Financial Institutions and Blockchain: Not Such an Odd Couple
Blockchain is an emerging fintech technology, and financial institutions are taking notice. In 2015 alone, capital markets institutions spent an estimated $75 million on internal blockchain initiatives. The investments are expected to increase steadily over the next several years. The Aite Group estimates that capital market firms’ spending on the technology will reach $400 million by 2019. Financial institutions are seizing on blockchain technology to bring efficiency gains to two major areas: 1) transaction settlement and 2) inter-organizational data sharing. These activities have traditionally been difficult to accomplish without a trusted intermediary between institutions. However, with blockchain technology, institutions can transact directly.
What is Blockchain?
Blockchain (also known as Distributed Ledger Technology) is a distributed database. Unlike traditional databases, blockchain includes a consensus protocol among participants that governs changes to the database. This method ensures transactions written to the database are authentic and tamper-resistant. The transactions written to the database can be read-only data, such as debits and credits to accounts, or can be executable logic, known as “smart contracts.” A smart contract could enforce payments to and payouts of an insurance contract by detecting a claim event, for example. Blockchain replaces trusted third parties that are often relied on to store shared data or execute contracts.
Blockchain in Financial Services
To use blockchain, financial institutions can establish private and “permissioned” blockchains among partner institutions. These blockchains allow institutions to select who may access or modify the chain. Hyperledger Fabric is one such permissioned blockchain that is now offered as a service by IBM. Private and permissioned blockchains have many applications in financial services:
Bank-to-bank transfers: Today, bank-to-bank transfers typically rely on clearinghouses. Clearinghouses maintain records of banks’ balances with one another to settle bank-to-bank transactions. A blockchain can eliminate the need for clearinghouses. Banks can maintain a trusted ledger of balances on a blockchain. Once on the blockchain, transactions can clear in seconds. The Ripple protocol is one implementation of bank-to-bank transfers on a blockchain.
Financial trading: Financial trades can also be cleared with blockchain. Financial instruments can be digitized into digital assets, and then ownership of these assets can be recorded on a blockchain. When a trade is considered, the parties can verify that the sender owns the asset and the receiver has the payment. To complete the trade, the parties digitally sign off on the transaction to update the ledger.
Insurance: Insurance is an opportunity to leverage “smart contracts.” Today, insurance policy holders have to contact and often and argue with insurance providers over claims. Insurance companies are burdened with the operational cost of processing claims. The blockchain can allow for insurance contracts to execute automatically, based on claim events. For example, a contract could be coded to receive premiums or detect claim events (such as a person’s death in the case of life insurance) then initiate payments to policyholders.
Customer Identity: Blockchain can help financial institutions comply with Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) regulations. Often, financial institutions work with one another on behalf of common customers and have duplicate and conflicting customer data with partner institutions. Customers could supply their data once to a blockchain ledger and selectively share it with certain institutions, reducing work for customers and organizations.
Blockchain is a network bridging trust between parties. Since the technology is designed for use by multiple parties, institutional adoption of blockchain technology will not result from isolated teams, but from consortia-led efforts among institutions. Research and experimentation is not an immediate benefit to a firm’s bottom line, but institutions that don’t invest in the technology and on partnerships will likely find themselves far behind a few years from today.
