Blockchain & financial services: match of the century
February 12, 2024
With the approval of a spot Bitcoin exchange-traded funds (ETF) last month, and the likes of BlackRock among the 11 issuers, there’s no question that the digital asset industry has been anointed a new level of legitimacy.
However, the industry has always been about more than the speculation and price action that surrounds native crypto tokens. It is the underlying blockchains, their use cases and integration with the world as we know it, that drives the fundamental value behind these assets.
The financial services industry spans a broad spectrum of offerings, from facilitating day-to-day payments, brokerage, asset management, lending and borrowing. Over time, the institutions that offer these services have refined their products to appeal to consumers in the digital age. Unfortunately, the security and efficiency of these systems are still years behind – the existence of hidden fees for middle-men processing transactions and fund custodians makes this clear as day.
Blockchain technology has the potential to streamline many of these operations in traditional finance, eliminating risk and creating more productive capital markets. Several high-speed decentralised networks today have the ability to revolutionise the world of traditional finance, and disrupt the way money flows across the world.
An accountable financial system
A blockchain-based solution acts as a shared source of truth for participants, and eliminates the single-point of failure prevalent in centralised entities. Transactions are stored on a decentralised ledger that keeps track of them transparently and publicly, and because it all takes place on self-executing smart contracts that no one needs to administer, systems will be able to power more real-time transactions.
Santander estimated that blockchain technology could save banks US$20 billion a year in costs if Payment Service Providers and the crypto community forged a relationship. Most of these high-performance networks are also scalable by design, allowing for faster transactions by eliminating the agent that acts as a middleman in traditional financial services.
Shared ledgers also improve the security of these transactions, with the existence of two security keys for each transaction – a public key for every user and a private key that is shared between the parties of that transaction. The programmable smart contracts can store different types of information, automatically verifying and enforcing the data that has been predefined.
Perhaps, most importantly, the integration of blockchain-based systems into existing traditional financial ones can significantly reduce errors made and the need to reconcile transactions.
These systems would not only benefit the end user, but also, potentially open up new avenues for traditional financial institutions to garner additional revenues from new products like tokenised assets and real-time asset management.
Integration imagined
The existing rails to facilitate cross border payments typically require a timeframe of around two to seven days, with around US$40 billion taken by middlemen and financial institutions in fees. A blockchain-based system would entirely eliminate these costs, while allowing real-time gross settlement between banks.
Meanwhile, the global corporate lending market is projected to reach US$47.2 trillion within the next decade, but is still plagued with many of the inefficiencies that hinder the user experience. For instance, those without access to a bank account are entirely excluded from the financial system, and the everyday user is subject to high costs of borrowing and collateral requirements.
If the rapid growth of decentralised finance, or DeFi, protocols have shown us anything, it’s that there’s a more efficient way of doing things. The total value locked across all chains now stands at US$58 billion – a far cry from the US$160 billion at the end of 2021, but still representative of the substantial value these blockchain-based lending markets have to offer.
As the industry evolves, we’ve seen these protocols become more inclusive, and actually build tools that would onboard traditional finance players into the space. A number of DeFi companies have created whitelisted pools which institutions can gain access to after a Know-Your-Customer/Anti-Money Laundering (KYC/AML) screening process. Alkemi Network, for instance, is focused on building infrastructure to be one of the first “bank-grade” DeFi protocols.
Lending platforms like Aave and Compound let users borrow funds using their crypto assets as collateral and lend their crypto at rates that traditional finance would find hard to compete with.
In May 2021, Aave began testing a private lending pool with KYC and AML restrictions in place so that institutions could get a taste of the DeFi ecosystem. Compound unveiled Compound Treasury in June 2021, with the aim of providing non-crypto native businesses and financial institutions access to the benefits of its decentralised protocol.
On-chain marketplace Maple Finance has launched blockchain-based U.S. Treasuries, that has attracted millions of dollars in deposits and a direct lending arm targeted at Web3 firms.
Bridging the gap
Blockchain is the backbone of the crypto industry, but it can also be a revolutionary tool for the users and controllers of the financial services industry. By introducing open banking standards with programmable smart contracts, that will allow standardisation of existing processes, financial markets can become more liquid and more accessible.
A decentralised and transparent platform could revolutionise the way trade agreements are made, asset servicing and custody, as well as loan syndication and underwriting. Tokenising real-world assets and rapid cross-border transfers would create more efficient financing structures through secured networks.
In short, data runs the financial world today, and it may not be long before everything that runs on data, runs on blockchain.
Words: Samyuktha Sriram
