Every day, people around the world transfer billions of dollars. These transactions rely heavily on paper, although most people send money digitally. In financial environments, bankers always keep financial records. But, what if there was a database that had the qualities of a ledger that could instantly record transactions and monitor and record changes in real time? What if this system doesn’t require time-consuming third-party verification? This is exactly what Blockchain technology offers and technology is creeping into the financial industry.

Blockchain offers banks a decentralized ledger. All of a financial institution‘s transactions are stored in multiple controlled access computers creating a track that no one can edit or delete. When a financial institution adopts Blockchain, the technology supports most of the company’s workflows, including record keeping, equity management, debt management, and cybersecurity.

When did blockchain enter the financial sector?

Blockchain and Bitcoin (CRYPTO: BTC) arrived almost at the same time. Financial institutions weren’t ready to jump on the bandwagon, but they did later. In 2015, NASDAQ Led Blockchain Stock Trading using their platform, Linq. This first exchange allowed financial institutions to trust Blockchain and find ways to get into technology. Using the system, NASDAQ has opened the door for banks and financial institutions to use the ever-accessible Blockchain technology. The use of Blockchain will reduce the operational costs of banks by more than 25%.

After the NASDAQ, several banks adopted the Blockchain including:

  • JPMorgan Chase (NYSE: JPM) – Their platform, Quorum, is dedicated to Blockchain R&D. This system manages a range of transactions and services, including stock trading and smart contracts.
  • Goldman Sachs (CRYPTO: GS) – The Goldman Sachs ‘Circle is a project that explores the use cases of digital currency and Goldman Sachs’ Circle technology. Goldman Sachs is looking to reduce cryptocurrency volatility and get more people to accept digital currency.
  • Bank of America (NYSE: BAC) – The bank has created a blockchain-centric network that maintains all bank records and authenticates company and individual customer data. Only authorized persons have access to the general ledger and its recorded entries.

How do financial institutions use blockchain?

Cross-border transactions

The blockchain is in fact capable of disrupting the entire banking system that we are currently monitoring. While not fully implemented by banks around the world, some banks have started using Blockchain to transact and make payments across borders now. In the past, cross-border payments were the preserve of Swift and Western Union, but now banks can use Blockchain to send money anywhere in the world.

When using Blockchain, transfer costs represent between 2 and 3% of the total cost of transactions. This is much cheaper than what traditional third parties charge, between 5 and 20 percent of the total cost. Because Blockchain does not require third party verification, transactions are faster.

Big banks are already using Blockchain to conduct cross-border transactions. In 2016, for example, Westpac and NAB (two of Australia’s largest banks) have partnered with Ripple (a Blockchain Solution for Global Payments) to make international payments easy and affordable.

In 2015, the Commonwealth Bank of Australia planned to partner with Ripple (CRYPTO: XRP) to make global trading a reality. Later, in 2016, the The US Federal Reserve has formed a partnership with IBM (CRYPTO: IBM) to create a Blockchain-based digital payment system. There are so many other banks that have adopted Blockchain to facilitate cross-border transactions. These banks include Barclays Bank, BNP Paribas and Deutsche Bank.

Removal of third parties from the stock exchange and trading

The traditional process of an exchange is long with so many third parties involved. This process may take more than 2 business days. With Blockchain, unnecessary middlemen don’t need to be there as buyers and sellers can access trading from their computers anywhere in the world.

The use of Blockchain in exchanges can reduce information redundancy, thereby improving the flow of transactions. The blockchain manages transactions between smaller groups of traders and only records the final transaction. In 2017, NASDAQ has partnered with Citigroup to create a Chain Blockchain ledger. This ledger records all transactions and changes in ownership. When fully implemented this will be a game changer for the trading industry as it can reduce many procedures between trades and make the process much simpler and faster.

Digital identity verification

Identity verification involves many steps and takes some time. Before a transaction is made, the bank must perform face-to-face verification via online or over-the-counter video call, after-service login authentication, and authorization. Customers should take all of these steps for each financial service they use. However, with Blockchain, customers can reuse their identity on different platforms.

With Blockchain, once a user registers their identity, they don’t need to repeat the registration every time they need to use a new service as long as those services are powered by Blockchain. Users only need to make sure that they limit the private information they share with different services.

Several companies use Blockchain-based customer identification systems. Companies like Tradle and Cambridge Blockchain have created systems that help financial systems easily identify their customers. Tradle creates a system that stores verification data and gives the owner full control over the data. Another such company is ID2020, which creates digital identities for people without identity papers. ID2020 is supported by Microsoft, Accenture, and the Rockefeller Foundation.

Syndicated loans

Syndicated loans concern a group of banks lending to individuals. Due to the complex nature of the process, syndicated loans take up to 19 days when banks use traditional lending vehicles. These banks face the challenges of verifying customers. Banks must also operate within the framework of bank secrecy law and anti-money laundering laws. As such, the bank is responsible for detecting, preventing and reporting any activity related to money laundering.

With Blockchain, banks in a syndicate can share tasks like KYC guarantee, compliance, and then tie those tasks together into a single block. The advantage of this is that when a bank verifies customer compliance, the other banks verify other factors and they can all access the data in a single block. Banks can then exchange information, making it easier for them to process transactions. Banks will benefit from low costs to meet regulatory requirements while users will benefit from the fast lending process.

Accounting, auditing and bookkeeping

Accounting involves a lot of paperwork and digital developments in accounting are slow. Regulatory requirements state that financial institutions must confirm the integrity and validity of data. With Blockchain, banks and other financial institutions can streamline compliance procedures and reduce cases of double entry in accounting.

Companies no longer have to keep separate records for different recipes. Instead, they can enter all transaction records into a common ledger. All recordings are cryptographically protected and are broadcast. These records are transparent and cannot be edited. Financial institutions can also use Blockchain smart contracts to pay bills automatically.

Auditors can automatically audit financial statement data in a central location to save time spent going through documents. Auditors just need to generate a fingerprint and compare it with what’s on the Blockchain file. If the fingerprints are the same, the data has not been changed.

Easy access to credit reports

Through a blockchain-based system, businesses and individuals can receive quick loans based on their credit and repayment history. In the traditional method, credit ratings from credit scoring companies are not always accessible to small businesses. These traditional methods are also not ideal because they involve paying a company to access its sensitive data. Thanks to Blockchain, borrowers can make their reports accurate, transparent, secure and shareable.

The data owner must record their transaction history and use a private key to secure it. From there, the fully encrypted transaction will be stored outside the Blockchain at the same time the hash-encrypted data is stored inside along with the metadata and time stamps.

When someone needs to access the data, they submit criteria for credit history. Blockchain smart contracts will also identify and verify the data, then filter it and return the results. This saves the data buyer the costs and time that they would otherwise spend accessing the data.

Hedge funds

A hedge fund is a mutual fund or an investment partnership between a group of institutional investors and a fund manager. Hedge funds maximize returns for investors while minimizing losses. The number of hedge funds using cryptocurrencies has increased.

Decentralized cryptocurrency hedge fund platforms allow many crypto strategists and investors to participate. This is different from traditional hedge funds where a fund manager in a single entity controls the funds.

Other areas where blockchain is used:

Financial institutions are also applying Blockchain in crowdfunding, peer-to-peer transfers, and trade finance. More and more financial institutions are adopting Blockchain technology in their operations. However, some are still hesitant. The growing number of blockchain-based technologies will see financial institutions streamline their operations. Most of these technologies are disrupting the financial industry for good.

About the Author
Rithesh Raghavan, Director of Acode, a digital agency in India, and co-founder of Acoweb.