How Will Blockchain Change Banking? How <i>Won't</i> It?

Our global financial system moves trillions of dollars, serves billions of customers and supports a global economy worth more than $100 trillion. Imagine what it could do, were it not in such shoddy condition. It is antiquated, a kludge of industrial technologies and paper-based processes dressed up in a digital wrapper. It is centralized, vulnerable to data breaches, systems failure and terrorist attack. It is exclusive, denying billions of people access to basic financial tools. It is opaque, baffling monetary policy makers and financial regulators, thanks to the compartmentalization of oversight. And it is monopolistic, lobbying for the status quo and stifling disruptive innovation.

Enter blockchain, the vast global distributed ledger running on millions of devices and open to anyone, where not just information but anything of value — money, equities, bonds, titles, deeds, contracts and virtually all other kinds of financial assets can be moved and stored securely and privately– and where trust is established, not by powerful intermediaries like banks, governments and technology companies, but rather through mass collaboration and clever code.

Blockchain entrepreneurs and incumbents alike are working to resolve the limitations of the antiquated financial system by using blockchain technology to devise new ways to perform the eight core functions of financial intermediaries.

Authentication of identity and reputation

Today we rely on rating agencies, financial data analytics firms, and retail and wholesale banks to establish trust, verify identity in a transaction and decide who merits access to the system. In contrast, reputation accrues on the blockchain itself. Blockchain technology lowers and sometimes eliminates the need for trust altogether in certain transactions.

Payment system

Payment card networks and money transfer services solve the double-spend problem, making sure that no dollar is spent twice as it moves from one person to another. The blockchain can do this by consensus for the movement of anything of value — currencies, stocks, bonds and titles — of any size or distance, dramatically reducing friction and democratizing economic growth and prosperity.

Savings

Retail and investment banks, brokerage houses, and asset management firms are the repositories of value. The average Joe uses a safe deposit box or a savings or checking account. Large institutions use so-called risk-free investments such as money market funds or Treasury bills. The blockchain can replicate all these instruments peer-to-peer.

Loans

Retail, commercial and mercantile banks along with credit scoring and rating firms facilitate the issuance of credit card debt, mortgages, corporate and municipal bonds, T-bills, and asset-backed securities. On the blockchain, anyone could check creditworthiness before issuing, trading and settling traditional debt instruments directly, reducing friction and increasing transparency. The unbanked and entrepreneurs everywhere could access loans from peers.

Exchanges

Trading is the exchange of financial instruments for the purpose of investing, speculating, hedging and arbitraging. It includes post-trade clearing and settling. Blockchain cuts settlement times on transactions from days or weeks to minutes or seconds. This efficiency creates opportunities for the unbanked to participate in wealth creation.

Venture capital and investment

Investing in an asset or enterprise gives individuals the opportunity to earn a return, be it capital appreciation, dividends, interest or rent. Raising money normally requires investment bankers, venture capitalists and lawyers to name a few. Blockchain technology automates the matchmaking, enabling more efficient, transparent and secure models for peer-to-peer financing, recording dividends and paying coupons.

Insurance and risk management

Risk managers attempt to protect individuals and companies from uncertain loss or catastrophe not just through insurance but through myriad derivatives meant to hedge against unpredictable or uncontrollable events. Blockchain supports decentralized models for insurance, making the use of derivatives far more transparent. Using reputational systems based on a person’s social and economic capital and online behavior, insurers will have a more meaningful picture of the actuarial risk.

Accounting

Accounting is the systematic recording and reporting of financial transactions. It is a multibillion-dollar industry controlled by four massive audit firms. Yet traditional accounting practices are not keeping pace with the velocity and complexity of modern finance. The blockchain’s distributed ledger will make auditing transparent and in real time and enable regulators to more easily scrutinize financial actions within a corporation.

When we started our research two years ago, few if any banks had woken up to this opportunity. Now, virtually every major player in the financial service industry — from banks to insurers to audit and professional service firms — are investing significant resources into this frontier.  Blockchain can reduce many costs for banks, providing a boost to productivity and making it easier to offer products and services to a global clientele. They can also reduce risk in the industry, particularly in wholesale finance. Settlement times for many financial instruments take days, sometimes weeks, tying up capital and exposing industry participants to huge counterparty risks. Blockchain promises to radically simplify many business processes, reducing risk and boosting transparency. This explains why more than 45 leading banks, including Credit Suisse, RBC and UBS, have joined the R3CEV Consortium to develop blockchain infrastructure for banking and why IBM launched the Hyperledger project, counting Deutsche Bank, DTCC, the London Stock Exchange Group, Wells Fargo and State Street as members. But this is not all upside for banks, of course. Blockchain also radically lowers barriers for new entrants to create alternatives to the conventional banking industry, challenging incumbents in virtually every market where they operate, and so it’s as much a threat as an opportunity.

We do not believe blockchain is an existential threat to the companies who embrace this new technology paradigm and disrupt from within. The question is who in the financial services industry will lead this revolution in a positive way? Throughout history, leaders of old paradigms have shown difficulty embracing the new. Why didn’t AT&T launch Skype, or Visa create Paypal? CNN could have built Twitter, as it is all about the sound bite, no? General Motors or Hertz could have launched Uber. Marriott could have launched Airbnb.  As with major paradigm shifts that preceded it, blockchain will create winners and losers. Though opportunities abound, the risks of disruption and dislocation must not be ignored. Still, we are hopeful today’s financial services leaders will not become tomorrow’s losers. After all, too much is at stake.

The unstoppable force of blockchain technology is barreling down on the immovable infrastructure of modern finance. We would like this collision to transform the old money machine into a prosperity platform for all.

Alex Tapscott is the founder and CEO of Northwest Passage Ventures. Don Tapscott is CEO of the Tapscott Group, a fellow at the Martin Prosperity Institute at the University of Toronto and the chancellor of Trent University.