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Blockchain Could Transform the Financial Services Industry

by on Firm News. Published August 31st, 2022

Blockchain Finance FI

Blockchain, or distributed ledger technology, has moved beyond its status as just the “backbone” of cryptocurrency and may be poised to revolutionize the financial services industry

Blockchain & Financial Services Key Takeaways:

  • Distributed ledger technology offers the potential to change the way banking, investment services, and payments are managed.
  • Blockchain’s appeal is its potential to cut through layers of inefficiencies and integrate many fragmented operational processes.
  • Companies are also interested in blockchain’s ability to provide full transparency across finance and business operations. But there are also concerns about privacy, data security, and energy usage.
  • Two-thirds of global CFOs surveyed recently believe their companies will “lose a competitive advantage” if they do not adopt blockchain.

Will Blockchain Disrupt the Financial services Industry?

Many analysts believe that blockchain technology has the power to disrupt the financial services industry. Its supporters say it will be a welcome disruption, enabling new efficiencies and higher transparency across operational practices. Blockchain’s unique features—transparency, security, decentralization, and constancy of information—position it to improve some challenges facing the global financial services marketplace. 

Although the technology began with cryptocurrencies as an alternative to “big finance,” it is now viewed by many industry participants as integral to a forward-thinking financial services business model. But it is not without its detractors and challenges. And blockchain’s widespread adoption is expected to be met with new regulations that address specific legal, ethical, and economic issues.

The Rise of Blockchain Technology in Financial Services

Once popular only in crypto or high-tech circles, blockchain has now gained momentum in the business community. The financial services industry, especially the financial technology (fintech) sector, has led other sectors in blockchain adoption. According to Deloitte’s 2018 “Crunch time” report, “Blockchain has the potential to reshape processes that are defined inside finance because of its cost and control benefits.”

Points About Blockchain

The US Government Accountability Office (GAO) offered these points about blockchain in its March 2022 report in response to a Congressional request:

  • Blockchain is not new; it is an “innovative way of using existing, mature technologies.”
  • The core function of blockchain is to create a decentralized “tamper-resistant ledger for digital assets.”
  • Blockchain uses “cryptographic techniques to computationally verify transactions” in an immutable ledger.
  • Blockchain duplicates and distributes data on assets across many computers and users, reducing the likelihood “that a single failure or dishonest user could compromise network integrity or tamper with the ledger.”

Blockchain technology is implemented in one of two ways: “permissionless,” in which access is unrestricted, and “permissioned,” in which access is only granted to specific users. While cryptocurrencies typically use permissionless blockchains, many other transactional applications are permissioned.

Blockchain has the potential to eliminate layers of operational inefficiencies by reducing the need for oversight by central authorities. It enables near real-time transactions, including trading of digital assets, and creates a permanent and irreversible record. 

Applications of Blockchain in the Financial Services Sector

Blockchain has many potential applications beyond its role in facilitating the exchange of cryptocurrencies. The technology is ideally suited for streamlining financial transactions because of its elevated levels of security and permanence. And it has become a potent disrupter of the status quo within the financial services industry by enabling decentralized finance (DeFi) startups. 

According to the Deloitte report, the application of blockchain technology can be introduced to improve “almost any finance process.” Blockchain’s common finance applications include “order-to-cash, trade finance, intercompany transactions, fraud and risk detection, and reconciliation.” Examples of all these applications are being piloted by companies across the globe. According to the Forbes Blockchain 50, companies ranging from Amazon to Walmart are incorporating the technology into their operations. Well-known entries on the list from the financial services sector include Ant Financial, Citigroup, JP Morgan, and MasterCard. 

Smart Contracts in the Financial Services Industry

The employment of smart contracts in many companies serves as an entry point for adopting blockchain. These contracts are currently used in healthcare, supply chain management, government systems, and financial services. Replacing traditional contract transactions with smart contracts can reduce transaction costs, improve security, enable audits, and increase the speed at which deals can be finalized. 

Blockchain’s value is enhanced with other technologies, such as artificial intelligence and automation. Its advantage is the robustness of the technology—it excels in situations where the scale or complexity of a network exceeds the capabilities of traditional tools.

Concerns About Blockchain Technology

If blockchain makes the jump to a mainstream tool, it will be after it clears several hurdles. Enabling blockchain for everyday use will require standardization and simplification of platforms, detailed agreements among blockchain participants, and education to streamline the application for all users. 

Critics of the widespread adoption of blockchain center their arguments on four key points, as summarized by the GAO:

4 Key Points of Blockchain Concerns:

  • Privacy—Blockchain’s distributed nature and mass access lead to privacy concerns, particularly when used to facilitate financial transactions. If the encryption becomes compromised, blockchain users would be looking at a massive security breach and all the liability that entails.
  • Data reliability—During transactions, many external sources can add data to the blockchain. Blockchains, like many other data management systems, are not equipped to check the accuracy of data from external sources. Financial losses and other dire consequences can result if the integrity of the data is compromised.
  • Long-term data security—There is a concern that as technology continues to evolve, the power of quantum computing may be able to “break” the encryption algorithms that keep data stored on the blockchain secure.
  • Energy consumption—There is some evidence that blockchains use more energy than traditional centralized databases. Although the research isn’t definitive, early studies have shown that certain blockchains generate a high level of carbon emissions and may be subject to environmental regulations.

Blockchain and Financial Services – Conclusion

Since the technology is still evolving, establishing clear regulations concerning blockchain may also prove difficult. And any new legal and regulatory aspects will create additional compliance considerations for companies leveraging the technology. 

Nevertheless, there are considerable opportunities to harness this technology for competitive advantages that go along with the responsibilities of ensuring its appropriate use. 

The attorneys at Johnston Clem Gifford routinely advise clients on emerging technologies, regulatory compliance, and other supervisory and governmental matters. Our Financial Services team works with the world’s largest institutions as well as smaller and middle-market firms. Contact us online or by calling (214) 974-8000.

Photo by Peio Bty on Unsplash