How Blockchain is Impacting the Finance Industry
If you’ve been following financial news for the past few years, you’ve probably seen references to the ‘blockchain’, especially when it comes to cryptocurrencies like Bitcoin. But what exactly is blockchain and how does it work? Here’s a look at what every investor should know about blockchain for businesses.
What is blockchain?
While the inner workings of the blockchain can get a bit technical, in essence, this technology is simply a new form of database. It is used to store information electronically, like any other database. But while traditional systems use a centralized database, blockchain technology distributes your data across multiple points of authority. Information can be updated on multiple computers on a network, therefore allowing any authorized person to view the entire financial ledger without an intermediary.
In this context, there are different categories of blockchains:
Access to the blockchain is open, allowing everyone to participate. Bitcoin works with this type of open-source blockchain, for example.
This type of database restricts access only to authorized users on a private network. Moreover, this type of blockchain is used in the most sensitive banking or financial sectors. Those outside the trusted network cannot see the transaction book.
Also known as a “sidechain,” this type of hybrid setup allows different blockchains, private and public, to interact with each other. It allows transactions to take place between different blockchains.
How blockchain works
To better understand how blockchain works, it is useful to distinguish between this type of architecture and a traditional database. A blockchain is made up of groups of data called blocks. Each block has a storage limit, and when that limit is reached, the block is chained to another full block. Together, these blocks of data make up the blockchain.
This is an important aspect of what sets a blockchain apart: once a block is full, you can’t go back and change its content. It can only be written once and then modified or supplemented. In contrast, a database structures the information in tables that can be modified as needed. Moreover, a blockchain is an irreversible timeline that cannot be changed later. Each block is assigned a timestamp for reference, creating a useful audit trail for any user authorized to access it.
There are many potential benefits of using a blockchain, including:
- Increased efficiency
- Faster processing speed
- Reduced errors
- Better customer experience
- Faster transaction settlement
- More secure transactions
Use in finance and banking
You can see these benefits at work by applying blockchain to the banking industry. In traditional circumstances, it can take several days for funds to appear in your account. Banks process an extremely high volume of transactions every day, which is equivalent to the standard processing time.
When banks integrate blockchain technology, transaction processing times are drastically reduced. Whereas in a controlled network, you simply add a new block to the existing chain, including all the data related to your transaction. This is almost instantaneous, without having to wait for central processing. Institutions on the blockchain can also exchange funds between themselves.
Liquidation and dispatch of shares can take up to three days. Meanwhile, his money and his shares freeze. At best, this can be inconvenient and, at worst, pose a significant risk. However, blockchain applications can reduce third-party involvement for optimized services. Many financial platforms are already experimenting with this technology, including the Chinese bank WeBank and the Australian Stock Exchange.
How to invest?
It is a common misconception that blockchain and Bitcoin are the same. In fact, blockchain is the technology that lays the foundation for digital currency trading.
While government-backed currencies like the US dollar and the Federal Reserve are in control of a central authority system. The cryptocurrency is blockchain-compliant. This means that you can operate without a central authority, meanwhile reducing risk and eliminating transaction costs. You can invest in blockchain technology by buying cryptocurrencies, as the higher demand for cryptocurrencies increases the value of blockchain. As a result, Bitcoin is an investment in the blockchain.
Established companies like IBM and Intel are investing heavily in commercial blockchain applications. Therefore, you can consider acting yourself as a direct investor for blockchain application startups or buying shares in established IT companies that are entering the field.
Ultimately, blockchain may still be an emerging technology, but it is rapidly becoming legitimate as its applications expand. By reducing human errors and manual manipulations, it offers a way to increase the financial efficiency of online transactions.
How does blockchain impact capital markets?
Capital markets refer to the matching of issuers with the demand for capital, investors with the corresponding risk and return profiles. Whether the issuers are entrepreneurs, startups, or large organizations, the process of raising capital can be difficult. Companies face increasingly stringent regulations, longer time to market, volatile interest rates, and liquidity risk. In emerging markets particularly, they must overcome the lack of rigorous supervision, in-depth regulation, and sufficient market infrastructure for issuance, settlement, clearing, and trading.
So, blockchain offers multiple benefits for various capital market use cases:
- Elimination of a single point of failure with decentralized public services
- Facilitate capital market activities by optimizing processes, reducing costs, and reducing settlement times.
- Digitization of processes and workflows, reducing operational risks of fraud, human error, and general counterparty risk
- Digitization or tokenization of assets and financial instruments, making them programmable and much easier to manage and trade. Symbolically, they gain greater market access through greater connectivity and the possibility of fractional ownership. This translates into greater liquidity and a lower cost of capital.
How does blockchain impact asset management?
Private equity firms, real estate funds, and niche markets face demands to improve liability risk management, adapt more dynamic decision-making structures, and cope with the complexity of growing and changing regulations.
Unlike traditional currency, blockchain can effectively streamline asset and stakeholder management. It allows:
- Automated fund launch
- Transparent stakeholder engagement with digitized assets and services
- Digitization of the portfolio and existing holdings for greater market access, liquidity, and division
- Customizable built-in privacy settings for transaction privacy
- Voting and other shareholder rights and obligations are programmed into digital assets. This enables a seamless user experience and reduces the risks of human error.
- Creation and application of incentive mechanisms to promote participation and sanction harmful activities
- Improved governance and transparency for investors and stakeholders
- Efficient management of the capitalization table
- Automated fund management
- Automated transfer agency in asset management
How does blockchain impact banking and lending?
Basic banking services include transaction, loan, mortgage, and payment services. However, these services depend on legacy runtime processes. For example, between information verification, credit rating, loan processing, and fund distribution, it takes people 30-60 days to obtain a mortgage and 60-90 days for small or medium-sized businesses to obtain a business loan. On the other hand, blockchain can streamline banking and loan services, reducing counterparty risk and shortening issuance and settlement times. It allows:
- Authenticated documentation and KYC / AML data, reducing operational risks and enabling real-time verification of financial documents.
- Optimized credit prediction and credit rating markets, instantly informed by the collection of user activity and authorized data over a network
- Automated union formation, fund subscription, and disbursement, that is payment of principal and interest, reducing unionization costs, delays and friction.
- Facilitation of asset collateral, as digitization enables real-time asset management, monitoring, and enforcement of regulatory controls.
How does blockchain impact trade finance?
Trade finance refers to the infrastructure, processes, and finance that support international trade supply chains. The industry continues to rely on paper-based processes that are susceptible to security vulnerabilities. Individual transactions can take 90-120 days to process letters of credit, verify documents, and build trust among stakeholders. Whereas blockchain can digitize the entire life cycle of trade finance with greater security and efficiency. It can enable more transparent governance, reduced processing times, lower capital requirements, and reduced risks of fraud, human error, and overall counterparty risk. It allows:
- Digitized and authenticated documentation (i.e. letters of credit and bill of lading) and KYC / AML data with real-time verification of financial documents
- Asset digitization to enable faster settlement times
- Creation of more efficient financing structures through shared secure networks and digitized processes.
- Creation of a cohesive financing vehicle for the entire commercial life cycle, eliminating the traditional practice of negotiating independent financing vehicles for each stage of the commerce.
How does blockchain impact insurance?
General insurance claims are prone to fraud and the evaluation of claims can take long periods of time. Blockchain can safely streamline data verification, complaint handling, and disbursements, dramatically reducing processing time. It allows:
- Authenticated documentation and KYC / AML data, reducing the risk of fraud and facilitating claims evaluation.
- Automated complaint handling with the use of smart contracts
- In case of certain risks, pay parameterized automated contracts
- Automated disbursement of insurance payments
- Tokenized reinsurance markets to facilitate policy reinsurance in open markets, moving away from traditional brokerage and relationship systems