The traditional financial market is built on trust in central authorities namely banks, brokerages or exchanges. Yet, as the technology of blockchain is heading for its peak, this prevalent aspect of the financial industry is caught ever more strongly in a crossfire of criticism. The distributed ledger technology (DLT) is making these single points of authority redundant thanks to the decentralized database which the blockchain provides. The question arising for the finance industry is what implication this brings to existing systems and processes and what possibilities open up because of technological advances.
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After the financial crisis in 2008, cross-border capital flows diminished in order to reduce risk. Banks, especially in the eurozone became more local, reducing their international businesses. Technologies like blockchain or machine learning are now able to transform and digitize the markets again, offering new ways for cross-border capital flows. Especially distributed ledger technologies open the market to a more global audience, allowing more companies, investors and countries to participate in the financial industry as they provide faster, lower-cost and more efficient international transactions. The globalization of banks, or overall the financial market, is nowadays necessary to meet customer expectations and increase efficiency. Therefore data analytics and algorithms to understand risks in international markets might pose a competitive advantage.
Current processes in financial institutions and companies rely strongly on manual networks thus are prone to errors and frauds. A possible improvement is offered by the blockchain technology which holds various benefits for these organisations making them more transparent, resilient and at lower cost. The following points are an extract of various benefits the blockchain technology has for the finance industry:
1. Enhanced efficiency through transparent records
As the decentralized ledger of a blockchain is synchronized across computers, the effort for reconciliation on transactions is diminished. Additionally, the efficiency enhances with reducing settlement time because transactions are transparent and can be reviewed by all relevant participants.
2. Increased data integrity
Records on the blockchain are immutable and transparent hence improving data accuracy and security. Furthermore, transparency reduces the number of frauds and errors. The blockchain also has the potential to create a single source of information around customer identity and thus reduces costs and risk issues of customer due diligence regulations (e.g. KYC (know your customer) processes). Different banks or institutions involved in a process have access to an independent verification of each client which reduces administrative efforts. On the other hand the single point of failure in form of a single responsible authority is eliminated through decentralisation.
3. Faster processing
A faster processing which for example is provided through accurate customer information that can be accessed by everyone in the network increases customer experience. Also the application of smart contracts increase speed as they ensure a transfer to contain accurate information due to conditions written in the code of the smart contract.
4. Higher availability of capital and lower cost of business
The blockchain consensus mechanism and smart contracts enable faster and automatic transfers. Through removing the intermediary transactions fees can be eliminated or at least reduced. Moreover, capital flows are freed up as the purchase of funds is processed in real time.
Risks and challenges
Apart from the benefits which the blockchain technology can have for finance organisations, a study by PwC in July 2018 on the contrary implies a rather sceptical view by banks, insurance companies and wealth managers. In total 300 executives of the German finance industry were asked about their experiences with establishing blockchain in financial services. 34% say that the influence of blockchain will rise but only in the next ten years. Also the expections of impact on profits is debated as nearly half (48%) consider the impact unfavourable or without any consequences. On the other hand, financial services are considered to be the leading industry in blockchain adoption with 46% in PwC's global blockchain survey 2018.
The barriers companies or institutions named to face are mostly regulatory implications, lack of trust among users and the missing ability to bring networks together. One pain point for many are cryptocurrencies which show strong volatility and pose bubble-like conditions thus having unclear implications for monetary policies and financial stability. Apart from cryptocurrencies the challenges institutions face in regard of blockchain technology are:
- Interoperability: the technology needs to be compatible with different systems
- Privacy: the trust in entities e.g. banks needs to be shifted to trust in technology
- Security: handling different levels of access permission to reduce cyber hackings
- Scalability: handling of huge data bases
- Energy consumption: existing rewarding mechanism consumes massive energy amounts
- Legal regulations: international regulations need to be in place when blockchain experiences broad adoption
The impact of blockchain technology in finance is undeniable despite scepticism of various parties in the industry. Still there are many factors such as legal implications that need thourough consideration before blockchain technology reaches broad adoption.
McKinsey: A decade after the global financial crisis
McKinsey: The new dynamics of financial globalization
KPMG: Blockchain and the future of finance
PwC: Global Blockchain survey 2018
PwC: Blockchain in Financial Services
Hackernoon: How is Blockchain revolutionizing banking and financial markets