Applications of Blockchain in Banking

Throughout history, elements of transactions such as gold and silver have emerged to facilitate the exchange of value and protect buyers and sellers in making a successful transaction. Businesses exchange value with suppliers and consumers with these media of transaction until the paper money was brought to use in 1913 in view of making the financial system stable while achieving efficient means of exchanging goods and services.

Over the years, the worldwide transaction volumes started to witness exponential growth and thus uncontrollable complexities are now exposing the vulnerabilities in the existing systems of transaction to the world. In spite of this, many methods of transactions remain inefficient, expensive, vulnerable attacks, and suffering from limitations such as:

Unlike the use of golds and silver, every nation of the world invented their individual currencies, leading to inequality among currencies, thus causing unfavorable border-to-border transactions rules, and a shortage of money as a result of complex exchange routes.

According to a report released by ripple.com:

“in the US, sending money abroad typically takes 3-5 days, costs $42 and has an error rate of at least 5%. With $180 trillion worth of cross-border payments occurring globally every year”

Cross border payments that involve third party validations are exposure to financial crimes. This is because the payment arrangements can be used to disguise the identity of the true payor and true source of funds.

The centralized computing models of conventional banks expose customers to audacious exploits from operators of the banks and external cyber-attacks. Therefore, the need for a fast, secure, and much more successful transactions that are easily agreed on by parties participating in the transaction becomes inevitable.

Application of Blockchain technology provides a unique and more successful way to solve these problems in a much better way. The technology with its decentralized nature, allows multiple parties to have real-time access to a constantly updated immutable digital ledger. Considering these tremendous benefits, the Blockchain, having been treated with levity by the banks suddenly became the hottest buzzword in the banking sector.

Today, banking and financial services become obvious applications of the blockchain. Financial players are mainly focused on evaluating the possible influence of blockchain on payments circuits, capital markets processes, risk management activities and credit services. Now, the banking and financial services industries have a complex relationship with blockchain. In other words, blockchain presents numerous opportunities to transform how people exchange value. We explore some of the areas of banking currently being transformed by the blockchain.

The way by which financial institutions prevent the inappropriate and criminal use of funds and services is the ‘Know Your Customer’ (KYC). The process involves establishing the identity of the customer using various documentation, understanding the nature of the customer’s activities to make sure the source of the customer’s funds is legitimate, and assessing whether the customer poses a risk. The process helps financial institutions to know relevant information about users for them to be able to provide better, safer, and more secure platform. In centralized applications used by banks, KYC process is conducted by requesting the customers to submit certain documents, email, and phone verification. Because of the complexities involved, the process takes the length of time before completion, which leads to unfavorable delays in business processes.

According to a survey conducted by Thomson Reuters, financial institutions spend up to $500 million per year to keep up with KYC. The blockchain approach is to allow the computer to automatically verify the documents under certain predefined conditions defined by the smart contract. The blockchain with its cryptographic protection mechanism becomes a solution to the problem of sharing customers’ information across the border in a secure manner.

Unarguably, the internet has made transactions faster than ever before with the use of digital payments, yet transferring money from one individual to another isn’t always a simple endeavor. Both parties involved in the transaction still have to trust one-another to receive their payments. Cross border transactions still take days if not weeks before confirmation.

The smart contract provides trustless transaction and timely delivery of payments because participants can view the same ledger of transactions that is updated through consensus and made immutable through cryptography. With the day-to-day improvements and innovation by entrepreneurs, it is believed that in the long run, this can make it possible for individuals and corporations to transact more directly, making payments simpler, faster and much more secure.

Trade finance refers to financial transactions related to trade receivables finance and global trade. The operations involved include lending, issuing letters of credit, factoring, export credit and insurance handled manually which result in huge amounts of paper works. Statistically, around 80 percent of world trade relies on transactions involved in trade finance. Unfortunately, the paper-based model used in verifications and validations result in delays, unnecessary duplication of documents, fraud and inefficiencies in operations. As a result, financial institutions are seeking to increase efficiency in the processes involved in terms of time, costs, security, and effort by replacing the paper-based models with digital data models.

The blockchain structure allows the creation of a digital ledger of transactions that can be distributed amongst a decentralized network by using cryptography and sharding techniques. Its decentralized nature allows developers to streamline the trade finance processes, giving each participant on the network to securely amend the ledger having agreed upon by the consensus of all the participants on the network.

Blockchain removes the duplication of documents since each document on the blocks of ledger is assigned a unique hashed id. The speed of confirmation of transactions on the network is reduced to minutes if not seconds. Also, update on the network is reflected as quick as possible. Therefore, increasing transparency between all participants, and reducing the frictional effects of capital tied down as a result of delays in transactions.

Several companies have been taking the lead in utilizing the benefits of the blockchain in solving the problems in banking and finance. Some of them efforts include Yes Bank, CommonWealth Bank, and Axis Bank, RAK Bank, Standard Charter Bank, and Kotak Bank to mention a few.

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