Blockchain in Finance

The global financial system moves trillions of dollars a day and serves billions of people. But the problems in this system are multitudinous - Adding cost through fees and delays, creating friction through redundant and heavy paperwork, and opening up opportunities for fraud and crime. Regulatory costs continue to hike and remain a top concern for bankers. This all adds cost, with consumers ultimately bearing the burden.

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Why is our financial system so incompetent?

First, it hasn’t evolved with the digital age- it is still largely paper-based. Second, it’s centralized, which makes it resistant to change and vulnerable to systems failures and attacks. Third, it’s exclusionary, denying billions of people access to basic financial tools.

But the solution to this innovation standstill has emerged: blockchain.

What is Blockchain?

A Blockchain is an immutable and distributed ledger. Using Blockchain, participants can transfer value in a way that is as simple and similar to sending an SMS but entirely peer to peer & without an intermediating body.

The first implementation of blockchain was in Bitcoin, where every “node” in the network has a copy of the ledger, and “miners” solve a cryptographic puzzle to arrive at a single source of truth.

A private Blockchain is the similar underlying technology applied to businesses or in a private setting.

Blockchain technology is revolutionary because digital records are maintained on a distributed ledger system. It is the most significant development after the ‘Internet’.

-A Blockchain database cannot be tampered or altered without the consent of every single participant in the distributed network.

-It facilitates highly secure management & sharing of records,
provides superior trust, transparency, and traceability.

-Blockchain is already being enthusiastically adopted across private sectors and by multiple governments around the world.

Why Blockchain is suitable for Finance

  • Trust: Banks and financial institutions are middlemen to confirm and validate transactions. Blockchain can disrupt banks by bringing about “automated trust”
  • Smart contracts: The concept of Blockchain smart contracts enables automation of outdated bank software while maintaining security of all transactions. 
  • Data security: Secure data transfer such as financial statements, user KYCs can be done through the blockchain in near real time. 
  • Single source of truth: The blockchain acts as a shared, secure database that serves as a single source of truth to all transactions. It also removes the need to trust third-party data sources. This makes transactions cheaper and near instant.

Applications

Cross-border Payments

Existing situation: Sending money overseas is always a big problem that businesses and individuals face. Cross-border payments are a vital revenue stream for banks. In 2015, the payments constituted 20 percent of the entire transactions in the payments industry, generating 50 percent of transaction revenues. Moreover, the money transfer requires multiple approvals and takes up to 2 days.

With Blockchain:  Using the Blockchain, all data can be shared with parties in real time and securely, hence reducing operational costs. With blockchain smart contracts, approvals can be instant, and data transfer time is reduced significantly. Hence, this disrupts the existing system and automates, reduces costs and time for cross border payments.

Stock trading, clearing, settlement

Existing system (Expensive, Insecure, delayed) : Trading stocks or derivatives on the stock market is always followed by clearing and settlement of the trade. Clearing houses handle trillions of dollars of assets daily. This process takes 2 days to occur, hence you actually get ownership of the asset in 2 days after the trade.

With Blockchain (Instant, cheap, and secure): On a Blockchain platform, this transaction can happen in near real time, with two scenarios: either replacing clearing and settlement houses, or bringing them onto the platform and having them execute smart contracts that automates their processes. The blockchain makes the transaction faster, cheaper, and more secure than the earlier centralized systems approach.

Blockchain Participants Ecosystem

 

  • Permission-based/Closed Network Participants that act as miners.
  • Clearing Ecosystem members themselves act as participants
  • Some of them are entitles to execute Smart contracts
  • Some of them are entitled to carry out transactions and maintain Ledgers (Blockchain.

Blockchain in Trade Finance

Existing situation: Trade finance requires the coordination of banks, vendors, customers, port authorities, customs for various data sets. Data flows take time, effort, and are expensive; Trust between overseas parties requires LoCs to be taken.

With Blockchain: Enable secure data sharing in real time, and hence reduce the time, effort, and cost involved in executing a trade finance deal.

Blockchain and Procurement

Blockchain smart contracts: Legal contracts with different clauses, vendor to client contracts, PO contracts, all can be put on smart contracts and hence saving costs and time.

PO structuring: Order validation, invoice processing, reconciliation from request to receipt can be done over a blockchain.

Real time settlement: Settling contracts, payments, goods receivables vs invoice and payment tracking.

Integration with ERPs: These solutions aren’t siloed, but sit on top of an ERP solution that then communicates with libraries written on the blockchain smart contracts.

Examples of Blockchain in finance

  • JP Morgan Quorum: JP Morgan has developed an enterprise grade blockchain platform that mainly serves the finance industry for enabling the writing of secure smart contracts for building the next generation banking applications and not outdated software.
  • Ripple: Ripple is a Blockchain platform and a cryptocurrency (both being separate) which is now competing with SWIFT to enable near real time cross border payments through it’s platform. It uses Blockchain to sync information and data transfer securely and in near real time, hence reducing time and effort.
  • Debt structuring: Banks in India are coming together to build a private blockchain platform that enables secure sharing of debt data and structuring loans to SMEs. CBA in Australia has been picked by the World Bank to build a bond trading platform on Blockchain.
  • Stock trading: Blockchain is being explored by NASDAQ and the Japan exchange group to enable a blockchain based trading platform.
  • Miscellaneous use cases: Outside of mainstream use cases, blockchain can be used to sync real time ATM machine withdrawals and deposits, secure data transfer within banks, sharing of KYC information across vendors.

Blockchain consortia

Blockchain consortium or federated blockchain is a type of blockchain network where multiple organizations maintain the system. However, it’s permissioned and not public. You would find it more similar to private ones. 

You could think of it as a platform where multiple companies come together and share their information if needed. It’s a collaborative environment, which is a highly beneficial blockchain industry consortium. Some benefits of Blockchain Consortium are- lower costs, low transaction fees, and a safe, regulatory environment.

Hyperledger is the most well-known private blockchain consortium right now. It is maintained by the Linux foundation, with the major contributor being IBM. 

Enterprise Ethereum Alliance, BankChain, R3, B3i, IBM Food Trust are a few other Blockchain Consortia.

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