Why Banks Must Embrace Blockchain Beyond Cryptocurrency

Blockchain has unfortunately been characterized by the media as valuable for its associated speculative cryptocurrencies that have grabbed headlines and attention due to their volatile nature. In doing so, the coverage has obscured the true value of the underlying, highly innovative and potentially transformative technology.

For banks, blockchain has potentially significant upside with important, sector-specific applications such as cross-border transactions, fraud reduction and trade finance, to name just a few. The trust and data security that blockchain enables can benefit financial institutions on a number of fronts. While we all digest the latest headlines about FTX, we would do well to look at some of blockchain’s potential applications and its likely effect on institutional operations.

In fact, the use cases for blockchain are expanding rapidly. Yet the core features championed by blockchain enthusiasts have remained constant: enabling anonymous peer-to-peer trusted transactions without the need for an institutional intermediary. The cryptocurrencies linked to public blockchains facilitate the payment of fees to the network protocol providers that support the transaction. The low cost of these fees and near-instant transactions have the potential to cut out the middleman, but it doesn’t have to be that way.

We are beginning to see increasing consumer awareness and use of cryptocurrencies for instant peer-to-peer transactions. This in turn increases consumers’ expectations of transaction processing by the financial services companies they do business with. Banks have the opportunity to take advantage of blockchain technology to accelerate transaction speeds and reduce errors and costs. Failure to begin experimentation and preparation now could plant the seeds for future decline and disintermediation of emerging technologies that offer greater convenience.

Payments across national borders

Three days to clear a bank deposit? Weeks to gather information and settle a claim? These service levels will soon be a thing of the past. The marketplace will reject these service levels in favor of new service providers that offer a faster and more consumer-friendly value proposition. Now is the time for financial firms to prepare their operations for this eventuality.

The most well-known application of blockchain technology in banking is cross-border payments. In its current state, sending money between nations is an arduous process, subject to reconciliation errors and delays. Ripple and the Universal Digital Payments Network announced at Davos offer two competing solutions – one public and the other private – for real-time payments and reconciliation across borders. Financial institutions at the forefront have already saved $301 million in 2021 by integrating blockchain technology into cross-border payments. However, that is only a fraction of the technology’s potential. If more traditional banks succeed in following suit, they are predicted to cut cross-border payment costs by upwards of $10 billion by 2030.

Trade finance can also benefit greatly from blockchain technology. They have the potential to simplify and unify the entire process, from negotiation and execution of contracts, all the way to post-trade settlement as payments are automatically triggered by sending and receiving events with real-time financial reconciliation. By digitizing all documents and automating key processes, blockchain can reduce the time it takes to complete a trade from days or weeks to mere minutes. In addition, by providing a single shared platform for all parties involved in a trade, blockchain reduces carrying and operating costs. With all data stored on a decentralized ledger, there would be no need for duplicate records or costly manual reconciliation.

Finally, blockchain can dramatically overhaul a bank’s lending practices by helping to reduce the costs and time associated with loan processing. This is achieved by incorporating smart contracts, which can automate many of the manual processes involved in loan assignments, including identity verification, credit checks and documentation. Just like with trade finance, this benefit is twofold; the process is not only more efficient, but it also reduces the possibility of fraud and error.

Blockchain technology does not shift the benefit from the customer to the bank or vice versa. It benefits both parties. From a know-your-customer (KYC) and anti-money laundering perspective, it can also benefit authorities and become a means to more easily achieve regulatory compliance. While some banks may be concerned that moving to blockchain could negatively impact fee income, it is possible that large banks could offer value-added services to smaller competitors, such as KYC, as a service for a fee. In this context, fee income will be shifted, but not necessarily reduced.

Early proponents of blockchain envisioned the rise of DeFi, or decentralized finance, cutting out banks entirely. However, this over-idealized view of democratic finance can only be achieved if combined with the security, stability and liquidity provided by commercial banks and sovereign central banks. Look no further than collapsing centralized crypto exchanges for confirmation. If major financial institutions can embrace blockchain technology and translate its implications into operations, new operating models will emerge to accelerate transaction speeds, reduce operational costs, make data more secure, enable more satisfying customer experiences and potentially transform revenue opportunities. It is a recipe for competitive differentiation, growth and profitability.