" The Internet of Everything needs a Ledger of Everything "
- Harvard Business Review on Blockchain
Blockchain, the technology that has
supported the much-hyped bitcoin
ecosystem, has piqued the interest
of the financial sector. The industry
that witnesses millions of
transactions worth trillions of
dollars every day is now beginning
to experiment with blockchain to
see how the 'decentralized ledger
of all transactions across the
network' concept can be leveraged
to transform the global financial
system.
Blockchain is billed as a
tamper-proof technology that can
run simultaneously on millions of
devices across a network, making
it failure-tolerant as well. The
technology uses 'smart contracts'
to automate the recording and
execution of transactions, with the
potential to drive down processing
costs significantly.
Here are the basic principles
underlying blockchain.
-
Decentralized Ledger: Blockchain is essentially a digital
ledger where every transaction
is updated simultaneously
across all nodes as a new
'block.' This allows participants
to access identical information at
the same time across the
distribution chain
-
Consensus Validation: For any
transaction to be added to the
blockchain, it needs to undergo
an agreed upon validation
process. This allows participants
to place trust in their
transactions even in the absence
of a central authority
-
Immutable and Tamper-proof: Only verified transactions are
added to the chain. Transactions
once recorded in the blockchain
are irreversible and immutable.
Thus, it is impossible for anyone
to tamper with data without
leaving evidence of the same
-
User Authentication with
Cryptographic Security: Each
user with access to a blockchain
is issued two cryptographic keys
— private and public. The private
key is used for 'write' access,
while only the public key is
exposed to other nodes to help
verify requester details. This
cryptographic security of user
access makes it almost
impossible for identities to be
hacked and data to be
compromised
-
Smart Contracts:
Blockchain
transactions are programmed
through smart contracts that
encode all the commercial and regulatory rules that need to be
enforced. Transactions between
nodes can thus be triggered
once all the conditions have
been met. For example, the
receipt of a required set of
documents confirming the
acceptance of credit terms can trigger the release of a loan
to a customer
The inefficiencies and loopholes
ailing the financial services
industry stem from the growing
complexities of distribution,
disparate regulations covering international transactions and
delay in sharing transaction details
across participating agencies. Let
us analyze the leading use cases
for how blockchain can address
these issues across stock markets,
retail banking, asset management
and insurance.
Quicker Settlements in Stock Markets
According to the World Federation
of Exchanges database, the total
value of stocks traded globally is
around USD 77.5 Trillion,1 and the
market is getting bigger and more
complex by the day. With
transaction time and operational
costs being a top concern, major
stock exchanges are exploring
blockchain for its potential to allow
almost immediate settlements and
automate compliance through
smart contracts, with greater
levels of security and transparency.
Another key impact of blockchain
on the stock market is likely to be
the democratization of trading.
With decentralization, the
correlation between distance from
the stock exchange and entry price
is reduced, thus making the
proximity to exchange servers
irrelevant. This will reduce the
need for market intermediaries,
lower transaction costs and
introduce transparency in the share
settlement process.
NASDAQ is already using
blockchain technology to issue and
manage private securities, while
the London Stock Exchange is
exploring opportunities with a
cross-industry group of institutions
to change the way securities are
traded in Europe. Other exchanges
such as the Tokyo Stock Exchange,
South Korea Stock Exchange and
the National Stock Exchange of
India are also looking into the
potential benefits of blockchain.
Simplifying Payments in Banking
A decentralized ledger can simplify
payments in retail banks,
particularly international payments
that involve high fees and several
days to complete. Blockchain can
also be used to verify customers'
identities in retail banking. Once
customers' personal data is verified
by an authorized agency, they can be issued private and public keys for
the blockchain. The ledger then
functions as a decentralized and
common mechanism to authenticate
a customer's identity across banks.
Switzerland-based UBS bank has
been leading a consortium of global
financial companies in a blockchain project aimed at expediting backoffice
functions and inter-bank
settlements, which could save the
industry billions of dollars.2 R3 CEV
LLC, a New York-based company,
leads the world's largest financial
consortium focused on blockchain,
including more than 100 banks and
regulators.3
Increased Accuracy in Asset Management
The asset management industry
has been growing rapidly over the
last few decades and is expected to
touch USD 145.4 Trillion by 2025.4
To meet investors' demands for a
global set of products, the industry
uses intermediaries, making the
process complex and time-consuming.
The distributed ledger
concept can enable direct trading
and settlements across boundaries,
which in turn can reduce costs, increase data accuracy and
reduce delays.
FundsDLT, a blockchain-powered
funds distribution platform, has
been developed as a collaboration
between Luxembourg Stock
Exchange subsidiary Fundsquare,
Post Group subsidiary InTech and
KPMG Luxembourg. Using smart
contracts and distributed ledger
concepts, FundsDLT is expected to provide asset managers a new
distribution channel with
significantly lower transaction costs
and delays.5 Fundsquare is also
partnering with iHub, the innovation
and hacker space for technologists,
investors and tech companies, to
introduce a blockchain-based Know
Your Customer platform for the
funds industry that is eventually
expected to be integrated with FundsDLT.6
Fraud-free Claims Management in Insurance
The insurance industry, although
slower than the banking sector in
evaluating the benefits of
blockchain, has been making
steady progress to benefit from it.
The strongest use cases for
blockchain in insurance are:
-
Driving effective and fraud-free
claims management: Automating claims triage and
processing through smart
contracts, easy access to
customer history, as well as
centralized customer
authentication will all enhance
claims efficiencies manifold.
Cross-industry data sharing
will enable proactive fraud
prevention
-
Supporting digital
transformation: Blockchain will
offer actuaries access to
completely digitized, contextual
data, to significantly reduce the
effort and enhance the accuracy
of risk models and estimations
-
Enabling product innovation: Blockchain, with its potential for
almost real-time transaction
settlements, will allow insurers
to introduce new risk instruments
and exploit capital opportunities
in the market. Allianz, a leading
multiline global insurer, recently
came out with a blockchain-enabled
solution for the captive
insurance market. The company
is also exploring other blockchain
opportunities in the corporate insurance segment.7 Smart
contracts stored on blockchain's
decentralized ledgers help in
supporting peer-to-peer
transmissions. This opens up the
opportunity for other forms of
customized insurance products
Recently, consulting firm Deloitte,
payment services provider, Lemon
Way, and blockchain start-up,
Stratumn, developed a blockchain-enabled
solution for micro-insurance called LenderBot.8
Stratumn and Deloitte have also
tied up with 14 insurance
companies under the French
Federation of Insurers to test a
blockchain platform that can enable
sharing of information across
insurance companies.9
The Regulatory Question
The financial services industry is a
highly regulated one, and the pace
of blockchain adoption will depend
on how the changes are supported
by regulatory bodies across the
globe. Some regulations connected
to blockchain are already in force
as listed below:
-
The U.S. state of Delaware has
passed a bill that recognizes
stock trading using blockchain
-
The Australian Securities and
Investment Commission
regulatory framework mandates
financial services companies
using distributed ledger
technology to have proper
infrastructure and risk management systems in place in
order to operate
-
U.S. regulator, Commodity
Futures Trading Commission,
has established a blockchain
panel to examine how the
technology can be used in the
derivatives market
-
The European Securities Market
Authority and the Financial
Conduct Authority, U.K., have
each published papers that
discuss the risks and benefits of
blockchain on the securities
markets
-
Switzerland's Zug region is now
known as 'Crypto Valley' for its
cryptocurrency-friendly regulation. Switzerland is
marketing itself as an epicenter
for Initial Coin Offerings or ICOs.
Changing global scenarios and
volatile financial markets need a
technology like blockchain to
increase international transaction
speed and reduce costs. By 2020,
blockchain is expected to have a
significant impact on the financial
sector worldwide with widespread
adoption. Blockchain is not a threat
to the sector, but an innovation that
can revolutionize the current
system and make it more secure
and efficient. Companies should
start exploring and investing in this
technology to compete in a
disruptive environment.
References:
1. https://data.worldbank.org/indicator/CM.MKT.TRAD.CD
2. http://fortune.com/2016/08/24/ubs-central-banks-blockchain/
3. https://www.reuters.com/article/us-r3-blockchain/bank-backed-r3-launches-new-version-of-its-blockchain-idUSKCN1C80MS
4. https://press.pwc.com/News-releases/global-assets-under-management-set-to-rise-to--145.4-trillion-by-2025
5. http://www.cityam.com/267970/blockchain-warming-up-asset-manager-natixis-says-has-made
6. http://www.assetservicingtimes.com/assetservicesnews/article.php?article_id=7831
7. https://bravenewcoin.com/news/lenderbot-by-deloitte-and-stratumn-to-bring-insurance-to-the-sharing-economy-using-bitcoins-blockchain/
8. https://www.coinspeaker.com/2017/11/10/stratumn-teams-deloitte-test-blockchain-platform-14-insurance-companies-france/
9. http://www.agcs.allianz.com/about-us/news/blockchain-prototype-captive-insurance-press-release/