Use Cases

Banking on Blockchain | Why Financial Institutions Are Betting Big?

Wednesday, September 4, 2019

Almost every week now, a fresh story breaks, detailing another financial organization’s jump into blockchain. Bank of America owns over 80 blockchain patents and patent applications. JP Morgan is creating its own cryptocurrency. And HSBC has already processed over $250 billion of forex trades on its in-house blockchain platform.

The blockchain technology market is expected to grow at a 70 percent CAGR over the next five years with financial services leading the charge. | Source: Grand View Research


What’s drawing these existing businesses to blockchain and digital currencies? As with most companies, the short answer is profits. But, when you dig deeper, it becomes clear that these financial institutions see the immense value of blockchain technology. And they don’t envision a future without it.

Let’s break down the three most substantial reasons why any financial organization should have blockchain technology in their arsenal.

Blockchains Create More Efficient Banks 

You’ve probably heard it before, but it’s worth repeating. Public blockchains are trustless, immutable, and distributed - three attributes that bring a host of benefits to the banking industry. 

However, most blockchain implementations in the financial sector today rely on a permissioned blockchain, not a public one. Therefore, only certain entities (i.e., banks) have access to the ledger. For the sake of brevity, though, let’s not get into the intricacies. Just know that a permissioned blockchain still provides the benefits we’ve described above, albeit at a slightly less impressive level. They effectively transform existing financial software by eliminating or consolidating disparate functions. 

Transactions utilizing blockchain technology are peer-to-peer, enabling trustless execution without the need for an intermediary. Banks can automatically configure transaction triggers, such as failing credit checks and overdue payments, with significantly less overhead. There’s no counterparty risk, and with instantaneous clearances, there’s little to no settlement risk as well.


Blockchains facilitate peer-to-peer communication between banks.


The benefits of blockchain bank transactions don’t stop there, either. In addition to diminishing the risk of errors typically found in siloed databases, migrating transactions to a shared ledger (i.e., blockchain) drastically reduces reconciliation time and costs.

Earlier this year, banking giant HSBC, connected its blockchain network to a Middle Eastern retailer to facilitate transactions for a supply chain. The company reported a 40 percent drop (12 days less) in transaction times, leading to substantial cost savings.

A blockchain’s immutability brings another set of benefits. Most importantly, it enables financial institutions to audit their records confidently without fear of manipulation. It’s nearly impossible to alter a blockchain record without the network knowing.

The distribution of a blockchain’s ledger provides yet another layer of security and reliability. Because all counterparties and stakeholders hold a copy of the ledger, a hacker has no single point of entry he/she can exploit. And, if the system of one counterparty goes offline, the other stakeholders still maintain the banking records.

Smart Contracts Improve the Loan Process

Current bank loan processes are lengthy, cumbersome, and costly. Like transactions, a traditional loan typically requires several expensive intermediaries, including underwriters, auditors, and trustees. Communication between each of these entities takes time, and they each charge fees along the way. 

Utilizing smart contracts (effectively digital contracts) to move loans to a blockchain produces advantages at every step of the loan process. Here’s what a simple loan on a blockchain looks like:

  1. A borrower establishes their identity and applies for a loan from a bank.
  2. The bank originates the loan on a distributed ledger (blockchain) and now owns that loan on the blockchain.  
  3. Smart contracts establish loan terms such as the interest rate, payment penalties, and length of the loan.
  4. Now, the bank likely wants to free up some capital. So it aggregates similar loans into an MBS (Mortgage-Backed Security) directly on the blockchain and sells it off to investors. 
  5. Finally, the bank can exchange and settle those loans directly on the blockchain without intermediaries.

 

Notice the lack of intermediaries. Generating loans via blockchain simplifies a traditionally complicated process. | Source: Provenance


Traditionally, the aggregation and securitization of loans requires coordination between multiple parties and takes time. By originating these activities on a blockchain, the process requires less, or even no, middlemen and is accomplished much faster

Provenance, a financial services blockchain, estimates that banks that move loans to a blockchain network will see cost savings of 150 to 200 basis points. Currently, home equity loans issued on Provenance’s blockchain take 5 days instead of the typical 45 days with other lenders. From origination to settlement, blockchain is already transforming the loan process. 

The Liquidity Advantage

Looking further into our example, there’s another unique benefit to blockchain loans and other securitized assets. Blockchain securitization creates liquidity in a traditionally illiquid market. 

Because the loan is issued on a blockchain, two banks transacting that particular loan have real-time access to all the loan metadata. They don’t have to wait for reconciliation reports from a third-party to determine the status of their loan. Hence, not only is liquidity improved due to direct transactions, but also because of the bank’s improved visibility into their assets. 

This liquidity opens up an entirely different cash flow option for financial institutions of all sizes.

Stablecoins Improve Payments and Remittances

The prices of many cryptocurrencies fluctuate wildly, making blockchain integration for bank payments and remittances challenging. However, several financial institutions are discovering ways to receive the benefits of blockchain technology, without the volatility of cryptocurrency that often accompanies it, through the utilization of stablecoins.

Simply, stablecoins are cryptocurrencies that are pegged to traditional assets, like U.S. dollars. Because stablecoins implement blockchain technology, you gain many of the benefits we’ve outlined so far when using them. 

For financial institutions, stablecoins not only provide more efficient processes, but they also open up entirely new markets. Fewer costs enable banks to provide services to the previously unbanked, encompassing 1.7 billion people worldwide.


Stablecoins are rapidly becoming the preferred method of peer-to-peer payments. | Source: TradeBlock


For the first time in history, stablecoin transaction volume has surpassed that of Venmo, one of the leading peer-to-peer payment apps. What’s more impressive, in 2019 so far, people transacting with stablecoins have seen significantly fewer fees than those working with Venmo. Stablecoin users paid less than $900,000 in fees through the second quarter, whereas Venmo is estimated to have charged around $150 million in that same time.

Once again, some financial institutions are already ahead of the game. IBM has produced a blockchain-based financial rail system, Blockchain World Wire, for cross-border stablecoin payments. Additionally, the People’s Bank of China is on the cusp of launching a stablecoin itself as a complementary currency to the yuan.

The Inevitable Future of Blockchain Banking

As outlined in this article, the advantages of blockchain for banking can be summarized as follows:

  1. Reduction of reconciliation costs from improved auditability. 
  2. Fast settlement time and less counterparty risk. 
  3. Real-time visibility into transactions, which improves liquidity.  
  4. Overall efficiency improvements that reduce the reliance on expensive middlemen. 

Whether you’re a 10-person FinTech startup or 10,000-employee banking enterprise, integrating blockchain into your business processes should be a priority. As traditional organizations continue to dive into blockchain technology, it is hard to refute that digital assets won’t play an integral role. As a financial institution, it’s an area in which you can’t afford to get left behind.

Interested in learning more? Subscribe to our newsletter and stay up-to-date with all the blockchain innovations occurring in the banking industry. Our team at Abstrakt is building technology for this financial future. 



Almost every week now, a fresh story breaks, detailing another financial organization’s jump into blockchain. Bank of America owns over 80 blockchain patents and patent applications. JP Morgan is creating its own cryptocurrency. And HSBC has already processed over $250 billion of forex trades on its in-house blockchain platform.

The blockchain technology market is expected to grow at a 70 percent CAGR over the next five years with financial services leading the charge. | Source: Grand View Research


What’s drawing these existing businesses to blockchain and digital currencies? As with most companies, the short answer is profits. But, when you dig deeper, it becomes clear that these financial institutions see the immense value of blockchain technology. And they don’t envision a future without it.

Let’s break down the three most substantial reasons why any financial organization should have blockchain technology in their arsenal.

Blockchains Create More Efficient Banks 

You’ve probably heard it before, but it’s worth repeating. Public blockchains are trustless, immutable, and distributed - three attributes that bring a host of benefits to the banking industry. 

However, most blockchain implementations in the financial sector today rely on a permissioned blockchain, not a public one. Therefore, only certain entities (i.e., banks) have access to the ledger. For the sake of brevity, though, let’s not get into the intricacies. Just know that a permissioned blockchain still provides the benefits we’ve described above, albeit at a slightly less impressive level. They effectively transform existing financial software by eliminating or consolidating disparate functions. 

Transactions utilizing blockchain technology are peer-to-peer, enabling trustless execution without the need for an intermediary. Banks can automatically configure transaction triggers, such as failing credit checks and overdue payments, with significantly less overhead. There’s no counterparty risk, and with instantaneous clearances, there’s little to no settlement risk as well.


Blockchains facilitate peer-to-peer communication between banks.


The benefits of blockchain bank transactions don’t stop there, either. In addition to diminishing the risk of errors typically found in siloed databases, migrating transactions to a shared ledger (i.e., blockchain) drastically reduces reconciliation time and costs.

Earlier this year, banking giant HSBC, connected its blockchain network to a Middle Eastern retailer to facilitate transactions for a supply chain. The company reported a 40 percent drop (12 days less) in transaction times, leading to substantial cost savings.

A blockchain’s immutability brings another set of benefits. Most importantly, it enables financial institutions to audit their records confidently without fear of manipulation. It’s nearly impossible to alter a blockchain record without the network knowing.

The distribution of a blockchain’s ledger provides yet another layer of security and reliability. Because all counterparties and stakeholders hold a copy of the ledger, a hacker has no single point of entry he/she can exploit. And, if the system of one counterparty goes offline, the other stakeholders still maintain the banking records.

Smart Contracts Improve the Loan Process

Current bank loan processes are lengthy, cumbersome, and costly. Like transactions, a traditional loan typically requires several expensive intermediaries, including underwriters, auditors, and trustees. Communication between each of these entities takes time, and they each charge fees along the way. 

Utilizing smart contracts (effectively digital contracts) to move loans to a blockchain produces advantages at every step of the loan process. Here’s what a simple loan on a blockchain looks like:

  1. A borrower establishes their identity and applies for a loan from a bank.
  2. The bank originates the loan on a distributed ledger (blockchain) and now owns that loan on the blockchain.  
  3. Smart contracts establish loan terms such as the interest rate, payment penalties, and length of the loan.
  4. Now, the bank likely wants to free up some capital. So it aggregates similar loans into an MBS (Mortgage-Backed Security) directly on the blockchain and sells it off to investors. 
  5. Finally, the bank can exchange and settle those loans directly on the blockchain without intermediaries.

 

Notice the lack of intermediaries. Generating loans via blockchain simplifies a traditionally complicated process. | Source: Provenance


Traditionally, the aggregation and securitization of loans requires coordination between multiple parties and takes time. By originating these activities on a blockchain, the process requires less, or even no, middlemen and is accomplished much faster

Provenance, a financial services blockchain, estimates that banks that move loans to a blockchain network will see cost savings of 150 to 200 basis points. Currently, home equity loans issued on Provenance’s blockchain take 5 days instead of the typical 45 days with other lenders. From origination to settlement, blockchain is already transforming the loan process. 

The Liquidity Advantage

Looking further into our example, there’s another unique benefit to blockchain loans and other securitized assets. Blockchain securitization creates liquidity in a traditionally illiquid market. 

Because the loan is issued on a blockchain, two banks transacting that particular loan have real-time access to all the loan metadata. They don’t have to wait for reconciliation reports from a third-party to determine the status of their loan. Hence, not only is liquidity improved due to direct transactions, but also because of the bank’s improved visibility into their assets. 

This liquidity opens up an entirely different cash flow option for financial institutions of all sizes.

Stablecoins Improve Payments and Remittances

The prices of many cryptocurrencies fluctuate wildly, making blockchain integration for bank payments and remittances challenging. However, several financial institutions are discovering ways to receive the benefits of blockchain technology, without the volatility of cryptocurrency that often accompanies it, through the utilization of stablecoins.

Simply, stablecoins are cryptocurrencies that are pegged to traditional assets, like U.S. dollars. Because stablecoins implement blockchain technology, you gain many of the benefits we’ve outlined so far when using them. 

For financial institutions, stablecoins not only provide more efficient processes, but they also open up entirely new markets. Fewer costs enable banks to provide services to the previously unbanked, encompassing 1.7 billion people worldwide.


Stablecoins are rapidly becoming the preferred method of peer-to-peer payments. | Source: TradeBlock


For the first time in history, stablecoin transaction volume has surpassed that of Venmo, one of the leading peer-to-peer payment apps. What’s more impressive, in 2019 so far, people transacting with stablecoins have seen significantly fewer fees than those working with Venmo. Stablecoin users paid less than $900,000 in fees through the second quarter, whereas Venmo is estimated to have charged around $150 million in that same time.

Once again, some financial institutions are already ahead of the game. IBM has produced a blockchain-based financial rail system, Blockchain World Wire, for cross-border stablecoin payments. Additionally, the People’s Bank of China is on the cusp of launching a stablecoin itself as a complementary currency to the yuan.

The Inevitable Future of Blockchain Banking

As outlined in this article, the advantages of blockchain for banking can be summarized as follows:

  1. Reduction of reconciliation costs from improved auditability. 
  2. Fast settlement time and less counterparty risk. 
  3. Real-time visibility into transactions, which improves liquidity.  
  4. Overall efficiency improvements that reduce the reliance on expensive middlemen. 

Whether you’re a 10-person FinTech startup or 10,000-employee banking enterprise, integrating blockchain into your business processes should be a priority. As traditional organizations continue to dive into blockchain technology, it is hard to refute that digital assets won’t play an integral role. As a financial institution, it’s an area in which you can’t afford to get left behind.

Interested in learning more? Subscribe to our newsletter and stay up-to-date with all the blockchain innovations occurring in the banking industry. Our team at Abstrakt is building technology for this financial future. 



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