BLOCKCHAIN – for FI
Blockchain is one of the more exciting and more misunderstood emerging technologies. Blockchain is a distributed database that is used to maintain a continuously growing list of records. It essentially offers a decentralized ledger of all transactions across network. When a transaction occurs, everyone on the network knows about it.
Nearly every global bank is experimenting with the blockchain technology as they try to figure out the cost savings and operational efficiencies it promises to deliver. Banks are exploring the technology in number of ways, including through partnership with fintechs, membership in global association, and via the building of their own in-house solutions.
India’s largest banks are building a consortium to test an interbank blockchain platform, putting the country at the cutting edge of adoption of the technology that forms the backbone of cryptocurrency Bitcoin. Unlike existing technology systems in which a bank maintains its own database, a blockchain system would allow banks to maintain a copy of the transactions. As they occur, the system would update all the records simultaneously, removing the need to reconcile transactions between different banks.
The fundamental idea of blockchain is to provide transparent and trusted dealings between trustless participants without the need for a centralized monitoring/regulating authority or an intermediary. To understand the relevance of blockchain in the banking sector, firstly there is need to understand what blockchain actually is.
By allowing digital information to be distributed but not copied, blockchain technology created a backbone of a new kind of internet. Blockchain can be defined as an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.
Blockchain is a distributed database. Information held on a blockchain exists as a shared and as continually reconciled database. The blockchain data is not stored in a single location, meaning the records it keeps are truly public and easily verifiable. No centralized version of this information exists for hacker to corrupt. Hosted by millions of computer simultaneously, its data is accessible to anyone on internet.
Blockchain technology is like an internet in that it has an in-built robustness. By storing blocks of information that are identical across its network, blockchain cannot be controlled by any single entity and has no single point of failure.
The Blockchain network lives in a state of consensus, one that automatically checks with itself every ten minutes. A kind of a self-auditing ecosystem of a digital value, the network reconciles every transaction that happens in ten-minute intervals. Each group of this transaction refers to as a “Block”. Two important results that come with this are Transparency – data is embedded within the network as a whole and it cannot be corrupted – altering any unit of information on the blockchain would mean using a huge amount of computing power to override the entire network.
Relevance to Financial Services Industry
The distributed ledgers that underpin the blockchain technology have many transformative applications within the financial services industry.
- Easier to onboard customers
Know your Customer (KYC) and Anti-Money Laundering (AML) is a major obstacle for the financially excluded. Today, KYC is an expensive, time-consuming and high-friction process that has to be duplicated every time a customer enters a new financial relationship with a service provider. Creating a centralized network-defined registry can make the entire process of establishing and validating identity simpler, faster and cheaper. The need for such a solution can be seen in the overwhelming reception for SWIFT’s centralized KYC repository, which has already been embraced by more than 2,000 financial institutions in over 200 countries and territories across the world. At the same time, startups, like Tradle and Polycoin, are also working on blockchain-based compliance solutions that will streamline KYC processes and even extend to AML procedures.
Blockchain can power a KYC shared ledger that multiple banks in a region can use. With this system, only one bank needs to onboard the customer. Banks thus, lower their compliance costs and reduce all the friction in onboarding new customers. The rapid expansion of reporting and compliance regulations also opens up the possibility of a comprehensive blockchain-based regulatory solution that automates and streamlines the exchange and consumption of information between financial service institutions and regulators.
- Easier to transfer money
Now that customers have been onboarded, a blockchain based payment rail allows for the smooth transfer of electronic money. By building blockchain payment rail and connecting it to the mobile phone, customers can easily send funds across borders quickly and cheaply. No more standing in line for hours at money exchanges. People will be able to send money right from home and still receive a low rate. This is possible because a blockchain based system can be launched for a fraction of the cost of legacy system.
- Create better insurance products for a changing market
Several of the biggest challenges in insurance today are legacy systems, and processes for issuing policies and managing claims. In India, insurance adoption is less than 5%, to sell to that market of 1.3 billion people; insurers will have to lower their costs. A blockchain based insurance platform will allow insurance policies to be issued on to the blockchain and be transparent for all. Smart contract system will allow for the real-time claims management, so the customer does not have to spend time gathering the materials, making copies, mailing them in, and then waiting three to six months for the payout.
Lower cost foundation has been built; insurers can divide the policies in different categories- short term policies or usage-based insurance at a low cost and still make a profit. The price of things like personal injury insurance, hospital stays and bike insurance will all come down.
Much has been made of the potential for blockchain technologies to open up new ways for business and society. Leapfrogging — using the lack of existing infrastructure as an opportunity to adopt the most advanced methods — has been a highly effective strategy for developing nations over the last few decades. The most visible example of leapfrogging today is in nations like Kenya and South Africa, which have rolled out near-universal telephone access using 3G networks instead of laying down copper cables, and provided internet access by smartphone rather than with desktop PCs.
One of today’s most celebrated examples of leapfrogging is the M-Pesa mobile payment system in Kenya and Tanzania, which lets people bank in their national currency using only their phones, leapfrogging traditional banking practices and creating a mobile banking revolution. This in turn boosted development by allowing relatively poor farmers to reliably send and receive payments at affordable rates, fostering economic growth by lowering transaction costs. Research funded by the Bill & Melinda Gates Foundation has found that mobile money services have lifted 194,000 Kenyans out of poverty, with a particularly large impact in female-headed households.
India’s Aadhaar biometric ID card system is a great example. It secures transactions by “fixing” people’s identities, thus facilitating trade. The system assigns a unique 12-digit number to all Indian residents, which is stored in a central database along with biometrics such as fingerprints and iris scans. If someone wants to perform a transaction, such as opening a bank account, they present the card and have their fingerprint or iris scanned. This helps to prove their identity, cutting down on fraud and creating market efficiencies. The system currently serves a billion people. This is by far the largest and most comprehensive adoption of biometrics technology by any government in the world; transactional security is a priority in India. Aadhaar can be used to sign up for new mobile phone service, a process that still requires paper ID in many countries and is frequently subject to fraud.
Transactional security extends beyond biometrics, which only secures the last link in a financial transaction; blockchain could secure the entire transactional process. For developing economies, this security is vital for ordinary people who want to trade. Even better, blockchains can spur local high-tech innovation.
Blockchains can also address the most pressing needs of developing-world governments: the modernization and digitization of government functions. The current world leader in blockchain adoption is Dubai, and there is much in Dubai’s approach that could be adopted by developing world nations. The Dubai Blockchain Strategy envisions moving all government documents — more than 100 million documents per year — onto a blockchain by 2020, creating a new platform for innovation and huge cost savings.
The approach Dubai is taking to blockchain adoption, with the central government providing services on the blockchain as a way to strengthen innovation could be an example for developing countries looking to kick their economic growth into a higher gear by establishing standards of integrity in fundamental systems of trade.
Global trade, with local regulation facilitated by technology, works because technology makes the transaction costs manageable. Blockchains default to being open data, which would allow governments and companies to rapidly learn from, test, and evolve new, more efficient best practices for conducting and facilitating trade. In such a future, the transaction costs of economic activity are drastically reduced.
If M-Pesa and similar services could lift tens of thousands of people out of poverty, imagine what a full-scale transformation built on blockchain might do. It could create hyper efficient government with provably trustworthy infrastructure; new markets and opportunities for citizens to access the formal economy on equal terms; efficiencies of operations that lower prices and improve the quality of goods for all consumers; and a kick start to high-tech innovation around the world. All the goods flowing in and out of developing world countries could be tagged. For example, safe medication, protected from fraud, could flow in, while properly harvested wood and safely manufactured goods flow out.
Nations that already have somewhat efficient systems might lack the incentive to adopt blockchain technologies at this time, but the rest of the world may well see an opportunity to innovate on internet time. If they do, the many ways they might leapfrog developed nations are limited only by the imagination of billions of people whose first real access to governance and trade infrastructure will look entirely 21st-century. Those are big dreams, and we should not be surprised if some of the world’s next leading megabrands and global platforms are born far away from the traditional centers of technology development. The future is global, and so is blockchain innovation.
By Humneet KAUR