s platform are central to the application of blockchain technology for the improvement of current economic and transactional issues.
Ethereum is a blockchain platform that Vitalik Buterin proposed in 2013 and launched in 2015. The platform was designed in order to support other kinds of cryptocurrencies by providing a generalized framework that could effectively support blockchain applications.
One of the central features of Ethereum is that it makes it possible for developers to build consensus based decentralized applications (Dapps). The platform is not itself a currency, however, Ethereum does use Initial Coin Offerings (ICO) as a source of funding for networks.
Ether is the currency and incentive for quality networks and for mining as well. Every computation results in a transaction that has a fee. Ether tokens are therefore the reward that is issued for mining and thereby both incentivizes and compensates maintenance of the network.
To incentivize miners and maintain the accuracy of the network, fees and coin rewards are a part of the model. Computations (or mining) are costly and difficult. Fees discourage abuse or malicious behavior as networks must behave within the parameters of the consensus model of the program in order to be rewarded.
A function of the platform is the deployment of smart-contracts. Smart-contracts are self-executing and run on a simple IFTTT (If-this-then-that) code, so when one stipulation of the contract is met, the proceeding instruction can occur. Both blockchain platforms and the use of smart-contracts are central to the appeal that blockchain applications have to financial institutions.
Asset Management and Cryptocurrencies
Transactions using blockchain applications are not only monumental because large institutions are finally catching up with the alt-kids of the crypto world. They are groundbreaking because blockchain eliminates the need for multiple intermediaries and is making transactions in real-time.
Blockchain technology can be used for a number of applications. Bitcoin and cryptocurrencies are just one application of the technology. And making transactions is just one aspect of the role that blockchain can play in the financial sector.
Using blockchain technology makes transferring funds much more direct and efficient than traditional wire transfers. The internet has been blowing up because of several blockchain milestones in 2019. One of which is the successful test by ATB which uses XPR.
Using XPR, ATB was able to platform successful transfers funds internationally in a fraction of the time that a typical wire transfer takes. Ripple was able to complete a test cross-border transaction in 20 seconds using XPR, something that usually takes a wire transfer 2-6 days and involves several intermediaries.
Smart Contracts and Automated Agreements
As mentioned, blockchain also uses smart-contracts. The program of a smart-contract executes the agreements. By applying a code to contracts, terms and transactions can be settled automatically and autonomously. The code dictates the conditions under which the contract is met. The deployment of a smart contract fulfills the agreed stipulations.
Smart contracts are applied to improve management and accuracy of the following: insurance policies, stock markets, corporate cash management or tax reports.
Not only do smart-contracts make the fulfillment of obligations automatic, but demands that both users agree to the set terms. Smart-contracts also eliminate the need for middlemen, which is appealing for reasons all on its own.
For more on Smart Contract, read about it here: How To Audit a Smart Contract.
KYC: Know Your Client
Another feature of shared networks is the easy on-load of new customers without the need for a whole new set of paperwork for the collection of personal information. For example, one’s bank, mortgage, and insurance are typically all individual entities. This means that Client X must establish their identity separately with every institution. Not only is this repetition time consuming, it is error-prone and costly.
To simplify this process, Client X can upload her personal information to a blockchain and then she can selectively share this information easily and accurate whenever it is necessary. Not only does this use of blockchain simplify the life of Client X, but KYC is a huge expense for financial institutions.
One stat states that a bank can spend between £40 and £300m a year on KYC Compliance. JP Morgan reported that they have spent up to £1.6 billion on their compliance department and must employ more than 13,000 people to keep track of regulatory changes.
The outcome of the most recent Thomson Reuters survey reveals that KYC compliance and record-keeping underscores a central challenge that faces the 1100 financial institutions that participated in the survey. This is due to the many considerations that make KYC a cumbersome process.
Moreover, KYC issues for both clients and the institution themselves continue to increase; regardless of the fact that more attention and resources are given to customer knowledge. One estimation states that in 2016, financial institutions with $10 billion or more in revenue have seen their average spend on KYC-related procedures increase to $150 million from $142 million.
Problems of compliance capabilities associated with scarce resources persist, in spite of the fact that the number of deployed employees has skyrocketed to an average of 307 KYC compliance professionals in 2017 from 68. In fact, the survey revealed that the process of on-boarding new customers has increased from an average of 32 days from 28, and given the available data, and that this time lapse is expected to continue to increase.
Using blockchain to share store and share customer information thus has huge potential for savings and improved services.
Applications and Limitations
Before blockchain can be adequately adopted and broadly adapted to serve the current needs of financial institutions, there are several limitations the technology presently faces that must be dealt with. Issues include the following: scalability, lost keys, sustainability, inoperability, and trust.
In order to adequately serve the current scale of payments currently made, any transaction platform needs to deal with millions of transaction a second. Santander is the first UK bank to use blockchain technology. They are currently using Ripple blockchain applied to ApplePay. However, for now, only transactions between ￡10 and ￡10000 are possible. And the only currencies used are GBP, EUR and USD between 21 countries.
Lost or Misplaced Keys
Cryptography is used so that only the rightful recipient of an asset can unlock it using their private key. Keys can be lost or misplaced which makes ownership change of the assets a potential issue.
Hash mining and blockchain transactions consume energy at an incredibly high rate. This is an issue that has been approached in many ways. For starters, most large mining pools are now in areas where energy is cheap. While others are working on more energy efficient equipment.
Although blockchain technology is incredibly adaptive, there is no one blockchain for all purposes and requirements. For broad adoption by financial institutions, interoperability is an issue that needs to taken seriously.
In order for blockchain applications to expand into the same ubiquitous role as fiat currency, platforms and currencies must be able to process a much higher rate of transactions. For example, Bitcoin can handle approximately 60 transactions per second, as compared to Visa’s rate of 47,000 per second.
That means that for Bitcoin to rival Visa’s numbers, it would be equivalent to trading four terabytes of data per year. Ether, comparatively, takes approximately 14 seconds to generate a block and is considerably cheaper than Bitcoin, with transaction fees less than 2% of Bitcoin’s.
Along with scalability, the cost of transactions is also a factor in terms of sustainability; both financially and energetically. More nodes are necessary to process the increased traffic caused by more users and more transactions. Again, running nodes and mining is a costly process.
Naturally, miners typically prefer transactions with higher fees. This means that during peak times, to have a transaction verified efficiently can escalate from the fraction of a cent to a number of dollars. The fees for verification are therefore highly susceptible to supply and demand.
Developing Trust and Cyber Hygiene
Let’s have a look at those using blockchain for solutions to financial and bureaucratic challenges. Estonia is a shining example, as it has been committed to the transition to a truly digital society since 2002. Since 2002, Estonia has progressively moved its bureaucracy onto the digital realm. From everyday processes to maintaining medical records and divorce filings. Estonia is a paragon of transitioning to a paperless society.
President Kersti Kalijulaid attributes the effective transition of their bureaucracy and economic growth to a people ready and willing to exist in a paperless world. She also stresses the importance of maintaining cyber hygiene. That is, Estonians are committed to the growth of their economy through digitization. Also, both the government and the citizens are committed to maintaining the intelligent use and trustworthiness of their digital society.
Estonia’s government is leading the charge with the democratic application of blockchain platforms. However, China’s Sesame-credit system demonstrates pretty clearly the dark side of the digitization of society. Using this credit-system, Chinese citizens receive credits (or demerits) based on their daily behaviors. These can then be used to control access to financing and the ability to travel.
The comparison of the two uses and management of personal data is relevant to demonstrate the potentially dubious uses of data collection. It also highlights what the president of Estonia might include in her description of cyber hygiene.
Estonia, JPMorgan, Santander are a few of the increasing examples of institutions that are using blockchain applications. Digitization and blockchain tech has been applied to solve persistent problems, as these are examples that are committed to the improvement with digitization.
In conclusion; there is an enormous amount of potential for our managing our ever-changing financial existence. The more we investigate and experiment with blockchain and Dapps, the better we will be able to harness the potential of the technology in order to maintain the democratic use of applications and protect the integrity of individual autonomy.