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Blockchain in banking: Bitcoin and beyond

'Blockchain' has become the buzzword in the financial world since the time it debuted in 2009. Blockchain is thought to be so impactful that it is considered to be the next big thing after the internet.

Till date, the most prominent use of blockchain is for payments of bitcoins. Though bitcoin has the advantage of being transferred instantaneously, it has not made significant progress as a well-accepted currency. Bitcoin has neither caught up as a preferred means of transaction, nor is it expected to replace the existing currency system.

Though banks, customers and regulators have largely stayed away from bitcoin, the underlying technology used to conduct bitcoin transactions - blockchain, and the concept of distributed ledger has started getting industries thinking on how this new technology can be used to their advantage. Though its wide stream application is still to be seen, banks have started realizing the power of blockchain and are contemplating investing in the technology. Banks are now betting on blockchain as a reliable alternative to processes that are intermediary-dependent and effort intensive.

What is Blockchain?

Blockchain is an electronic distributed ledger for all bitcoin transactions where completed transactions are added in a chain-line linear chronological order as "blocks" of records. Transaction information that is once verified and recorded as a block cannot be removed or modified, thus making them secure and tamper-proof. Each block is linked using a hash address of the previous block, thus sequentially recording the transactions. This ledger is shared by all members (nodes) participating in the ledger network and uses cryptography to protect against any tampering of information.

These cryptocurrency networks can be 'permissionless', meaning, anyone can perform a transaction or a validation anonymously. There are several risks in this type of blockchain due to the presence of users who are no completely trustworthy.

The 'permissioned' blockchain networks, on the other hand, are those which permit only approved persons or parties to post transactions or validate the network.  Many risks that are present in the permissionless blockchain are done away with, in these permissioned blockchain. Hence this is the preferred choice of banks and regulators alike.

Which industries can be benefitted by Blockchain?

Blockchain is a database and contradictory to popular belief, it is not a finance specific technology. It can be used in any industry where there is a need to store data.

This technology has particularly caught the fancy of financial institutions, but now more and more non-financial sectors like retail, real estate, insurance are taking the baton. To generalize, it can be said that blockchain technology can be used in any industry that has a lot of record-keeping and repetitive documentation.

In banking particularly, though blockchain technology can be used in any banking process, it is thought to have a greater impact on the back-end clearing and settlement process than the front-end processes.

The potential of blockchain need not be limited only to one industry. Cross industry implementation of blockchain is another way this disruptive technology can be explored.

Regulatory aspects

Though it has the disadvantage of being slightly risky due to the absence of regulatory bodies, there are currently no regulations in place for the use of blockchain technology. European Securities Market Authority (ESMA) is currently taking a 'wait and see' regulatory approach to blockchain, while Financial Institutions Regulatory Authority (FINRA) has warned that mismanagement in blockchain could increase the vulnerability in markets. Whether multiple regulatory bodies or a single entity would regulate and govern the blockchain use, is yet to be decided. The presence of a regulatory body would definitely help as they would then mandate standards for interoperability as well as sharing of costs/revenues.

Banks must not overlook the regulatory uncertainty that is still prevailing in this area and hence must exercise caution when experimenting in blockchain.

Conclusion

Blockchain is not just a new technology, it is a very exciting technology to begin with. It can improve as well as disrupt several industries. It is also something that banks and other industries still have to explore deeper. Industries need to partner and collaborate with technology providers/start-ups and regulators and ideate on how this new disruptive technology can be leveraged to its true potential. Demonstrating this successfully can not only help organizations cut on infrastructure and processing costs, but also improve customer experience.

However, organizations should not rush to adopt Blockchain, without establishing a solid business case and benefits. They must carefully strategize and identify the area of operation that would most benefit from this technology. Remember, blockchain is not the answer to everything!

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