Banks and Blockchain: A Transformational Technology

By Jason Bomers and David Uhryniak
12/20/2018
Banks and Blockchain: A Transformational Technology
Blockchain technology is poised to transform the banking and financial services industries, enabling businesses to do things that were impossible before the technology was developed.

Although much of the initial public attention to blockchain revolved around its role in bitcoin transactions, the eventual impact of this technology will extend far beyond cryptocurrencies alone. Today’s leading financial services organizations are finding innovative new applications for this breakthrough technology, which has the potential to fundamentally transform the way they do business.

Beyond the hype – blockchain’s potential

As is often the case with new technology, the early days of blockchain’s development saw a fair amount of speculation and exaggerated expectations. Today, however, most objective industry observers are coming to regard blockchain as a technological innovation that has the potential to be more than merely disruptive – in fact, it has the capability to fundamentally transform the way banking and financial services industries operate.

This growing appreciation of blockchain’s potential is spreading within the banking industry itself. For example, when executives from large banking organizations who were participating in a recent Crowe webinar were asked their opinions about blockchain’s capabilities, fully half of the respondents said they believe it will transform banking over the course of the next 10 years.
exhibit 1
Moreover, nearly all of the remaining respondents recognized that blockchain would generate some change in the industry. Very few (3 percent) believed blockchain would lead to only minimal changes in the years to come. 

It also is instructive to note that when executives from community banks were asked the same question, their responses were nearly identical. The same number (50 percent) said they believed blockchain will transform banking, 44 percent foresaw some change, and just 6 percent said they expect only minimal changes due to blockchain over the coming years.

Demystifying blockchain

It is not necessary to fully grasp all the technical workings of blockchain in order to appreciate its potential, but it is helpful to have a basic, conceptual understanding of how it works. Broadly speaking, blockchain is a combination of technologies that enable transactions and contracts to be executed without a central controlling authority. 

More specifically, a blockchain is a type of shared database that creates a permanent record of transactions. The database is distributed across a number of participants in a network and therefore is not under the control of any single participant. A blockchain network may be open to the public, as most cryptocurrency systems are, or access can be restricted to approved participants only, which is how most corporate blockchain networks are structured. 

While the data within a specific transaction or contract can remain confidential, the ledger entry that contains the encrypted information is transparent to all users. All participants have the same version of the ledger, which is updated in real time with each new entry. Above all, once the blockchain entry is posted on the network, it cannot be changed, so users can rely on the validity, authenticity, and immutability of all entries. These features make blockchain particularly advantageous for handling financial transactions and smart contracts, which require that a specific contract term or “milestone” must be met before the next transaction can take place. 

Transforming financial services business models

Blockchain technology can allow banks and other financial services organizations to do things they have never been able to do in the past. It is this capability that makes blockchain transformational and more than a disruptive technology. Critical features and characteristics that make blockchain so potentially powerful include:
  • Scalability. Blockchain enables businesses to reinvent and automate many deliberate and manually intensive functions, making it possible to increase scale economically. For example, in the past, floorplan lenders traditionally were constrained by the need to perform on-site audits and physically validate their dealers’ sales and inventory records. With blockchain technology, lenders can use smart contracts to enforce loan terms and eliminate the dealer from the sales verification process. This capability not only reduces the costs and constraints of performing physical audits, it also can significantly reduce the potential for fraud.
  • Efficiency. Automating manual and paper-based tasks also reduces costs, and can increase the speed of work processes since intermediaries and manual verification are no longer necessary. This capability is already being demonstrated in the payment processing industry, where blockchain can allow processors to complete payments directly and eliminate intermediary networks. Not only does this capability reduce costs, it can dramatically accelerate the settlement time required for transactions. One large national institution already has reduced average payment times from several days to a matter of just a few seconds, while cutting processing costs by nearly two-thirds.
  • Engagement. Blockchain can give merchants, customers, and lenders better visibility into their various transactions and multifaceted business relationships. This capability can help make loyalty rewards programs more robust, efficient, and appealing to customers, to cite just one example. One major credit card issuer recently launched a customer reward blockchain that enables transaction-level data to be identified and gathered in real time. This not only gives merchants more insight into the impact of their marketing efforts, it can improve the consumer experience by enabling better, more targeted incentives.  
  • Transparency. Using blockchain technology, banks and other financial services providers can now access customer information across their various business units, while still maintaining customer privacy. For example, in many organizations the new customer onboarding process can take a number of days, with customers encountering numerous requests for the same information they already have provided. Blockchain allows banks to share and automatically update customer information among all business units, which streamlines the process, improves the customer experience, and reduces acquisition costs. In addition, it also offers the capability to improve other business functions, including sales, marketing, and compliance with Bank Secrecy Act and anti-money laundering (BSA/AML) regulations.
Blockchain technology also is being used to streamline various lending processes such as mortgage application approvals, title searches and verification, and the disbursement of funds for commercial loans. It also holds particular promise for helping to streamline the processing of syndicated loans, which can enable smaller banks to participate in new lending opportunities by mitigating some of the associated risks.

Getting ready for blockchain adoption

As of now, the U.S. financial services industry appears to be lagging behind other regions in applying blockchain technology, but the trend toward greater adoption is clear. Financial institutions worldwide are currently developing and implementing various types of blockchain infrastructure. The Asia-Pacific region accounts for more than half of these early adopters, while only 13 percent are found in North America. Nevertheless, the number is growing. Furthermore, although payment transactions currently account for more than half of the adopted use cases, other applications such as trade finance and know-your-customer (KYC) verifications are increasing rapidly.

Regardless of the specific application, the adoption of blockchain requires far more than technological expertise alone. For most organizations, the first step is to verify whether blockchain is indeed the most appropriate solution for the particular issue being addressed. To begin making the business case for blockchain, proponents must be able to demonstrate why blockchain would be preferable to using a traditional database for the function in question. Next, proponents must be able to demonstrate potential cost savings, revenue enhancements, or measurable improvements to other critical business metrics. Concerns related to governance, security, audit policies and procedures, and other risk management and control issues also must be addressed. 

For example, although no specific blockchain use cases exist for internal audit or cybersecurity, each has a significant role to play in blockchain development. Internal audit’s function will need to evolve to validate that the individual components of a blockchain are functioning correctly. This includes validating access permission, encryption, and cryptographic code, as well as reviewing the validation of smart contract transaction codes, functionality, and security. The relevant governance, risk management, and control procedures also will require internal audit consideration. 

In a similar way, blockchain can be used to enhance a financial institution’s cybersecurity profile. But at the same time, the use of blockchain will introduce the need for certain additional cybersecurity enhancements. These include applying recognized cybersecurity practices to the validation of permitted users or nodes, as well as validating sound cybersecurity practices in developing smart contracts and managing the necessary external interactions that will be involved in the process. 

While the challenges – both technical and otherwise – can be significant, a number of current use cases suggest the potential rewards of adopting blockchain technology can be dramatic and downright transformative. At a minimum, executive and management teams at financial services organizations should be taking steps to see that they are up-to-date on the growing application of this breakthrough technology.

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Jason Bomers
Principal, Innovation and Transformation Consulting Leader
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David Uhryniak
Blockchain Services Leader