Blockchain, Cryptocurrencies, and the Future of Digital Banking
“Banking is necessary. Banks are not.” Wells Fargo, an international American banking and financial services holding company, made this statement in their 2004 annual report. Since then, we have seen financial institutions worldwide, digitizing their offerings to extend their legacy services to as many channels as possible.
Fast forward to 2009, an anonymous programmer / group of programmers under the name Satoshi Nakamoto invents Bitcoin; a cryptocurrency and a digital payment system that was released as open-source software in 2009.
Bitcoin was primarily created as a peer-to-peer system based on blockchain technology to avoid banks. Here, transactions take place directly between users without the need for an intermediary. Network nodes verify transactions and records them in a publicly distributed ledger called a blockchain. Since the system has no central repository / single administrator, Bitcoin is the first decentralized cryptocurrency in existence. Since then, other cryptocurrencies like Ripple, Monero, Litecoin, Etherium, etc. have been introduced to market.
So Why Bitcoin?
When a payment is made, it always involves some form of trust. At a shop, we seldom share personal information. When we use our debit / credit cards for carrying out transactions, there is a demand for a complex infrastructure to ensure that transactions are carried out securely and efficiently. But this costs the merchant a percentage of the sale amount. In case of international transactions, there is a need for custodians, notaries, clearing houses, and central security deposits. This reduces liquidity due to blocked assets. A 2014 report from McKinsey and Company indicated that payments revenue will grow by 8 per cent each year through 2018, at which point annual revenue will reach $2.3 trillion and account for 43 per cent of all banking-services revenue.
With cryptocurrencies, all this revenue could disappear. Sending money between two cryptocurrency wallets is cheap and effective, just like sending an email. Transactions with cryptocurrencies are transparent because of its compliance and auditing protocol that maintains secrecy and anonymity through design. Cryptocurrency would do for payments, what email did for the postal service.
A study made by Cambridge University in 2017, states that there are 2.9 to 5.8 million unique users that actively use a cryptocurrency wallet, mostly Bitcoin. Today, businesses that accept Bitcoin as a form of currency include Microsoft, Virgin Galactic, Subway, Dell, Bloomberg, amongst others.
So, What Does All This Mean For Banking?
While some might think cryptocurrencies and blockchain mean death to banks in a way, there are some recent initiatives worldwide that gives an indication of what blockchain could mean for the financial sector.
A London-based fintech start-up is implementing a permissioned blockchain model to create a bank using Etherium smart contracts. This approach will operate using a decentralized information model that will minimise costs while maximising data fidelity and security.
Another tech giant has launched a blockchain initiative for trade finance between a telecom operator and three middle-east based banks to explore the use of logistics solutions for the import and re-export process of goods in and out of the region. The blockchain solution is expected to transmit shipment data thereby enabling participants to receive real time information about the state of goods and status of the shipment.
When it comes to trading, two global banks have used blockchain to carry out a live oil trade between different parties involved. The use of blockchain technologies brought down transaction times by almost 80%.
With the power of block-chain technology, we can convert each transaction from being conventional contracts into smart contracts. A smart contract is time based and that makes it secure, tamperproof, and reliable.
What advantages does blockchain technology have to offer?
Now, let’s look at a universal fact – Of all the living organisms that have inhabited planet earth, man is only one that has documented their existence extensively. Whether it is the cave man or the person making an Instagram post of their food, our kind is constantly documenting our existence. But truly, what is it that defines our existence? What proves the fact that we exist? The only aspect that gives legitimacy to our existence is time. It is one of the truest units of measure. Without time, we don’t exist.
Using blockchain one can create digital tamper proof records of ownership. Self-executing smart contracts can be used in the insurance domain for settling travel insurance that automatically makes a payment if a customer’s flight is cancelled unexpectedly or arrest the use of a car if a loan payment against it is not paid. Blockchain has the potential to transform the banking system by reducing the settlement time for securities transaction as there is no requirement for collateral and hence, has better liquidity.
Some of the pros and cons of blockchain technology are:
1. Blockchain data is complete, consistent, time based, accurate, and widely available. Since transactions are transparent and immutable, any changes to public blockchains are publicly viewable by all parties. One cannot delete or modify information.
2. Transactions between two parties take place without the need for an intermediary. This ensures full control over the information they share. Due to this same reason, blockchains have no central point of failure and can withstand malicious attacks. While interbank transactions traditionally takes days for clearing, especially outside of working hours and involve third part intermediaries, blockchain transactions are processed almost instantaneously with almost no transaction fees incurred; if at all any are involved.
However, it’s not all 1s and no 0s.
1. Since modern currencies have always been created and regulated by national governments, digital cryptocurrencies face a hurdle in widespread adoption by pre-existing financial institutions and complicated government regulation to settle. While solutions exist, including private or permissioned blockchains and strong encryption, there are still cyber security concerns that need to be addressed before the general public will entrust their personal data to a blockchain solution.
2. Resolving challenges such as transaction speed, the verification process, and data limits will be crucial in making blockchain widely applicable since the technology is very nascent. Blockchain applications offer solutions that require significant changes to, or complete replacement of existing systems which could come with integration issues. Blockchain offers tremendous savings in transaction costs and time but the high initial capital costs could be a deterrent.
3. The Bitcoin blockchain network’s miners attempt 450 thousand trillion solutions per second in efforts to validate transactions. This uses substantial amounts of computational power. The energy consumption involved in mining blockchains is huge compared to conventional transactions.
Incumbents have always had their issues with disruptors. But the truth of the matter is, one must learn to change with the times; it is either innovate or perish. While it stands true that blockchain technology stands to wipe out a lion’s share of a bank’s income, banks should realize that they can leverage the power to blockchain to introduce new products and offerings that would replace old revenue streams. The world is turning digital, there are no two ways about it and like it or not, we are living in a digital matrix.