Blockchain’s Impact on the Finance Industry, Part 1

This is part 1 of our multi-part series on Digital Assets and Blockchain, and what these could mean for the finance industry.

It seems like you can’t take one step these days without bumping into someone talking about cryptocurrencies. But for all this talk, the average investor probably doesn’t understand the underlying tech behind it — which is the real value add — the blockchain.

Developed in 2009 as the technology behind cryptocurrency, blockchain is a vast, globally distributed ledger capable of recording anything of value. Assets can be moved and stored privately, securely and from peer to peer. For the first time in human history, two or more parties can forge agreements and make transactions without relying on intermediaries to verify their identities or perform the critical business tasks that are foundational to all forms of commerce.

So let’s ask ourselves, How will blockchain affect the finance industry? There are a lot of unknowns, both potentially negative and positive. Let’s start with the potential positives:

Fees

It’s estimated that consumers could save up to $16 billion in banking and insurance fees each year through blockchain-based applications. By reducing transaction costs and essentially cutting out the middleman, blockchain offers an efficiency that cuts through costly financial ‘red tape’. And with shorter clearance or settlement times, reduced back office and compliance costs, companies could also see similar savings as well as risk reduction.

Streamlined Processes

A large majority of financial securities exist today purely electronically and are managed centrally through trusted third parties, incurring considerable operating costs. Blockchain supports the validation and execution of transactions in near real time. This means it can be used to:

  • Remove friction from the client onboarding process
  • Streamline management of model portfolios
  • Speed the clearing and settlement of trades
  • Ease compliance burdens

Data Integrity of the Audit Trail

Like most forms of technology, blockchain in accounting and audit greatly reduces the potential for errors when reconciling complex and disparate information from multiple sources. One reason is you can’t alter a record once it’s been committed under blockchain, even if you own the record. And because every transaction is recorded and verified, the integrity of the transaction is guaranteed. Plus with the advent of smart contracts, trade is enabled with fewer barriers and protected via the digital wallets on either side of the transaction.

But with any new technology there are always potential negatives or concerns:

Adoption

In June, IBM was selected to build a blockchain-based international trading system for seven of the world’s biggest banks, including Deutsche Bank, HSBC, KBC, Natixis, Rabobank, Societe Generale and Unicredit. And, Microsoft and Bank of America Merrill Lynch have teamed up on a new project using blockchain in trade finance, aiming to create a framework that could eventually be sold to other businesses. However, just because companies want to start implementing it, doesn’t mean your customers are going to jump on board, especially when it concerns their money.

Regulation

While Blockchain is tantalizing to FinTech, with nearly all blockchain-based proofs of concept developed by banks having been undertaken in conjunction with fintech partners, new territory could mean the wild wild west when it comes to oversight.

“Blockchain and cryptocurrencies aren’t regulated as a technology generally speaking. It depends on the application. So, whatever they’re used for, it’ll fall under the appropriate regulator — and sometimes the inappropriate regulator.” – Marco Santori, Cooley

Scalability

Like any endeavor, how you scale could mean the difference between profit and bankruptcy. Blockchain networks still aren’t capable of handling the high transaction volumes that could rival that of large industries and financial institutions. Without the appropriate scaling solutions, transaction costs would be too high and the wait times too long for viable adoption. For example, Bitcoin blockchains can only achieve 3-4 transactions per second compared to 56,000 for Visa’s VisaNet. Plus, when you add to this the fact that more than half of the world’s big corporations are considering blockchain and 2/3 of them expect the technology to be integrated into their systems by the end of 2018, proper scaling becomes even more vital.

The one thing we can be certain of about blockchain is that we don’t know what impact this technology will have and how many industries it will affect. Even with all the excitement surrounding it and its entrance into the mainstream, it’s still in the early days. Smart investors and tech titans will tread lightly and keep a watchful eye on this continually and quickly evolving space.

Stay tuned for the next post in this series on what blockchain and cryptocurrencies mean specifically for asset management and investing vs. payments and banking.

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