How Blockchain Technology will disrupt the Financial industry?

Blockchain technology - the buzzword of 2018 can revolutionize all industries, but what impact will it have on the Financial industry...

Written by Hristiana Dyulgerova

How Blockchain Technology works?

The first successful widespread implementation of blockchain technology, also known as BCT, was in the form of bitcoin, a cryptocurrency introduced by Satoshi Nakamoto in 2008, a person whose identity has not been confirmed to this day. Since then, blockchain technology has had many iterations released, each bringing new features and increasing efficiency of previous versions. Even though its first widespread use was cryptocurrency, blockchain technology has the potential to revolutionize and disrupt numerous fields, including the financial sector [viii].

The main concepts behind blockchain technology are security, speed and transparency and they are all enforced by the way that the inner workings of the technology operate. The process behind the operation of any blockchain involves a shared ledger which contains all the transactions that have taken place since its creation which are then split into blocks that refer to the to the block preceding them, hence the name blockchain [xii].

This ledger is updated constantly with new transactions that have been authorized by the network, making up the next block. In addition to this, each block can be identified by a unique identifier, also known as a hash. This hash is calculated for each block and cannot be tampered with since it changes even if the slightest change is made to any of the transactions contained within it [iv].

Being aware of the order of transactions as well as having uniquely identifiable blocks ensures that incorrect and fraudulent transactions are not processed by the network or carried out. An additional feature that provides greater security and transparency is the de-centralized nature of blockchain technology. By having a network of nodes authorizing transactions in unison, the chance of the network being highjacked by a malicious attacker is minimized [iv].

The benefits that blockchain technology provides have sparked interest in many sectors. The financial sector is included in these as it can benefit greatly from blockchain technology in terms of efficiency, speed and security. This interest has been made apparent since several financial institutions have shown interest in BCT while others, such as the Bank of America and HSBC are in the testing phase of adopting the technology [xii].

Five ways in which Blockchain Technology will disrupt the Financial industry

1) Improving financial security

Experts claim that fraudulent activities are common within the financial sector and overall within sectors where operations are based on financial transactions[ix]. In these sectors security is a key element, however stock exchanges as well as banks are frequently faced with heavy losses because of economic crimes. Centralized systems are usually the main reason for those losses, because of their vulnerability to cyber and hack attacks. Therefore, there is a need for a system that provides more security and can minimize such attacks.

Blockchain technology can provide the security that financial industries need. BCT operates on distributed database system which cannot be corrupted, hence failure is impossible. Software automating process serves for the update of the distributed ledgers in real time. In other words, when transactions or other events occur the software automatically updates the ledger [ix]. This system guarantees that all network participants have their own up-to-the copy of the ledger where all transactions are listed, in this way fraud can be avoided. Efficiency as well as cost savings for both clients of financial institutions and banks, are increasing thanks to the automated process that blockchain technology provides. In addition to this, the use of a decentralized record keepers also reduces the costs for the banks and make the process much more efficient [xi].

Through the use of distributed ledger holders and the execution of instructions by a cryptographic code being enforced, blockchain technology eliminates the need of a third-party authenticator for transactions. This allows for a great reduction of overheads in management and risks of fraud [i].

2) Know Your Customer – Anti-Money Laundering

Anti-money laundering and Know your customer are two problematic areas for all financial institutions. The costs of dealing with these problems are increasing continuously for organizations. For example, all banks and financial institutions in general need to individually perform AML and KYC processes which are time and effort consuming. The main reasons for those procedures are the overall reduction of fraudulent activities as well as money laundering [ix].

By adopting blockchain technology, all financial institutions will have access to a ubiquitous system in which a clients’ information and independent verification will be stored, available for all financial institutions participating in the system. Therefore, Know your customer and Anti-money laundering processes will be much easier to complete since financial institutions will have all the necessary information on one system where information can be updated in real-time. BCT will help organizations minimize administrative efforts as well as to eliminate duplication of efforts. Last but not least, the costs for compliance departments in financial organizations can be significantly reduced through the use of blockchain technology [x].

3) Smart Contracts

A very promising feature that BCT enables is that of smart contracts. Smart contracts are computer codes that assist for the exchange of shares, money and anything of value in general. There is no need for third-party interaction when transactions are performed, thus cutting out the middleman, saving time and resources. Smart contracts are similar to traditional contracts regarding defining the rules of an agreement, their main advantage however is that obligations cannot be avoided because they are automatically enforced by the system [ii] [vi].

The integration of smart contracts in blockchain technology adds an additional layer of automation, security and transparency and makes all smart contracts on the blockchain immutable. The combination of smart contracts and BCT streamlines all procedures that would normally take place in the process of executing a contract as no external interaction is required for the contract to be carried out [iii].

Smart contracts could revolutionize financial transactions and disrupt the status quo in the financial sector by offering an infrastructure that provides additional security, transparency and speed compared to traditional methods. The capabilities of smart contracts in this financial industry have already been noticed, with some exchanges integrating smart contracts operating on blockchain technology to achieve greater automation, especially in situations where constant contextual awareness is required [xiv].

4) Blockchain technology as an security multiplier

The ability to track financial transactions is a greatly beneficial features that BCT provides. Since each transaction carries a unique fingerprint, it can be easily identified amongst all other and then subsequently tracked [x]. This fingerprint can be used as a tool to obfuscate confidential information regarding the transaction and all parties related to it when used by authorized government agencies. This ability can greatly benefit the financial sector as the risk of fraudulent or illegal transactions such as money laundering taking place on the network can be minimized [v].

A unique blockchain ID can also serve as a means to identify a person’s identity while keeping all the information on a secure network. The blockchain ID can be thought of as a never expiring ID card that is forever tied to one’s personal data. on a blockchain this is achieved by generating a hash unique to the person based on their name, date of birth, gender as well as a variety of other attributes that can guarantee that no two IDs are identical [vi]. This allows for the individual to be easily identifiable and to exchange funds between peers and family without the use of a bank or financial institution as an intermediary. In order to verify one’s identity, the information initially used to create the ID are used to unlock it [vii].

5) Improving financial transactions efficiency

Financial transactions are difficult and time-consuming processes for both financial industries and consumers. In addition to this, higher risk of errors, delays, illegal transactions as well as low efficiency are other problems which consumers often face with [x]. BCT aims in digitalizing all procedures in the financial industry which depend on paperwork. The adoption of BCT in the financial sector may lead to, the improvement of supply-chain finance efficiency and the reduction of manual operation risks. The main trading parties in a financial transaction are the buyer, the supplier and the bank which all share contractual information. Smart contracts can be greatly beneficial when used for financial transaction as they can ensure that payments are made without manual interaction and following the fulfillment of pre-defined requirements such as time [v].

Having blockchain technology adopted in supply-chain finance can disrupt the financial sector and can lead to the reduction of banks costs as well as trade financing enterprises costs. Moreover, the improvement of transaction efficiency allows for an overall smoother movement of financing channels. As a consequence, the overall trade chain income is greatly increasing [v].

References

[i] Atzori, M. (2015). Blockchain Technology and Decentralized Governance: Is the State Still Necessary?. SSRN Electronic Journal, pp.3-10.

[ii] Blockgeeks (2016). What Are Smart Contracts? A Beginner’s Guide to Smart Contracts. [online] Blockgeeks. Available at: https://blockgeeks.com/guides/smart-contracts/ [Accessed 15 Nov. 2018].

[iii]Challen, M. (2017). Smart Contracts 101. [online] PayNinja. Available at: https://www.payninja.co/smart-contracts/ [Accessed 16 Nov. 2018].

[iv] Cointelegraph (2018). How Blockchain Technology Works. Guide for Beginners. [online] Cointelegraph. Available at: https://cointelegraph.com/bitcoin-for-beginners/how-blockchain-technology-works-guide-for-beginners [Accessed 16 Nov. 2018].

[v] Guo, Y. and Liang, C. (2016). Blockchain application and outlook in the banking industry. Financial Innovation, 2(1), p.8.

[vi] Hofmann, E., Strewe, U. and Bosia, N. (2018). Supply Chain Finance and Blockchain Technology. 1st ed. Springer.

[vii] Knezevic, D. (2018). Impact of Blockchain Technology Platform in Changing the Financial Sector and Other Industries. Montenegrin Journal of Economics, 14(1), pp.109-115.

[viii] Marr, B. (2018). A Very Brief History Of Blockchain Technology Everyone Should Read. [online] Forbes. Available at: https://www.forbes.com/sites/bernardmarr/2018/02/16/a-very-brief-history-of-blockchain-technology-everyone-should-read/#dec72617bc47 [Accessed 15 Nov. 2018].

[ix] Pratap, M. (2018). How is Blockchain Revolutionizing Banking and Financial Markets. [online] Hacker Noon. Available at: https://hackernoon.com/how-is-blockchain-revolutionizing-banking-and-financial-markets-9241df07c18b [Accessed 12 Nov. 2018].

[x] Pritchard, J. (2018). Here’s How Blockchain Will Transform Banking and Financial Services. [online] The Balance. Available at: https://www.thebalance.com/how-blockchain-is-changing-banking-and-financial-services-4174354 [Accessed 18 Nov. 2018].

[xi] Rennock, M., Cohn, A. and Butcher, J. (2018). Blockchain Technology and regulatory investigations. Litigation. Practical Law, pp.36-38.

[xii] Shen, L. (2016). Blockchain Will Be Used By 15% of Big Banks By 2017. [online] Fortune. Available at: http://fortune.com/2016/09/28/blockchain-banks-2017/ [Accessed 15 Nov. 2018].

[xiii] Tekshapers (2018). Impact of Blockchain Revolution on Finance Industry. [online] Tekshapers.com. Available at: http://www.tekshapers.com/blog/Impact-of-Blockchain-Revolution-on-Finance-Industry [Accessed 16 Nov. 2018].

[xiv] Wang, X., Xu, X., Feagan, L., Huang, S., Jiao, L. and Zhao, W. (2018). Inter-Bank Payment System on Enterprise Blockchain Platform. In: IEEE 11th International Conference on Cloud Computing. pp.614-619.

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