How Blockchain is Transforming Financial Services

Thanks to increased interest in Bitcoin and other cryptocurrencies, blockchain technology is becoming more and more popular. Blockchain is an extremely versatile invention and its application extends far beyond the IT-sphere. In this article, we will tell you how blockchain is transforming financial services and show use cases of blockchain in finance.

How COVID-19 has impacted the financial services sector

Covid-19 has stalled the development of many businesses, but fintech was the exception. Despite the decline in investment in the sector at the beginning of the crisis, financial technologies have shown not only resilience but also growth. According to The 2020 Global COVID-19 FinTech Market Rapid Assessment Study, most types of FinTech firms have reported strong growth for the first half of 2020 compared to the same period in 2019. As for traditional financial institutions, they had to resort to accelerated technology adoption in order to meet new market requirements. So according to the World Economic Forum, two-thirds of the financial companies surveyed reported having made two or more changes to their existing products or services.

The main challenges for financial firms were an increase in late payments, an increase in the number of claims, problems with the adaptation of new clients, and a decrease in funding for fintech startups. And technology has become the main solution to these challenges. As the demand for digital products grew, alternative financial instruments began to gain particular popularity. For example, the number of users of blockchain-based solutions has grown dramatically. According to IDC, enterprise blockchain spending in Europe has risen 60%. And this is not surprising. Blockchain is a transparent and reliable technology that gives more independence to users of financial services.

Find out what is the future of fintech in the post-Covid-19 world by reading our recent article.

How blockchain affects financial services

Blockchain technology implies a fundamentally new approach to data management and use. Consisting of related blocks of information, blockchains are extremely reliable and transparent at the same time. Despite criticism and mistrust, blockchain enthusiasts have long been convinced that it will inevitably contribute to a profound transformation of the financial market. So, what are blockchain benefits for financial services, and how blockchain is transforming financial services? Let’s figure it out.

P2P payments

Peer to Peer is one of the most common methods of high-speed networking. It is a type of computer network that uses a distributed structure. The main principle of Peer to Peer (P2P) is absolute equality between all users (nodes). As a rule, in a peer-to-peer network, there is no distinction between the main server and the client computer, and each network node is engaged in solving both server and user tasks.

Peer-to-peer networks have become in demand not so long ago. Ten years ago, networks with “client-server” architecture were the most popular. But today P2P apps managed to displace their predecessor due to several advantages:

• Anonymity — the data of the users is stored without the involvement of third parties.
• Resilience — the network continues to operate even if most nodes shut down at the same time.
• Scalability — the network bandwidth is constant and the so-called “bottleneck” at certain points is excluded, as the data exchange can take place directly between the nodes.

The classical area of the Peer-to-Peer network application is the decentralized file exchanges, such as the well-known BitTorrent protocol. To maintain the stable operation of the resource, as well as to maximize the speed, developers use the peer-to-peer network, which offers the best scalability.

Also, P2P payment app development is popular today. With P2P apps users can easily pay directly without intermediaries and save on transaction costs, as well as track their finances.

Enhanced security

According to DataProt, poor security is the Achilles’ heel of a great number of companies:

• More than 1.76 billion corporate records leaked in January 2019 alone.
• Ransomware attacks happen every 14 seconds.
• 43% of cyber attacks are targeted at small businesses.
• The average cost of a corporate data breach in 2020 exceeded $150 million.

If at least 50% of companies have ordered blockchain development, the statistics wouldn’t be so bad.

The basis of blockchain technology is an electronic ledger of all financial transactions. Typically, such electronic ledgers are one of the main points of vulnerability. If attackers gain access to the main ledger, it could lead to a complete crash of the system. Accessing the records, an attacker could steal an unlimited amount of money or get personal information just by looking at the list of transactions. But this works only in centralized institutions.

In a blockchain, the ledger is decentralized — a single computer or system cannot gain control of the entire ledger. To gain access to the main ledger of records, an incredibly complex and well-coordinated operation would have to be organized. Thousands of devices would be attacked simultaneously at one moment. And it is almost impossible.

Another principle that provides exceptional security is the transaction chain itself. The main registry of records is a long chain of consecutive blocks. Each block included in this chain is only a part of the overall structure, which originates from the very first transaction made in the system.

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This means that anyone who decides to change information about a single transaction will first have to change all the records leading to that transaction very carefully and precisely. On this basis, illegal system interference seems to be an extremely difficult process, which is also one of the blockchain security advantages.

The next security advantage — more than two users (nodes) have to validate and secure the transaction in progress. Even in most modern processing systems, only a few levels of verification are involved — usually a seller, a buyer, and some third party (most often a bank or credit agency).

However, in a blockchain system, there are several thousand different nodes, each of which stores a complete copy of the records registry. Therefore, any of these nodes can also participate in transaction validation, and if a node does not accept a transaction for some reason, it will be canceled. This reduces the possibility of a false or fraudulent transaction almost to a minimum.

And finally, cryptographic keys. They are a marvel of modern cybersecurity. Each encrypted key is a long, complex sequence of data that is virtually impossible to decipher. And when you consider that two such unique keys are required for verification, the system begins to look like an impregnable fortress. Blockchain is considered to have a unique security system because, with this level of protection, it manages to maintain almost complete transaction transparency.

Cross-border transactions

The average percentage fee for cross-border money transfers was about 6.51% as of Q4 2020. This figure is even higher for transactions initiated through banks, averaging 11%. Cross-border payments are very expensive for senders, but blockchain can solve this problem too.

Blockchain does not charge additional fees as banks and other financial institutions do. Any amount is transferred with the same fee in the blockchain network. This guarantees cheaper transactions due to lower fees. But you should keep in mind that there is currently no regulation in some regions, which can cause some problems.

Nevertheless, many companies are entering the blockchain-based cross-border payments market, from young fintech companies to traditional industry players. Ripple Labs Inc. is a prime example of a fintech company emerging in this area with its XRP currency and RippleNet payment network. The sector of cross-border transactions is an illustrative example of how blockchain is transforming financial services.

Blockchain is a profitable technology for consumers and banks alike. The era of 8% fees for cross-border transactions is coming to an end. Consumers will be able to enjoy faster, more reliable, and secure international money transfers thanks to blockchain technology. The adoption of blockchain will allow banks to improve their profit margins by reducing transaction costs associated with traditional international payment systems.

Digital identity verification

According to a Javelin study, banks lose between $15 billion and $20 billion annually from identity fraud alone. At the same time, McKinsey estimates that ID on the blockchain will save banks $1 billion in operating costs. And fraud losses could drop to $7–9 billion.

Blockchain technology offers a decentralized, secure and immutable way to store data. Blockchains can ensure that a person’s digital data is stored in a safe place that cannot be hacked. Such data always contains the most up-to-date information.

Many companies realized the potential of this technology and began developing blockchain-based management and authorization systems for digital identity. Among the first were Bitnation, Civic, Cambridge Blockchain LLC, BlockAuth, and Existence ID. For example, Cambridge Blockchain LLC is working with financial institutions to create an intuitive and easy-to-use digital identity solution that fully complies with privacy laws.

IBM and SecureKey Technologies are also launching a blockchain-based digital identity network. It will be based on Hyperledger Fabric v1.0 from the Linux Foundation. Hyperledger Fabric is a blockchain with different levels of permissions (meaning that network participants can limit who can participate in the blockchain’s consensus mechanism). Blockchain with different levels of permissions will allow users to choose who to grant access to digital identities.

Another player in the decentralized ID market is IBM’s Verify Credentials product. It is a blockchain that provides data on demand. It allows a network user to decide for himself or herself whether or not to open access to his or her personal information. The developers expect that this system will be used in healthcare and finances. For example, banks can grant loans based on the clients’ income or their employment certificates taken from the blockchain.

DeFi as an alternative to traditional financial instruments

According to DefiPulse, the equivalent of $48.12 billion is locked in DeFi today. At its peak, the equivalent of $87 billion was locked into DeFi. This field attracts a lot of people due to its advantages. But what is DeFi?

DeFi is a kind of financial system based on blockchain and smart contracts. Its peculiarity is the availability of tools that eliminate intermediaries. DeFi opens up for users access to full control over their funds. There is no pressure from third parties, including intermediaries. And the instrument of interaction between the participants of the decentralized finance system is smart contracts.

According to statistics, many people simply do not have access to banking services. They do not even have the opportunity to open a deposit. According to the World Bank, 1.7 billion people out of a total population of 7.53 billion did not have a bank account in 2017. In 2014, the figure was 2 billion. But DeFi can change this.

With decentralized finance, users will have three incredible advantages over the modern system:

• Anyone will have access to financial services. They only will need the Internet and a crypto wallet. There will be no need for identification and no need for a financial company presence in the country/city.
• The ability to have complete control over assets and access to them. The need to trust intermediaries who charge interest for their services will disappear. Anyone can access the service while the system will have no single controlling authority.
• All the protocols on which DeFi operates are open source. Accordingly, anyone can create a financial product based on them. This will accelerate innovation and strengthen DeFi because, with each new product, more and more users and developers will move to such platforms.

In general, decentralized finance presents the latest monetary system, which is based on smart contracts and decentralized applications. It has no central authority. Everyone here is equal: the opportunities of the system’s participants do not differ depending on their place of residence, credit history, income, and other usual factors in the modern world. Here are the most promising directions of the DeFi development:

• Decentralized exchanges like 0x or KyberNetwork.
• Stablecoins like Dai or USDC.
• Asset management funds based on smart contracts like MelonPort.
• Tokenized lending platforms like Fulcrum or Compound.
• Decentralized forecasting markets like Augur and Gnosis.

The bottom line

So, answering the question of how blockchain is transforming financial services, we can say that blockchain is changing the financial market in a big way. It is changing things that no one has been able to change for years. Blockchain provides greater transaction transparency, enhanced security, and more asset management options. The key benefits of blockchain include:

1. Decentralization
2. Data persistence.
3. Transaction transparency.
4. High transaction speed.
5. Reduced transaction costs.

However, any technology needs to be properly implemented. So if you’re looking for a reliable blockchain development partner, feel free to check out our blockchain development services. The company’s portfolio includes more than 250 successfully completed projects. Crypto exchanges, lending/borrowing platforms, NFT marketplaces, issuance platforms, DeFi aggregators — IdeaSoft has experience working with projects of various sizes and complexity levels.

Let us help you discover the power of blockchain technology — let’s discuss your project now!