November 20, 2017

Report on How Blockchain Will Reshape the Financial Services Industry

"Blockchain is a young technology, first conceptualized in 2008," says a report written by The Economist Intelligence Unit (The EIU) for the UK Department of International Trade. "The financial industry has been among the first industries to seize upon the efficiency savings that its distributed ledger technology could deliver, and for good reason: Using distributed-ledger technology could help financial services providers lower the worldwide cost of cross-border payments, securities trading and compliance by $15-20 billion per year by 2022, according to Spanish banking giant Santander." The EIU's report, From concept to reality: How blockchains will reshape the financial services industry, "assesses blockchain's impact on processes and functions in the global financial services industry, as well as on the industry's structure. It also details some of the key changes to products and services that retail and business clients can expect in the years ahead."

Before I discuss some of the report's highlights and conclusions, it is important to provide a brief explanation of the bitcoin and blockchain. The report succinctly says,
Bitcoin is a digital cryptocurrency (a currency in which encryption regulates the generation and transfer of funds) that can be exchanged for goods and services via peer-topeer networks. A significant feature of bitcoins is that they are not issued by central banks, nor backed by them. The technology that supports bitcoin is blockchain. Also known as distributed ledger technology, a blockchain records the generation of bitcoins through a process of electronic ‘mining’, and stores the data on transactions in sequence, on a network of linked computers simultaneously. The blockchain data structure provides a verifiable history that only can be added to, not deleted or amended.
While I am certainly not an expert in blockchain, I am familiar enough with the technology to agree with the report that its real-life use still limited. "Its current use is mostly to be seen in the bitcoins— virtual currency created with blockchain technology—that cross borders with negligible regulation"

Moreover, "Incumbent banks, asset managers, insurers and technology firms are keen to experiment with the new technology. Their initial trials focus on niche areas of trade finance, payment settlements and reconciliation. While interest in applying the technology is growing, widespread implementation may take years. An all-encompassing financial blockchain is unlikely to emerge from current projects."

The report, however, notes that "the financial industry already has a consistent view of what needs to be done to put private specialist blockchains to good use." Some of the likely main features of the future use of blockchain in the global financial services industry include:

  • Closed systems: Collaborative blockchain networks will be closed to outsiders, to ensure that information does not land in the wrong hands and to prevent hackers from disrupting financial stability.
  • Back office first: The first objective for introducing blockchain technology will be to save costs. Blockchain will cut the cost of the daily checking and rechecking of ownership and transactions.
  • Regulatory overhaul: Financial industry rules may need a worldwide update, along with reforms to broader data protection regulation. Regulators want to encourage innovation but without upsetting stability.
  • Emergency markets: The first widespread changes to retail financial services involving blockchain may take place in emerging markets, where banking, investment and insurance penetration rates are low.
  • Less reliance on cash: Widespread use of blockchain technology, together with updates to compliance regulations, will enable central banks to substitute their own regulated, blockchain-based digital currencies for notes and coins. Some central banks, such as the Bank of England and the central bank of Norway, are already discussing discontinuing use of notes and coins entirely.
  • Smarter financies: Within 10 to 20 years, embedded smart contracts could transform how bank accounts work and how insurance pays out.
  • SME boost: Blockchain could help open up cheaper, non-bank financing to small and midsized firms, which provide two thirds of all jobs in Europe.
I also agree that "there will be no 'big bang' heralding the arrival of blockchain technology in the financial services industry. However, the revolution has already started." The report further asserts, "The first live implementations of financial applications of the technology are expected within two years. Mainstream adoption will take a decade or two."

The report provides the following conclusion:
Mainstream deployment of the technology in the composition of retail financial products will take longer. Even if parts of the financial system adopt blockchain technology relatively early, other changes—such as merging e-currencies into blockchain networks, and integrating the growing number of internet-connected devices—will take decades.
For widespread adoption of blockchain technology in financial services to take place, two things need to happen. Financial institutions need to change how they interact. Today's centralized system encourages each player to assume others could be at fault. Blockchain will only work if companies learn to share and cooperate, and see themselves as part of a blockchain network rather than solo actors.
More importantly, the consensus approach will require a reworking of current financial regulation. If blockchain is to truly deliver on its promise, then revision of rules that now require the use of various counterparties and clearinghouses will be needed. This reform process is a sensitive task: Regulators are keen to encourage innovation—but not at the cost of promoting instability in the financial system.
Do you agree with report's findings? What is your prediction on how blockchain will be used in the global financial services industry?

Aaron Rose is an advisor to talented entrepreneurs and co-founder of great companies. He also serves as the editor of Solutions for a Sustainable World.

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