Invented in 2008, the blockchain is the record-keeping tech behind the cryptocurrency Bitcoin. In the years since then, it has proven its range and has demonstrated the massive advantages it brings to different fields of business.
Despite the tech being complex, Blockchain has become a widely trusted concept that organisations and individuals globally have been using without hesitation for three primary reasons:
1. Decentralisation: A blockchain stores data across a peer-to-peer network, ruling out many disadvantages and threats a centralised database poses.
2. Transparency and Security: Anyone can view the contents of a blockchain, and users can connect their devices to the blockchain network as nodes. The content, however, is encrypted using cryptographic techniques and therefore immutable.
3. Inalterability: The blockchain ensures all data is secured; new blocks are always stored chronologically, at the end of the chain. Once a block gets added, it becomes extremely difficult to alter or tweak the information stored, as each block has an aforementioned unique hash.
As of right now, some issues prevent some industries and regions from making full use of the opportunities that arise from the Blockchain. However, it’s undeniable that Blockchain can and will transform financial services in particular. The financial markets have always been plagued by several shortcomings leading to significant inefficiencies. Enter Blockchain, that’s efficiently facilitating fund transfers, tokenising assets, and inventing whole new industries, putting the finance industry in an advantageous position.
So, what are some advanced features the Blockchain system brings to the table?
- Smart Contracts: Smart contracts are programs stored on a blockchain that automatically execute when certain predetermined terms and conditions are met. This particular concept has proven to be extremely important in the financial markets. As transactions get approved only when all the conditions are met (such as having a valid balance, having the right authorization, etc), and the terms are visible to all participants, the chances of fraud or mistakes is near-zero.
- Less Paperwork and Smart Cataloguing of Data: For complex paperwork that’s challenging to keep track of, the blockchain provides a hassle-free and much more beneficial way to keep up.
- Quick Transactions and Consumer Satisfaction: When you introduce Blockchain to the finance systems, all counterparties can have their transactions processed within as little time as it takes to add a new block to the chain (in Bitcoin’s case, for example, that’s approximately 10 minutes or lower), regardless of the hour or whether it’s a holiday or workday.
- Fraud Reaction and Security: Since Blockchain uses a distributed database system involving all concerned parties and each block has a unique hash incredibly hard to modify, the chances of breaches in security and cyber crimes are reduced by a proportion unheard of in any other solution. Of course, this means that inaccurate data in a blockchain would also remain immutable.
- Verification of clients: Right now, KYC systems used in most sectors store the data in central storage to pull it up when needed. But with the use of blockchain, a client’s data verified by one financial institution would be available for other organisations to see, eliminating the chances of identity theft and making it easier for all other organizations too.
Let’s take a closer look at what different sectors of the financial markets stand to gain from the use of Blockchain technology.
What changes does Blockchain bring to the stock markets, and capital markets in general?
- Improved Solvency: Blockchain-based digital assets allow the division of previously illiquid assets and the reduction of cost barriers, so there’s a broader opportunity for liquidity and investments, and it’s easier for both issuers and investors to participate.
Take real estate tokenisation, which involves splitting real estate investments into fractions for ownership. Now, non-institutional and underprivileged investors can afford it.
- Modified Financial Instruments: The tech allows original asset classes to be created for capital allocation, with rules that must be followed for the completion of it. Bitcoin, Ethereum, are all classic examples of original asset classes — they don’t represent any underlying asset or aren’t derived from any other asset.
- Easy and Secure Post-Trade Settlement: Applying blockchain can reduce the risks for counterparties post-trade and offer a much faster settlement of securities and liquidity improvements, with more transparency.
- No Need for Intermediaries and Third-Party Regulators: Since smart contracts come with rules and are executed only when all involved parties comply, the need for intermediaries or third party regulators decreases significantly.
- Transparency: The distributed ledger system of the blockchain ensures all data is updated in real-time, allowing all participants to monitor market activity. Of course, if data is stored off-chain with updates at periodic intervals, access to data may be delayed by those amounts.
- Reduced Risks: The quick and transparent settlement of funds reduces the chances of errors or risks and ensures all ends of the counterparty receive their purchase price and securities as fast as possible.
- Reduced Costs: As the expenses of transactions, allocation of funds and accounting, etc. decrease drastically, Blockchain allows for lower costs across the markets.
What changes does Blockchain bring to asset management?
- Access to the Market on a Massive Scale: The global reach of the blockchain, reduced insurance costs, and fractional ownership ensures availability of assets to larger investor pools.
- More Secondary Market Opportunities: Easy links between digital assets and associated networks help expand the scope for secondary market opportunities and for liquidity.
- Instant and Efficient Process: Smart contracts allow the entire asset management process to flow smoothly and save both time and additional expenses of transactions.
What changes does the blockchain bring to Decentralized Finance (DeFi)?
Decentralized Finance is a whole new movement that seeks to take the power of the blockchain and apply it to conventional financial models. Everything, from investments to lending, credit, assets, and more can move to models without a central authority, thanks to blockchain technology.
- Programmability and Competency: The blockchain allows automated execution of smart contracts and the creation of financial instruments and assets as needed, easing the entire process and improving liquidity and growth potential.
- The Know Your Transaction (KYT) Process: Blockchain-based DeFi processes lend organisations the power to analyse transactions, verify details, and essentially ensure compliance and prevent any frauds.
- Monitored Token Networks: The pre-programmable token networks make sure the tokens are only accessible to the users.
What changes does Blockchain bring to trade finance?
- Digitised and Accelerated Process: Normal, paper-based transactions often take a long time to come through, especially in international trade (up to 120 days). Blockchain can digitise and fast track the entire process and allow multiple stakeholders to communicate while maintaining total security.
- Registry of High-Value Items and Warranties: The superior data-keeping capabilities of blockchains enable us to track an underwritten asset’s origin, ownership, and claims and update data in real-time in an error-free way.
- Automated Parametric Insurance: Smart contract code allows processes to complete without human intervention.
- The Transparency in the Distribution of Insurance: The system aligns all decisions and actions of multiple parties at once and makes paying premiums a fast and relatively inexpensive process.
- Reinsurance Made Easier: The system allows all involved parties (primary insurers, reinsurers, regulators, brokers) to see all relevant data for themselves and automates a large part of the process.
- Improved P2P (Peer-to-Peer) Insurance: Blockchain can either improve an existing P2P model by integrating smart contracts into the system and automating a huge part of it or introduce new P2P models where the policyholders’ choices are arranged and incentivised with the help of tokens and the staking of tokens.
What changes does Blockchain bring to banking?
- Easy, Safe Sharing of Customer’s Data: The tech can record customer data (KYC) and make it available for other banks in the network to verify when necessary, reducing operational risks.
- Automated, Quick Processing of Funds: When it comes to the transfer of funds, the blockchain’s advantages have forced financial industries — including many banks, to reduce the cost and time of funds transfers.
Blockchain sure has its shortcomings that markets should be aware of, like:
- The fact that all data on transactions and participants can be available for everyone to see doesn’t leave much scope for privacy (private blockchain for enterprises and even retail markets do exist but don’t see much adoption),
- Increased traffic, as more parties join the network does cause scalability challenges. Bitcoin has been known to face issues in transaction speeds and fees as it began to take the load of more users joining its networks.
However, the ever-growing demand for cryptocurrencies is, fortunately, making financial markets reconsider the blockchain’s worth. And as everything else going digital, financial services are keeping up with the flow. It does make sense to switch to a network that can provide fast services with almost zero chances of failure at a significantly lower rate.