How blockchain can reshape financial services
The World Economic Forum (WEF) recently published a report on the future of financial infrastructure looking at how blockchain could reshape financial services. Noting that… Read more
The World Economic Forum (WEF) recently published a report on the future of financial infrastructure looking at how blockchain could reshape financial services.
Noting that 80% of banks are predicted to initiate blockchain / distributed ledger technology (DLT) projects by 2017, the report identifies DLT as one of a number of emerging technologies which include biometrics, cloud computing, cognitive computing, predictive analytics and robotics that will shape the future of financial services infrastructure.
According to the report the impact of blockchain will vary according to the particular use case, for example:
- Global payments: enabling near real-time point to point transfers of funds between financial institutions, reducing settlement times.
- Trade finance: enabling real-time multi-party tracking and management of letters of credit for faster automated settlement.
- Compliance: automating compliance processes which draw on immutable data sources where transaction records cannot be altered for faster and more accurate reporting.
- Digital identity: a fully digital system for storing and transferring identity attributes which could be directly integrated into financial infrastructure, for much faster and more accurate customer identification and counterparty matching.
- Digital fiat currencies: providing settlement to liquid, cash-equivalent tokens issued by central banks, eliminating the need for an inefficient linkage between cash and new financial infrastructure.
The report looks at a number of use cases and highlights the significant changes that could be made to current processes through the application of blockchain and the resulting benefits. Taking global payments as an example, trust between the sender of a payment and the bank or money transfer provider could be established via a digital identity profile. The obligation to transfer funds between sender and beneficiary could be captured in a ‘smart contract’, a computerised transaction protocol that forms the terms of a contract by reference to business rules codified on the blockchain. Through smart contracts, foreign exchange could be sourced from participants willing to facilitate the conversion of fiat currencies. Funds would be transferred in real time with minimal fees without the need for a correspondent bank. The beneficiary’s identity could be verified using a digital identity profile. A regulator could monitor transactions in real time and receive specific AML alerts and at any time review transaction histories stored on the ledger.
As an early stage, real-world example, Circle recently launched in the UK a free app allowing cross-currency transactions between US dollars and pounds sterling, using Bitcoin as an underlying currency. When a sender wishes to send a payment, the service charges the sender’s bank card, buys Bitcoins, sends them to the recipient’s account and makes the reverse exchange. There are no fees for the service. Customers hold their money in national currencies, using Bitcoins for such a short period of time that there is a low risk of being exposed to volatility in the cryptocurrency’s price. Circle has announced that it plans to extend this service to Euro-zone customers.
There have been regular press reports of major financial institutions taking an interest in blockchain. Recent announcements have included: UBS partnering with Deutsche Bank, Santander, BNY Mellon and the broker ICAP to develop a new form of digital cash which they hope will become an industry standard to clear and settle financial trades over blockchain, aiming for a commercial launch by early 2018; and Visa collaborating with digital payments start-up BTL Group to adapt its technology for processing interbank payments across multiple currencies with the aim of reducing costs, speeding up settlement times and reducing credit risk.
The WEF report highlights the potential for blockchain to achieve significant benefits over current processes. In the case of global payments for example, it could result in reduced costs and settlement times and more efficient KYC, AML and compliance processes. However, for these benefits to be realised, there are a number of major issues to be resolved such as:
- consensus on the type of DLT platform across a significant number of financial institutions to facilitate economies of scale;
- adopting common KYC processes used by banks and money transfer operators across different regulatory frameworks;
- clarification of an uncertain regulatory environment;
- creating a legal framework so that the rights and obligations recorded in the blockchain can be accepted as binding without the need for legacy solutions to be maintained in parallel; and
- managing the volatility of cryptocurrencies.
By some estimates, it will be three to five years before blockchain is adopted at scale. Significant issues still to be resolved before blockchain can be applied more widely include:
- security issues such as ensuring that distributed ledgers are secure and safeguarded against errors, building rules to prevent malicious behaviour, performing thorough end-to-end testing, verifying all code and having in place stringent IT controls to detect potential gaps in security;
- implementing new regulatory frameworks (US regulators recently cited concerns about distributed ledger systems, including possible operational vulnerabilities not becoming apparent until the systems were deployed at scale and possible vulnerability to fraud executed through collusion among a significant fraction of participants); and
- putting in place new liability frameworks (where liability and jurisdictional issues are not expressly dealt with by traditional legal agreements or smart contracts, it remains unclear which party will have to take responsibility when things go wrong).
A copy of the WEF’s report can be found here.