INTRODUCTION:
In the fast-paced world of modern banking, payment technology has undergone a revolution, transforming the way people conduct transactions. Gone are the days of solely relying on physical cash or checks; today's banking landscape is dominated by digital payment solutions that offer convenience, security, and efficiency. The rise of mobile banking applications, contactless payments, and digital wallets has made it easier than ever for customers to manage their finances on the go, enabling all-in-one transactions at the tap of a screen. These advancements have empowered customers and opened new opportunities for financial institutions to modernize operations and offer innovative services.
Both retail and financial banking institutions can leverage consumer innovations in their business models. We ask the question: how do digital payments impact large international banking businesses such as capital markets, foreign exchange, and derivatives? The answer is blockchain.
BLOCKCHAIN BASICS:
Blockchain technology stands at the forefront of payment systems within the banking sector. While many associate it primarily with cryptocurrencies like Bitcoin, its implications go far beyond. At its core, blockchain is a secure and transparent way to record transactions.
It operates as a distributed ledger, storing data across multiple nodes or computers. This structure ensures that once a transaction is added, it cannot be altered without consensus from the entire network. The decentralized nature of blockchain means no single entity has control, promoting transparency and trust. In the banking context, however, many institutions opt for private or centralized blockchains to safeguard sensitive information while still reaping the benefits of the technology.
SMART CONTRACTS EXPLAINED:
Smart contracts represent one of the most innovative applications of blockchain technology. These are self-executing digital agreements that automatically carry out the terms set within them. Essentially, they function as programmed contracts that activate once specific conditions are met. For banks, this means automating and streamlining payment processes, ensuring that contractual obligations are met seamlessly and without error. As the banking sector delves deeper into blockchain, smart contracts are poised to redefine traditional payment systems, offering a more efficient and reliable approach.
BENEFITS FOR CAPITAL MARKETS:
What does the capital market structure look like with blockchain applications?
There would be no need to operate data normalization, reconcile internal systems, or agree on exposures and obligations. There would be standardized processes and services, shared reference data, uniform processing capabilities, and near real-time understanding of counterparty risk. Privileged participants, such as regulators, could have access to all data on holdings, among many other improvements.
There are significant challenges to making these changes in such a critical and regulated industry. Technology is advancing rapidly, but acceptance as an industry standard requires validation on a much larger scale. In financial markets, innovations will demand collaboration with regulators. Disruptors move much faster, and the laws defined in multiple regions across the globe will need to catch up. Additionally, industry alignment would be required on specific design points to create a universal standard. There will need to be an explicit agreement on how blockchains will be managed and improved once they have gone live. Such an agreement would consist of governance processes, change control processes, and defined participant roles and responsibilities.
BLOCKCHAIN TODAY:
Although institutional adoption of blockchain technology seems difficult to implement, given the various challenges, financial institutions have begun investing in the future. One example of a project where financial community members are exploring blockchain innovation has taken place at the Depository Trust & Clearing Corp. (DTCC). DTCC, which processes all trades in the US stock market, has launched a private blockchain project to settle equity trades more quickly for their clients. Known as Project Ion, this platform is constructed to support end-of-day settlement, or (T+0) cycles, leveraging blockchain technology. Launched in 2002, Project ION is currently processing 100,000 transactions daily.
Prominent banks are also advancing this technology. JPMorgan Chase, DBS, and Temasek partnered to form Partior, designed to serve next-generation global payments and currencies and transform cross-border transactions. The platform, which the government of Singapore helped to build, also includes the UK bank Standard Chartered as an investor. Partior's primary offering is multicurrency cross-border payments using instant settlement with FX payment versus payment (PvP), which is planned to go live later in the year. Intraday FX swaps are also on the roadmap. In early 2023, Deutsche Bank and SMBC became members of its network.
In addition, Citibank has partnered with NASDAQ on Contour which is a global digital trade finance network powered by blockchain technology that enables multiple parties, including banks, corporates, and logistic associates, to cooperate seamlessly and securely in real time on a single platform. In April 2023, Citi completed its first transaction with a counterparty in India. The transaction demonstrates the strength of digital solutions that offer a safer, faster, and paperless solution for the Letter of Credit transaction between its customers. As a result, Letters of Credit, which can take 10-12 business days, can now be completed in 3 days or less. The company also reports a 50-60% reduction in transaction costs. 3
CONCLUSION:
Blockchain technology is not just a trend but a transformative force reshaping the landscape of modern banking. Navigating digital transactions, blockchain stands as a beacon of efficiency, security, and transparency. Its potential to revolutionize everything from daily banking operations to intricate capital market structures is undeniable. While challenges remain, especially regarding industry-wide adoption and regulatory alignment, the proactive steps taken by financial institutions signal a promising future. As the industry collaborates with regulators and innovators, we stand on the brink of a new era where transactions are swifter, processes are standardized, and the customer experience is enhanced. The future of banking, powered by blockchain, is not just a possibility but is on the horizon.
SOURCES
1. https://www.mdpi.com/2305-6290/6/1/15 (Figure 1)
2. https://consensys.net/blockchain-use-cases/capital-markets/ (figure 2)
3. https://www.nasdaq.com/articles/nasdaq-and-citi-announce-pioneering-blockchain-and-global-banking-integration-2017-05-22
About Monticello
Bip.Monticello, a member of the BIP Group, is a management consulting firm supporting the financial services industry through deep knowledge and expertise in digital transformation, change management, and financial services advisory. In partnership with Bip.xTech, we collaborate with our clients to infuse the spirit of data-driven organizations and build digital solutions, helping them make their operations more efficient and achieve a competitive advantage in the marketspace.