How Blockchain Will Change Traditional Finance

Since the beginning of organized trading, centralized financial systems have dominated the market, generally acting as a black box in the eyes of customers. Lack of transparency aside, they have conducted business in a monopolistic manner, building empires along the way by simply serving as middlemen.

But as the next iteration of the internet unfolds, these conventional economic and financial systems are being redesigned like never before. With this next generation internet, known as Web3, concepts such as blockchain, cryptocurrency and decentralization are rapidly entering the mainstream economy. This paradigm shift marks the emergence of a new trading arena that could fundamentally restructure our global financial system as we know it today, making it a more transparent, inclusive and safe place to trade. Below are five examples of how blockchain can improve and replace legacy financial systems that we have become so heavily dependent on today as a society.

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1. Trade finance

Trade finance is a fundamental part of the global financial system to reduce risk, expand credit and ensure that importers and exporters can engage in cross-border trade. Like most industries, trade finance suffers from logistical bottlenecks stemming from old, outdated manual documentation systems. For example, physical letters of credit are often still issued and transferred between different intermediaries to ensure payment.

Blockchain’s versatile nature can enable exceptional support for international trade transactions that would otherwise become prohibitively expensive due to trade and documentation processes. By storing and securing these processes on-chain (on the blockchain), businesses can digitally prove transaction details such as country of origin and product information in a reliable, cost-effective method. This will drastically increase trust between exporters and importers in the market due to exceptional transparency and data security. Furthermore, this can reduce the most significant risks that are present for trading partners today, including discrepancies in documentation and supervision around the flow of goods, among other uncertainties.

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2. Decentralized identity

To onboard customers, TradFi (traditional finance) institutions must verify their identity in a process called “Know Your Customer” or “KYC”, which requires customers to submit personal information such as passports, driver’s licenses and various supporting documents. TradFi systems take an average of 24 days on this KYC process, resulting in a terrible customer experience and reducing user retention. Banks store customer information on centralized systems, which makes this data vulnerable to various hacks.

Conversely, customers can upload their KYC information to a blockchain just once and authorize institutional access on an ongoing basis. The KYC process can be done in just a few seconds by storing KYC information on the chain as a “Decentralized Identity” or DID. In addition, financial institutions will no longer be responsible for the long-term security of customer data, which will reduce costs and liability.

3. Settlement infrastructure

Today, transferring funds around the world is a logistical nightmare. A simple wire transfer from one country to another must pass through a cumbersome set of intermediaries, ranging from custodian services to correspondent banks, before it reaches its destination. Each intermediary adds its costs, increases processing time and introduces a different security risk. On top of all this, the two account balances must be reconciled across a complex, fragmented financial system.

In contrast, institutions can leverage blockchain technology to act as a decentralized ledger to securely keep track of all transactions. This single source of truth can effectively eliminate the network of intermediaries used today by allowing the settlement of transactions directly on the chain – a 10x improvement over SWIFT. Furthermore, this could allow “atomic” transactions to be cleared and settled instantly with a confirmed payment, thereby eliminating the multi-day transfer time on international transfers and the 24-hour transfer time for domestic transfers imposed by financial service providers.

4. Modernized bookkeeping

TradFi institutions such as Mastercard, JP Morgan and Blackrock handle huge amounts of sensitive financial data every day that need to be transferred, reviewed and audited. Today it is expensive and difficult to maintain and reconcile ledgers with absolute certainty.

Instead, institutions can post this data to a private blockchain that will fundamentally improve internal processes by allowing the flow of information in a chronological, immutable and transparent manner. This can drastically improve security due to the traceability feature of the blockchain that can help detect fraud and develop a credible audit trail.

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5. Personal finances

Today, banks offer a paltry 0.21% APY on customers’ savings accounts. Meanwhile, behind the scenes, banks take a significant interest in customers’ money, keeping the lion’s share of the profits.

On the other hand, blockchain is based on creating a user-first market. When users instead place their savings into blockchain applications like Aave or Compound, they can earn 8-15% APY or more in some cases.

One of the main reasons people have bought cryptocurrency to date is to combat the rampant inflation that most countries are facing. Today, the global inflation average is a staggering 8.8% and almost certainly rising. With inflation far higher than the APY provided by the banks, people have little choice but to find better alternatives or watch their money sink.

For both reasons, the general public is likely to transfer more of their savings to crypto in the long term, reducing savings stored in banks and ultimately leading to a decline in TradFi revenues.

Conclusion

Many expect blockchain to completely replace the TradFi industry. Others believe blockchain technology will simply serve as a supplementary infrastructure to existing TradFi systems. Overall, it remains to be seen exactly how and to what extent the financial industry will embrace blockchain technology. However, one thing is certain; blockchain will usher in a new era of transparency, fairness and security for finance.