FinTech Series | DLT and Blockchain

Part 4 — Blockchain’s Real-World Potential in FinTech

In the previous installment we looked at some of the key FinTech segments and we now move onto the emerging tech most often associated with the industry, namely Distributed Ledger Technology (DLT) or blockchain.

While blockchain’s components — such as cryptographic hashes, distributed databases and consensus mechanisms — are not new. Their combination creates a powerful form of data sharing and asset transfer, capable of eliminating intermediaries, central third parties and expensive reconciliation processes.

Blockchain Market Analysis and Use Cases

The global technology research firm, Gartner, estimates the blockchain market will be worth roughly $23 billion by 2023, as a way of comparison the estimated business value created by AI is $3.9 trillion in 2022.

The Cambridge Judge Business School Report, ‘Global Blockchain 2017’ found:

• Financial and insurance-related DLT use cases are the most heavily targeted industry sectors.
• 30% of identified DLT use cases are related to banking and financial services, followed by government (13%), insurance (12%) and healthcare (8%).
• While the majority of infrastructure providers have a generic solution that can be applied to any industry, half of them target a specific industry sector or business.

EY’s Global Blockchain Benchmarking Survey of 2017 asked survey respondents to self-classify themselves as either software vendors or platform operators.

• 75% of study participants self-classified as software vendors
• 41% said they are operating a platform.
• 27% consider themselves to be both software vendors and platform operators.

The survey found that many DLT firms (11 per cent) have not yet decided on where they want to competitively position their firm within the DLT ecosystem.

There are four main categories for blockchain use cases:

• platform
• interfaces
• infrastructure and network
• security & analytics

Companies with open platforms mainly provide consulting services to corporate customers to help them build complex DLT solutions. These consulting services cover the entire lifecycle of a DLT project, from ideation sessions, feasibility studies, and the development of simple proofs-of-concept to the full design and deployment of a distributed ledger system in production use.

In general, it can be observed that monetisation of both open and closed platforms primarily occurs at stack levels higher than the core protocol layer. Many infrastructure providers are ‘moving up the stack’ by increasingly focusing on developing custom networks and applications on top of their core software platform for customers and clients. This means that a growing number of infrastructure providers are becoming full-service providers that use their platforms to offer customers a turn-key DLT solution.

Operators composed of established banks and technology firms are primarily focusing on DLT applications for digital identities and regulatory compliance, whereas ‘start-up operators’ are mostly engaged in activities related to capital markets. Application developers are currently most frequently involved in developing applications for insurance and regulatory compliance.

Blockchain for Banks and Financial Services Providers

There are two main ways in which DLT or blockchain can be of benefit to FS providers. Firstly, banks make money from the interest spread between the lender and the borrower. The spread which represents the profit for the banks has a major cost factor: the operational cost. This cost structure can be addressed by using blockchain technology. The second part is about KYC and AML processes. Again, blockchain can make this process more efficient.

Specifically, blockchain technology could assist with the following key services for banks:

Payments: A decentralised ledger for payments could facilitate faster payments at lower fees.

Clearance and Settlement Systems: Distributed ledgers can reduce operational costs and bring us closer to real-time transactions.

Fundraising: Initial Coin Offerings (ICOs) offer a new model of financing that unbundles access to capital from traditional capital-raising sources.

Securities: By tokenising traditional securities such as stocks, bonds, and alternative assets, blockchain technology could create more efficient, interoperable capital markets.

Loans and Credit: By removing the need for centralised gatekeepers, blockchain technology can make it more secure to borrow money and provide lower interest rates.

Trade Finance: Blockchain technology can create more transparency, security, and trust among trade parties globally.

Of these areas blockchain is most heavily involved in payments:

Mobile money — P2P Transfers: simple, reliable, cost effective and fast but are at risk of fraud and have a lack of interoperability and relatively low usage rates

Digital payments and remittances: lowers costs, higher transparency and higher privacy, savings in time and travel costs but have data security risks.

Blockchain Future Predictions

Despite blockchain’s tremendous potential for data accessibility, privacy remains a large concern on public blockchains. While the goal is to democratise data, the presence of possibly sensitive data from IoT and other devices could raise some privacy issues for individuals and organisations alike. Private enterprise blockchains that limit the availability of data to only those who own the chains goes some way to addressing concerns in this area.

Additionally, scalability remains an issue on major blockchains, which were not built to handle the massive demands expected of them currently. Ethereum, one of the most popular blockchains for development, can still only process roughly 15 transactions per second (TPS), Visa averages 1,600 transactions.

One reason for the lack of large-scale deployments is the reluctance of operators and prospective users to commit to a particular DLT platform and risk vendor lock-in. Similarly, many companies are experimenting with multiple competing open frameworks and platforms to gain the necessary expertise.

Another commonly cited issue is interoperability. A number of financial institutions have created their own blockchain projects that use permissioned networks, allowing access only to certain users. This is encouraging for the advancement and adoption of the technology, but it creates islands of information, a situation the technology was originally designed to avoid.

At the foundational research level, topics such as security, privacy, scalability, decentralised systems, trust, identity, risk and automation as they relate to financial services have all been studied. Key stakeholders including regulators, institutions, academia, industry and the public require cutting edge research and insights for continued developments to encourage greater adoption of the technology.

Ultimately, true advancements will emerge from the intersections of different disciplines. Interfaces of blockchain technologies with other technologies (AI, ML, IoT) need to be explored as the field moves to actual design and engineering.

Next in this series, I will examine what we can expect next from FinTech and how financial services will be transformed. You can revisit the beginning of this series in the first part introduction on Medium.