How Will Blockchain Revolutionize the Financial Industry?
By Syed Hassan Ali Rizvi on The Capital
BLOCKCHAIN: AN INTRODUCTION
What began as the technology to fuel cryptocurrencies, blockchain has now become a need for every industry. From healthcare to the food industry, every sector is starting to realize the potential of Blockchain and how it can revolutionize the world. Blockchain has changed the way data is stored and shared around the world.
The beauty of Blockchain lies in the simplicity of its mechanism. Blockchain consists of a set of blocks that contains data and these blocks are connected in a chain-like structure. Each block in the blockchain has its own encrypted hash, the hash of the previous block, and data. A hash often described as a “fingerprint,” is a secured 64-digit encryption which describes the block and all of its content. This 64-digit encryption, also known as a hash, is the bridge between two sequential blocks, thereby securing the blockchain. The unique property about blockchain is that it’s a decentralized public ledger which means that everybody with access can see the data, therefore
restricting a central authority to control it. In addition to being decentralized, the data in the blockchain is stored within multiple sources, such as computers and nodes. The ability to have multiple channels store data makes it easier to get the original data back if the data is modified
or breached.
Even though blockchain’s recent popularity has given way to a new technological space, the concept is fairly old and dates back to 1991. The concept behind blockchain was introduced by Stuart Haber and Scott Stornetta in 1991 to timestamp digital documents in order to avoid tampering of digital data. Blockchain remained unused until it was later used by Satoshi Nakamoto for Bitcoin.
In the past year, many industries have been looking to integrate blockchain technology to revolutionize their respective sectors. However, blockchain’s application has mostly evolved around the financial industry partly because of Satoshi’s invention of Bitcoin and the popularity that came with it. Cost and speed of transactions, security, transparency are all areas where the financial sector needs improvement. All of these things combined became the reason Bitcoin came into existence. This is important since the financial industry is at the core of how businesses and the world economy works. Hence, in the next 3–5 years, it’s critical to look at how blockchain can revolutionize the financial world.
When people talk about “revolution,” some have the premise that “revolution” is merely a positive change that a concept brings about in a particular area. However, the word “revolution” can also be categorized as to how an idea can bring about negative changes in a particular area. Therefore, there are some advantages and disadvantages that go along with the implementation of blockchain in the financial sector. In addition to the advantages and disadvantages of blockchain, the global effects of blockchain in the financial industry need to be considered in order to fully grasp the revolution blockchain can bring about in the financial sector.
At the time, the FinTech (Financial Technology) space is already implementing blockchain to disrupt the financial sector. According to a PWC(Price Waterhouse and Coopers and Lybrand) study, about 77% of the financial institutions have moved to blockchain. Therefore, it can be
predicted that blockchain, in the next 3 to 5 years, will revolutionize the financial industry by making it efficient, faster, and secure.
ADVANTAGES OF BLOCKCHAIN IN THE FINANCIAL INDUSTRY
CROSS BORDER PAYMENTS
Arguably the most important problem blockchain can solve is the problem of sending money across the border from a country, that is, cross border payments. Using the traditional financial system, sending money across borders takes up time and money. There are multiple intermediaries like banks and other companies who have to verify the transaction first before it goes to someplace else. This not only takes time but also involves a lack of transparency which makes people lose their trust in banks and other financial institutions. In addition, sending money across borders is highly expensive for most people. Even worse is that business dealers can’t trade with third-world countries that don’t have proper banking systems thereby preventing businesses from expanding globally.
To combat this problem, blockchain can be used to send money across borders efficiently. Using blockchain would make it easy for people to make a direct connection with each other digitally which makes sending money easy. There will be no intermediaries involved as blockchain would verify transactions in a matter of seconds rather than going through all levels of intermediaries to verify transactions. Eliminating intermediaries eliminates the need to spend
huge amounts of fees for cross border payments. Since blockchain is a decentralized distributed ledger, everybody can see how and when a transaction is being made which eliminates the lack of transparency involved in any transaction. In addition to that, blockchain’s “hash” encryptions
make the transactions across borders safe and secure which in turn increases satisfaction and security of customers.
ACCOUNTING AND AUDITING
For many banks, accounting and auditing are at the core of what they do. Today, account and audit processes can still be flawed or tampered. This means that reports can have deceiving numbers that do not paint a true picture. However, blockchain allows for fully transparent audits.
The implementation of blockchain can be seen to improve accounting and auditing in the coming years. Since blockchain has a decentralized system, it can store the transactional history automatically. Doing so will eliminate human errors as everything is being done by the blockchain algorithm itself. Blockchain’s peer-to-peer system will ensure that data is stored among multiple nodes/computers. In this way, if a hacker breaks into the system, other nodes can verify the change taking place and will instantly replace the tampered data with the original one. In addition, blockchain’s immutability prevents intermediaries from tampering with the transactional history or data. Aside from being secured and saving transactional history efficiently, another great benefit of blockchain is its ability to increase transparency since blockchain is a decentralized distributed ledger.
ELIMINATION OF FRAUD
Even though people argue that Blockchain is an “immature” technology, blockchain still has the potential to reduce fraud from cyberattacks and hackers. Our current financial sector works on a centralized system which makes it more prone to failure as there is only one point of failure instead of many points. This makes it easy for cyberattackers to breach into the system and steal all the personal data of customers. Because blockchain is decentralized, they don’t have a single point of failure and cannot be changed from a single node/computer. It would require 51 percent of blocks to get changed in order to alter a blockchain. That’s why the financial industry is highly interested in blockchain in their industry since more than 45% of financial intermediaries such as stock exchanges and banks suffer from cybercrime.
An example of how fraud can be reduced in the financial sector is AML (Anti Money Laundering). AML is the process of preventing criminals from disguising illegal income as being legal. Because the data on blockchain spreads across multiple nodes/computers, it can detect if there’s any unauthorized change in data. If an unauthorized change happens, the nodes help to revert the data to its original form. Another benefit of using blockchain in AML would be to use smart contracts. Smart contracts are tiny computer programs sitting on a blockchain which run when specific conditions are met, therefore, smart contracts can be used to detect a suspicious transaction and remove it from the blockchain
KYC (Know Your Customer)
KYC or Know Your Customer is a critical process for many banks, financial industries, and businesses to identify their clients in order to minimize financial crimes and money laundering activities. With the current financial system, financial institutions spend between $60 million and $500 million to keep up with the KYC. Since blockchain is a digital distributed ledger across many platforms, it would allow independent verification of one client from one organization to be accessed by other organizations as well. Therefore, the amount of money spent by financial institutions on KYC can be reduced significantly through blockchain.
FASTER TRANSACTIONS
The most important benefit that blockchain can provide to financial institutions is the ability to speed up transactions. With a centralized system, customers have to wait days in order to get their transactions processed since there are many verifications that the banks have to perform in order to consider the transaction valid. Blockchain has the ability to complete transactions in seconds. Therefore, people don’t have to worry about their transactions being delayed by financial institutions and wait in long lines of banks. In addition, blockchain is secure which removes people’s doubts about their transaction being hacked or tampered with.
CHALLENGES OF BLOCKCHAIN IN THE FINANCIAL SECTOR
Blockchain being an evolving technology, it still has a huge room for growth and improvement. With any new technology, comes adaptive measures and impediments. It is important to understand the challenges that financial institutions may face due to a blockchain approach.
NEW LEARNINGS BRING NEW CHALLENGES!
Because blockchain is a relatively new technology in the financial sector, introducing blockchain would be a technological challenge. This would require a revamp of the entire infrastructure in place. Since this can’t be done overnight, it is a rigorous and expensive process to restructure the infrastructure and resources. Therefore, blockchain may take time for financial institutions to adapt.
LACK OF SECURITY
Even though blockchain is deemed to be cryptographically secured, there’s still some doubt that blockchain is not as secure as it could be. With blockchain, hackers can get control of the entire blockchain in the case of a “51 percent” attack. The “51 percent” happens when hackers get control of 51 percent of the network in the blockchain. This allows hackers to add fake transactions to the blockchain and change the data inside the blockchain in their favor. The probability of the “51 percent” attack is rare since the hackers have to hack the network all at once and in a short period of time, however, it’s still feared in the blockchain system
COST AND EFFICIENCY
Blockchain technology will reduce costs significantly in the financial industry. However, the infrastructure of setting up the blockchain is quite expensive. It requires many computers/nodes to be set up to make it more decentralized and less prone to failures by hackers. Therefore, financial institutions might not invest in a technology that is still evolving.
THE GLOBAL IMPACT OF BLOCKCHAIN
If developed countries move to blockchain technology in the financial sector, third world countries would have to move to blockchain technology as well to allow for businesses with developed countries. This poses a challenge for third world countries since these countries are still keeping up with the pace of the developed countries in the IT field and introducing blockchain in their financial sector would be a “shock” to them. Some third-world countries don’t even have access to basic banking systems which will make it even hard to get around with blockchain. In addition, moving the financial industry to the blockchain infrastructure would be costly which might take a toll on their economy for some time. Therefore, for third world countries to move to blockchain in the financial sector would be a hindrance for them to manage businesses with other developed nations.
Another global impact would be on the jobs of many bankers and employees in the financial institutions. If blockchain is correctly implemented in the financial sector, bank tellers, auditors, accountants, and other employees in the financial institutions might lose their job since blockchain is doing everything for them. Therefore, financial institutions would have to either invest in blockchain technology or continue employing people in order to operate the current financial system.
However, the disadvantages of blockchain are not as dangerous considering its advantages. Introducing blockchain in third world countries would make it easy for people to make direct payments to other businesses locally or overseas, therefore, this would increase business expansion. This is an advantage for many third-world countries since the idea of a basic banking system is either rare or not at all in third world countries. In an effort to send transactions, people don’t have to worry about transaction fees or wait in long lines outside the bank. Therefore, this would motivate businesses in third-world countries to work with developed nations efficiently and securely. Even though third world countries might have to take some time to fully move to blockchain technology, it provides third-world countries to expand their businesses globally and make payments easily and efficiently.
REAL-LIFE EXAMPLES OF BLOCKCHAIN IN THE FINANCIAL SECTOR
MONEYMATCH: A CASE STUDY
Traditional financial institutions in Malaysia tend to focus on companies or customers that tend to send higher volume transactions and higher fees. This poses a problem to Small Medium Sized companies (SMEs) since they send small volume transactions to their suppliers and are on a budget that doesn’t allow them to pay as much fees as the large enterprises do.
Because of these problems, MoneyMatch, a cross border transfer service, partnered up with the Ripple cryptocurrency and helped SMEs send their small transactional volumes across global suppliers with little to no fees since Ripple operated on blockchain technology. Furthermore, Ripple helped MoneMatch to connect SMEs to more global suppliers to expand their business. Another great benefit of the partnership between Ripple and MoneyMatch was that it reduced the amount of time it took for the transaction to get verified. Usually, any transaction made by a company has to go through a long list of checks before processing the payment to the other side, however, with the blockchain technology of Ripple, it was made easy.
ROYA MEHBOOB’S AFGHAN CITADEL SOFTWARE COMPANY: A CASE STUDY
A very good example of how blockchain would impact the world globally is how Roya Mehboob, an Afghani woman entrepreneur, implemented blockchain to fuel her business. Because she lived in a third-world country, she didn’t have access to a basic banking system. Living in a society where women weren’t allowed to do business with overseas clients, it was difficult for Roya to find potential clients for her business. Even though she was able to find some projects for her business, she wasn’t able to control and secure her projects’ finances. All of these circumstances hindered her progress in becoming a successful Afghani entrepreneur.
Implementing blockchain technology helped her business tremendously. Before implementing blockchain, it was hard for her to take payments for her projects, control her finances, and pay her employees. Through blockchain, she was able to take direct payments from her clients and pay her employees on time without the need for any third party. Also, she didn’t have to worry about unethical practices involved in a transaction since blockchain was decentralized and secure.
Through Roya, many Afghanistani women entrepreneurs implemented blockchain technology in their own businesses. This made them feel empowered since they were in control of their own finances. They were assured that blockchain kept their payments safe, therefore, providing motivation for Afghani women to do business and interact with clients. All of the benefits of blockchain helped Afghani women establish successful businesses in their country. Not only was it beneficial for the women in Afghanistan but also for developed countries since developed countries were able to expand their business and see the untapped potential in a third world country.
On the other hand, introducing blockchain to Afghani women was difficult since they weren’t up to date with the current technology. It got even more difficult since women didn’t know how banking systems even worked. Even though blockchain helped establish many successful businesses for Roya and her fellow entrepreneurs, the demand for basic employees in the financial institution, for example, bank tellers, auditors, went down. This meant that people who are well versed with the banking system might not get a job which will make it difficult for people who have expertise in the financial sector to work with clients overseas.
CONCLUSION
Even though many famous financial institutions are implementing blockchain, it’s still an evolving technology and has room to grow before it can be fully integrated. It’s not crystal clear what to expect when implementing blockchain technology in terms of potential security risks, infrastructure costs, and privacy. However, blockchain has all the features of disrupting the financial sectors, and its advantages outweigh its disadvantages. Therefore, it’s important for financial institutions especially in the FinTech (Financial Technology) space to implement this technology and reap its benefits in the next 3–5 years. Moreover, as this technology develops, we have to address the socio-economic challenges that this technology might bring as well.
Links
- https://www.teampay.co/insights/how-blockchain-will-change-finance/
- https://atozmarkets.com/news/how-could-blockchain-technology-change-finance/
- https://techcrunch.com/2016/02/03/lets-be-honest-about-the-problems-with-blockchain-and-finance/
- https://themerkle.com/how-blockchain-is-changing-finance/
- https://www.yourtrainingedge.com/the-potential-impact-of-blockchain-on-financial-sector/
- https://knowledge.wharton.upenn.edu/article/blockchain-will-impact-financial-sector/
- https://www.youtube.com/watch?v=Z-Hct2PZNPs&list=PLpndQ-APwbNUvxtClWIrJCCP8lDY9g-6X&index=599
- https://ripple.com/insights/moneymatch-works-with-ripple-to-provide-cost-effective-global-payments-for-smes-in-malaysia/?fbclid=IwAR2kb4CoSRdky2MKz9rbBcpUO9tCXXU62PZOcfL7LbGDFXp7upvWUk1xlWA
- https://yourstory.com/2019/10/fintech-blockchain-technology
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