Bitcoin, the cryptocurrency that has been speculated to revolutionize the financial sector (depending on who you ask), is as controversial as it is volatile. Yet, it’s the technology that underpins Bitcoin and other cryptocurrencies that could be the catalyst for a financial sector transformation. This technology, known as Blockchain, combines cryptography and shared databases to create a secure, decentralized digital ledger that is continually updated. Blockchain technology has the ability to increase efficiency and lower costs in many areas in the banking industry, but which areas will be affected the most?
Blockchain technology may have a large impact on the payments process. The current payment process is slow and has security flaws that are exploited. These issues are attributed to the large number of intermediaries in the payment processing system. Blockchain eliminates the need for many of these intermediaries by completely automating the process, from payment to settlement.
Smart Contracts, also known as self-executing contracts, are programmed to execute transactions when a set of specified terms and conditions are achieved. A Smart Contract must be validated by a peer-to-peer network before execution, thereby reducing the risk of fraud and forgery. Smart Contracts eliminate the need for third parties; therefore ensuring accuracy, increasing efficiency, and saving money. Mortgage lending will likely benefit the most from this technology. The current mortgage lending process relies on third party intermediaries, trusted with incredible amounts of sensitive personal information, to perform their necessary step of the process while meeting compliance requirements. Smart Contracts would automate steps in the process such as identifying which type of loan a customer is eligible for based on set criteria. Financial Institutions could also use Smart Contractions to transfer title to the new owner when the predefined conditions are complete, such as loan funding. While some institutions have begun utilizing Smart Contracts, critical issues such as coding errors and other challenges have kept potential parties from adopting this technology.
Data breaches, such as with Equifax in which 143 million American consumers had sensitive personal information exposed, have put a large emphasis on the importance of cybersecurity. Traditional banking systems are built on a centralized database, resulting in hackers having full access to the system once it’s breached. Blockchain eliminates this vulnerability because it does not have a single point of failure and cannot be changed from a single computer. Due to the characteristics of Blockchain, a hacker would have to access every instance of a certain Blockchain and alter them all at the same time in order to corrupt or access information.
Know Your Customer (KYC) and Customer Due Diligence (CDD)
Know Your Customer (KYC) and Customer Due Diligence (CDD) regulations are focused on reducing money laundering and terrorist activities. While compliance with these regulations is important, KYC and CDD practices are labor intensive and expensive. A global survey conducted by Thomson Reuters found that on average, financial firms spend $60 million annually to meet KYC and CDD obligations. Costs are continuing to rise due to the increasing difficulty and complexity that compliance now requires. With the threat of harsh fines looming overhead for non-compliance, institutions are now seeking alternative methods for more efficient compliance. Blockchain offers institutions more efficient compliance practices through cross-institution client verification. This allows verification of one client to be accessed by other organizations, so the process doesn’t have to be repeated. Cross-institution client verification also increases monitoring and analysis effectiveness, therefore reducing the cost and burden of compliance.
Many financial institutions have noticed Blockchain’s potential, and have begun investing millions of dollars in its technology. It is important to note that there are still issues and challenges facing this emerging technology. Issues of privacy and regulation will have to be addressed before Blockchain can reach its true potential. The promise of more security, efficiency, and cost savings has many in the banking industry looking forward to Blockchain’s bright future.