Why Banks Must Embrace Blockchain Beyond Cryptocurrency

Blockchain, unfortunately, has been characterized by the media as valuable for its associated speculative cryptocurrencies that have grabbed headlines and attention due to their volatile nature. In so doing, the coverage has obscured the true value of the underlying, highly innovative, and potentially transformative technology.

For banks, blockchain has a potentially significant upside with key, sector-specific applications such as cross-border transactions, fraud reduction and trade finance, to name just a few. The trust and data security that blockchain enables can benefit financial institutions on a number of fronts. While we’re all digesting the recent headlines about FTX, we’d do well to look at some of blockchain’s potential applications and its likely effect on institutional operations.

Indeed, the use cases for blockchain are rapidly expanding. Yet the core capabilities championed by blockchain enthusiasts have been constant: to enable anonymous peer-to-peer trusted transactions without the need for an institutional intermediary. The cryptocurrencies associated with public blockchains facilitate the payment of fees to the providers of the network protocol supporting the transaction. The low cost of these fees and near instantaneous transactions have the potential to cut out the middleman, but it need not be so.

We’re starting to see rising awareness and use by consumers of cryptocurrencies to instantaneously transact peer-to-peer. This in turn raises consumer expectations for transaction processing by the financial services firms with which they do business. Banks have the opportunity to take advantage of blockchain technology to accelerate transaction speeds and reduce errors and costs. Failure to begin experimentation and preparation now may plant the seeds of future decline and disintermediation by upstart technologies that offer greater convenience.

Cross-Border Payments

Three days to clear a bank deposit? Weeks to gather information and adjudicate a claim? These service levels will soon be a thing of the past. The marketplace will reject these service levels in favor of new service providers that offer a speedier and more consumer-friendly value proposition. Now is the time for financial services firms to prepare their operations for this eventuality.

The most well-known application for blockchain technology in banking is cross-border payments. In its current state, sending money between nations is an arduous process, subject to reconciliation errors and delays. Ripple and Universal Digital Payments Network announced at Davos offer two competing solutions -- one public and the other private -- for real-time cross-border payment and reconciliation. Financial institutions on the cutting edge have already saved $301 million in 2021 by integrating blockchain tech into cross-border payments. However, that’s only a fraction of the technology’s potential. If more traditional banks successfully follow suit, they are predicted to cut cross-border payment costs by upwards of $10 billion by 2030.

Trade finance can also greatly benefit from blockchain technology. They have the potential to simplify and unify the entire process, from negotiation and execution of contracts, all the way to post-trade settlement as payments are automatically triggered by shipping and receiving events with financial reconciliation in real time. By digitizing all documents and automating key processes, blockchain could reduce the time taken to complete a trade from days or weeks to just minutes. In addition, by providing a single shared platform for all parties involved in a trade, blockchain reduces carrying and operating costs. With all data stored on a decentralized ledger, there would be no need for record duplication or costly manual reconciliation.

Finally, blockchain can dramatically overhaul a bank’s lending practices by helping to reduce the costs and time associated with processing loans. This is accomplished by incorporating smart contracts, which can automate many of the manual processes involved in loan origination, including identity verification, credit checks, and documentation. Just like with trade finance, this benefit is twofold; the process is not only more efficient, but it also reduces the possibility of fraud and errors.

Blockchain technology does not shift the benefit from customer to bank or vice versa. It benefits both parties. From a know-your-customer (KYC) and anti-money laundering perspective, it may also benefit governments and become a means by which regulatory compliance might be more easily achieved. While some banks might be concerned that moving to blockchain might negatively affect fee income, it is possible that large banks could offer value-added services to smaller competitors, such as KYC, as a service for a fee. In this context fee revenue would shift, but not necessarily be diminished.

Early proponents of blockchain imagined the rise of DeFi, or decentralized finance, cutting out banks entirely. However, this over-idealized view of democratic finance can only be achieved if it is combined with the security, stability, and liquidity that commercial banks and sovereign central banks provide. Look no further than collapsing centralized crypto exchanges for confirmation. If large financial institutions can embrace blockchain technology and translate the implications of it to operations, new operating models will emerge to accelerate transaction speeds, reduce operating costs, make the data more secure, enable more satisfying customer experiences, and potentially transform revenue opportunities. That’s a recipe for competitive differentiation, growth, and profitability.