THE NEXT BIG THING – NJBIZ

When people think of “blockchain” they often associate it with cryptocurrency. But in fact, crypto is only one facet of blockchain, which is designed to provide reliable and fast financial and other transactions. As such, blockchain is increasingly important to banks, according to some knowledgeable professionals.

Newbold

Blockchain is already impacting the banking industry, according to CSG Law member Sam Newbold. “It has the potential to disrupt consumer, commercial and investment banking, and banks are still coming to grips with the scope of blockchain,” he noted.

To their credit, the banks are not sticking their heads in the sand, he added. “Instead, financial institutions are investing in R&D around blockchain,” Newbold noted. “One of our clients is a leading provider of blockchain and cryptocurrency services, and the company is experiencing high demand for its expertise.”

While blockchain, which underpins cryptocurrency, has been around since the 1980s, “it didn’t catch on until recently,” he added. “But over the next few years, it will have a profound effect on banking and on institutions like the FDIC and other government actors, because the transparency of the blockchain will promote decentralized but relatively secure financial activity. Consider the controversy surrounding the 2008 banking crisis, when some institutions were classified as “too big to fail.” But when blockchain and decentralized cryptocurrency become widely touched, no one will be “too big to fail.” It will be like phone booths in New York City—the streets used to be packed with them, until cell phones made them obsolete, and instead the streets are full of bank ATMs. But Web 3 and blockchain-enabled cryptocurrency will make ATMs obsolete when everyone stores their currency in a digital wallet.”

Juliano

Jason Juliano is a director at EisnerAmper Digital and serves as technology lead for the firm’s digital assets committee. He has hands-on experience building B2B AI-enabled blockchain networks for banks and other organizations, noting that “Blockchain networks enable customers to transact faster and cheaper across banking platforms. But the changes it is driving, and will continue to operate, are not just operational. Historically, for example, when banks were looking for new hires, they focused on candidates who had banking and financial services backgrounds – but now banks are increasingly looking for digital assets and blockchain talent.”

However, Juliano cautioned that governance and compliance standards have not caught up with technological advances. “Federal and other agencies are encouraging banks to adopt blockchain and crypto initiatives, but regulators also want tighter controls and strong governance. The regulations are still evolving, although I would say that right now the New York State Department of Financial Services is probably ahead of most agencies.”

Juliano and his team worked with a national bank to set up controls and process improvements around blockchain networks. “Previously, we engineered a blockchain for a community bank, and helped the institution review partner vendor practices and rules of engagement,” he said. “There are still many regulatory and other changes to come — including, likely, federal Know Your Customer and anti-money laundering guidance — but overall, blockchain can bring many benefits, including speed and trust, to financial institutions and their customers.”

Blockchain technology brings many benefits to the “banking ecosystem,” said Spencer Savings Bank Senior Vice President and Treasurer Dushyant Abhyankar. He noted that banks traditionally store valuable assets, provide the infrastructure to facilitate payments and remittances, and provide capital and credit services to customers – and “Blockchain technology has the potential to provide a faster way to provide these services, along with a few other benefits . It verifies and transfers store of value in a banking ecosystem, has the potential to cut costs, provide faster processing of financial flows as well as regulatory/compliance transparency.”

Build a moat

Still, “The government and regulators have the challenging task of balancing blockchain innovation with consumer and market protection,” Abhyankar warned. “Over the past two years, we have seen governments and regulatory bodies really start to look into the booming crypto market and the technology behind its exponential growth worldwide. Due to the secure and anonymous feature of blockchain technology, governments want and regulators to ensure that bad actors around the world do not take advantage of the use case to conduct illegal activities.”

The banking industry is still at an early stage of adopting blockchain, he added. “There are regulatory roadblocks. Regulation is necessary to ensure participants have certainty around the status of cryptoassets, rules of engagement and investor protection. For this reason and at this time, Spencer Savings Bank has joined many other financial institutions in choosing to wait cautiously and not adopt blockchain technology But looking ahead, as the demand for this technology increases and some of the roadblocks can be overcome, all banks will have no choice but to slowly adopt this modern technology – using it to improve their current products and services, compete with other financial services institutions and be at par with the rest of the banking industry.”

Yang

In the long run, blockchain and other financial innovations will have a big, positive impact on banking, according to Steve Yang, an associate professor in the School of Business at Stevens Institute of Technology. “Cryptocurrency represents the earliest use of blockchain technology, but now a growing number of startups are looking for new ways to process payments, and many banks are working with blockchain behind the scenes,” he said.

In 2021, to address the need for research in blockchain and related areas, Stevens Institute of Technology and Rensselaer Polytechnic Institute—with sponsorship from the National Science Foundation—established the Center for Research into Advancing Financial Technologies (CRAFT). In addition to his other duties, Yang is the director of CRAFT.

“Blockchain is one of the key technologies being researched at CRAFT,” he explained. “It is a promising technology because it offers privacy, efficiency and transparency in a decentralized environment. Beyond payment possibilities, blockchain also enables developments such as NFTs [non-fungible tokens, which represent fractional ownership of artwork, digital content and other assets]which opens up new, non-traditional investment opportunities.”

In addition to its decentralized finance research, CRAFT is investigating innovations such as AI-enabled finance and quantum finance, which Yang said will “help secure our financial data, create and test fairer trading platforms, inform financial regulations, and support improved market simulation and stress testing tools that ensure stability in the financial system for everyone.”

Despite intrusions into US banking and in applications such as Apple Pay and Google Pay, “Asia, Europe and Africa are leading the way in Blockchain adoption,” Yang noted. “But I think the US will catch up. The Boston Fed, for example, is working with MIT to develop research on central bank digital currencies (CBDC).

In February, Boston Fed Executive Vice President Jim Cunha announced that “This collaboration between MIT and our technologists has created a scalable CBDC research model that allows us to learn more about these technologies and the choices to consider when designing a CBDC.”

Still, solving trust issues will be important to ensure widespread adoption of blockchain-related technology, Yang noted. “The blockchain platform is anonymous and involves multiple parties, so developing checks and balances and ensuring trust is central to the continued acceptance and growth of blockchain. That means regulatory agencies need to get involved, but they need to be careful and take a balanced position, and refrain from over-regulating the technology, as that can stifle development.Instead, regulators need to give the technology space room to grow.

Similar to cloud computing, blockchain offers speed, efficiency and the ability to transact across different systems. “But it’s not infallible,” according to CSG’s Newbold. “Code errors in the construction of blockchain infrastructure can create cybersecurity vulnerabilities; and users misplacing their private key or emailing it to someone – which could leave the information vulnerable to hacking and other threats – could lead to vulnerabilities.”

Regulation can help, “but it should be aimed at the way blockchain and cryptocurrency are used; instead of regulating the infrastructure itself, he says. “It’s like a greenfield, or undeveloped property. Greenfields themselves are generally not regulated – instead, regulations focus on what is built on them.”