The financial world is no stranger to the transformative power of technology. From the recent popularization of electronic trading platforms like Robinhood and Coinbase, to the rise of algorithmic trading across the financial sector, technology has continually reshaped the way that the financial services industry grows. Today, blockchain technology stands at the forefront of this technological revolution, promising to redefine the operational landscape of capital markets, particularly in the realm of back-office operations.
What is blockchain and how can it benefit banking?
Blockchain is defined as an ever-growing ledger that keeps a permanent record of all network transactions in a secure, unalterable, and chronological fashion [1]. Furthermore, it is a decentralized, distributed ledger system that allows multiple parties to record and verify transactions without the need for a central authority. Blockchain technology's potential to streamline and secure financial transactions has significant implications for back-office operations in capital markets, which are traditionally characterized by complex, tedious, and time-consuming processes with a high degree of manual intervention. Unsurprisingly, this leads to errors, regulatory compliance actions, and ultimately affects banks’ bottom line.
One of the areas where blockchain can bring about meaningful change is in the securities settlement process. Traditionally, the settlement of securities involves a complex web of intermediaries, including brokers, custodians, and central securities depositories. This process is not only time-consuming and costly but also prone to errors and risks. Blockchain technology, with its ability to provide a single, immutable record of transactions, can simplify this process, reduce the need for intermediaries, and significantly lower the risk of errors and fraud [2].
In a blockchain-based settlement system, securities can be tokenized, and their ownership can be transferred instantly and securely over the blockchain. This could potentially enable real-time, or 'T+0', settlements, reducing the counterparty risk and the need for post-trade reconciliation. Moreover, the use of the smart contract technology found in Ethereum can be leveraged. Smart contracts are self-executing contracts with the terms of the agreement directly written into code that can automate many of the manual processes involved in settlements to further enhance efficiency and reduce costs. For example, once the obligations of each contracting party are met, the smart contract will be executed and lead to an automated settlement between the two parties.
Beyond securities settlements, blockchain can also revolutionize other aspects of back-office operations. For instance, it can provide a more efficient and secure way of managing and reconciling internal records, reducing the need for time-consuming manual reconciliation processes. Blockchain can also enhance regulatory reporting and compliance by providing regulators with real-time access to these same internal records. Furthermore, regulators can rest easy knowing that due to the underlying immutability of blockchain, these records were not tampered with.
Market sentiments of Blockchain benefits
The same weakness that banking organizations tend to have with their usually outdated technology makes them a perfect target for the innovation of their systems that blockchain can bring. They also have the ability and appetite for a large degree of spending. This is especially true when an investment can lead to a high degree of cost-savings, which is exactly how these banking organizations make money in the first place. According to Juniper Research, which specializes in identifying and appraising new high growth market sectors within the digital ecosystem, Blockchain is expected to save banks billions annually in settling cross-border transactions [3]. Deutsche Bank, UBS, BNY Mellon, and USAA have been exploring blockchain technology for years. In 2020, more than 8,000 blockchain patents were filed [3]. For example, Deutsche Bank in 2020 tokenized their own Deutsche Bank bond on the EOS blockchain and in May 2023 participated in a successful blockchain government bond trial with the Tel Aviv Stock Exchange (TASE) and the Israeli Ministry of Finance [4]. UBS also began utilizing the blockchain by issuing a $50 million USD tokenized fixed rate note digitized on a permissioned blockchain in December 2022 [5]. It is safe to say that the financial services sector has continued to find blockchain technology useful, and as time progresses, it is exciting to see what else companies will do with this technology.
Despite the natural fit, the adoption of blockchain in capital markets is not without its challenges, and skeptics as it requires an overhaul of existing antiquated systems and processes that have been used for decades. Furthermore, a slew of regulatory issues stemming from concerns over privacy, security, and ill-intent need to be addressed. These regulatory issues often lead to negative press which deters banks. Understanding blockchain technology and separating the core technology from its applications is key to tackling common misconceptions and is pivotal to utilizing this technology for good.
In conclusion, while the road to blockchain adoption in capital markets may be a challenging one, the potential benefits it offers in terms of cost savings, efficiency, and risk reduction are too significant to ignore. As such, capital market firms, regulators, and technology providers need to work together to address these challenges and pave the way for the broader adoption of this transformative technology.
About BIP.Monticello
BIP.Monticello, a member of the BIP Group, is a management consulting firm supporting the financial services industry with its expertise in digital transformation, change management, and financial services advisory. Our understanding of the competitive forces reshaping business models in capital markets and digital banking are proven enablers that help our clients drive innovative change programs to be more competitive and gain market share in new and existing businesses. In partnership with Bip.xTech, we collaborate with our clients to infuse the spirit of data-driven organizations and build digital solutions in areas of AI, Natural Language Processing (NLP) and Machine Learning, helping them make their operations more efficient and achieve a competitive advantage in their Digital Transformation journeys.
Sources:
[1] Tera Cademy (2021). Blockchain Technology and its applications in 2021 [Webinar]. Skillshare. https://www.skillshare.com/en/classes/Blockchain-technology-and-its-applications-in-2021/516420909
[2] Bauvars, J. (2021). Applicability of Blockchain Technology in Securities Settlement. Complex Systems Informatics and Modeling Quarterly, 36-57. https://dx.doi.org/10.7250/csimq.2021-28.03
[3] Juniper Research (2021). Blockchain - Seizing the Finance Services Opportunity. [White Paper] https://www.juniperresearch.com/whitepapers/blockchain-seizing-the-financial-services
[4] Deutsche Bank. (2023, September 13). Transforming banking with DLT – Deutsche Bank.https://flow.db.com/more/technology/transforming-banking-with-dlt?language_id=1
[5] UBS. (2023, June 09). BOCI (Bank of China International) issues first tokenized notes, originated by UBS using UBS Tokenize - UBS. https://www.ubs.com/global/en/media/display-page-ndp/en-20230609-tokenized-notes.html