A blockchain is a decentralized, distributed and public digital ledger that is used to record transactions across many computers so that any involved record cannot be altered retroactively, without the alteration of all subsequent blocks.
The technology has disrupted different industries and sectors. Various features of a blockchain such as decentralization, immutability and transparency make it appealing for business sectors and domains all across the world.
Blockchain has the potential to solve a lot of problems because it is:
- Safe-decentralized hence not susceptible to hackers or corruption
- Secure- low operational costs makes blockchain reliable, promising and in demand solution for the industry. It reduces the involvement of too many people and manual processes which could increase the chances of errors and fraud.
- Decentralized- improves the security by creating multiple blocks which improves the security of financial institutions.
- Transparent: improves the transparency of transactions made through the financial institutions.
- Relatively cheaper-financial institutes perform the necessary function of keeping money safe and secure for people and therefore, the process in place require a lot of money. Mediators make the industry more expensive.
What are some of the applications of blockchain in the banking industry?
- Fraud reduction:More than 40% of the financial bodies and intermediaries including money transfer service providers as well as stock exchange are susceptible to heavy losses relating to economic crimes annually. The major reason for this is the centralized database system which is vulnerable and highly prone to cyber attacks as the single point of failure and can be exploited by hackers.Blockchain brings along a non-corruptible and secure technology operating a distributed database system hence no chances of a single point of failure.All blocks are linked to each other and due to this, if one block is breached all the other blocks on the blockchain immediately showcase the change.
- Renew your customer policies:Financial institutions and banks are strictly concerned about the increasing costs that they have to bear in order to comply with AML(anti-money laundering) and KYC (know your customer norms).These processes consume a lot of time and money that is $60 million to $500 million yearly. Banks need to upload the KYC data of a customer into a central registry which can be used for checking the information of a existing or new customer.With blockchain, independent verification of each client by one bank or financial institution would be accessible for other banks to use hence the KYC process does not need to be restarted again since most of the transactions in blockchain are in near real time. It reduces the duplication of efforts.
- Smart assets: transactions have to be recorded with a clear date and time stamp which at times could be challenging since supply chains all around the world involve a lot of many entities and components bought and sold continuously. Blockchain can hold these records of smart assets in digitized form and get them updated in real time. A smart asset system for the banks and financial institutes competing in the current times holds a lot of scope in the competition. A bank with a rich dataset can turn this data into valuable information for its clients with the aid of blockchain.
- Smart contracts: this is a self-executable piece of code that runs when certain conditions written on it are completed. They increase the speed and simplify complex process when used for financial transactions. It will also ensure the transfer of accurate information as the transaction will be approved only if all written conditions of a code are met. All terms are visible to all parties involved in the transactions hence chances of error at the time of execution are dropped drastically.
- Trade finance:Trade finance is considered one of the most useful applications of blockchain technology in the banking sector. All the involved parties such as a complex transaction can be on-boarded on a blockchain network and the information can be shared by exporters, importers, and banks on one common distributed ledger. Once certain specified conditions of the deal are met, the smart contracts will automatically execute themselves and the respective parties can view all the actions performed.
An example is an Israel-based start-up along with Barclays successfully executed a trade transaction that would normally take 7 to 10 days in just 4 hours using Blockchain technology. When compared to the existing infrastructure, the use of blockchain can reduce costs dramatically relating to licensing, ticketing as well as other overhead charges.
Challenges in adoption
The blockchain technology is not bounded by any international rules and regulations that place a standard to it. With the increasing need for interoperability among large industries like banks, the technology needs to be compatible with different systems and should hold the potential to get adopted by the masses. The integration of existing systems with a blockchain based model is a big challenge today as the current systems and processes cannot be entirely eliminated. If the actual adoption of blockchain allows multiple systems to work together smoothly, operational feasibility can be achieved.
Banks and financial institutions are the entities that are trusted by people for storing their funds. In order for blockchain to take their place, it is important to ensure that the data stored on the blockchain technology is kept securely and would not hamper the identity of any individual. As the transactions made on a public blockchain are publicly available, the need of exploring the potential of private blockchains for data-critical sectors is needed along with the resolution of issues like interoperability.
Private keys are the essential elements of a blockchain as they play a significant role in securing the data of an individual on the blockchain. However, a private key generated once has to be kept very securely as once it is misplaced or lost, there’s no way to get it back. Moreover, the encryption used to store data can be compromised by finding loopholes in the network which in turn, makes the blockchain susceptible to hacker attacks.
The blockchain network is secure and powerful as it is embedded with cryptography techniques. Cryptographic networks are complex to hack and thus, any kind of security breach in such networks would require a high amount of computational power in order to secure any hack. When a blockchain network is applied to any banking institution, it has to be secured with multiple security protocols. The network should be capable enough to restrict participating authorities to take control of the network only according to the access permission given to them. Depending upon the requirement, the blockchain involved in such systems or organisations could be permissioned or permissionless. People in an organisation need to be handled with different levels of access permissions in order to save the overall network from malicious insiders and cyber hackers.
Growth of existing databases is undeniable. The number of entries will keep on increasing as the number of people will continue to grow too. This poses a big challenge to the application of blockchain technology network. The network created through a blockchain should be able to handle the growing traffic while maintaining the speed of accessibility for the network participants. If the blockchain technology is applied to the current banking systems and institutions, it has to ensure the capacity of handling large volumes of data too.
Most of the current successfully running blockchain networks run on the concept of proof-of-work mechanism in which the network participants are rewarded based on how quickly they solve the equation to add a new block to the network. While this keeps the network working smoothly, it also increases the consumption of energy in enormous amounts in the form of computational work. This kind of computing power leaves massive carbon footprints which affect the environment. Before adopting Blockchain in an industry like banking, this issue needs to be resolved through alternate rewarding mechanisms.
If blockchain is applied in the banking sector, the need for international and national regulations around it will become mandatory. Currently, cryptocurrencies, the most popular application of blockchain, do not have any regulations around them which makes them susceptible to both profits and losses. However, if and when blockchain finds its place in the banking or finance sector, the regulations need to be in place so as to avoid chaos among people in case of any losses.