Blockchain in Banking: Vivid Advantages and Risks to Consider

Corporations are implementing blockchain in healthcare, logistics, and the gaming industry. However, the most popular niche for blockchain applications except cryptocurrencies is the financial sector. 

Experts have calculated that in the West alone, through the introduction of blockchain, banks can save 8 billion out of a total cost of $ 30 billion.

But is blockchain really a “magic pill” that can solve all the problems of the banking system? Let’s consider all the advantages and pitfalls of blockchain in banking.

Blockchain in the Banking System: Main Areas of Use

Banks, due to the specifics of their work, should constantly check and reconcile data. Each company independently maintains the relevance of data in its database. When a two-way exchange is required, these processes are too slow and ineffective. Blockchain can greatly simplify the data reconciliation process by making it part of the transaction processing routine.

The modern banking system is not perfect. Clients pay high commissions to banks and do not understand exactly where their money is going. Banks have to maintain a large staff and use the not always reliable SWIFT interbank transfer system. States bear the risk of being sanctioned and financially blocked if SWIFT is disconnected, as was the case with Iran and the DPRK.

The use of blockchain allows you to exclude intermediaries when performing banking operations and automate many processes. The efficiency of the banking system is also enhanced by lowering costs. Banks can generate additional sources of income thanks to the emergence of new business models and blockchain-based products.

In March 2019, German banks Commerzbank and Landesbank Baden-Wuerttemberg conducted test transactions on the new blockchain platform for trade finance Marco Polo, offering factoring services, discounting of receivables and payment of obligations. It is now one of the leaders among trade finance blockchain platforms: its business model is aimed at rapid expansion, thanks to a low entry threshold and the ability to integrate with other blockchain platforms.

Benefits of Blockchain in the Banking Sector

  1. Carrying out faster and cheaper transfers. 

This is especially beneficial for cross-border transfers and micropayments, where bank fees can be comparable to the amount transferred. In banks such transactions take a long time (up to 3-5 working days) and are expensive (from 1% of the amount). At the same time the transaction for 45.5 thousand bitcoins (about $ 280 million) in the summer of 2018 on the blockchain cost only $ 0.04 and was completed in a few minutes. A $ 100 million transaction on the Litecoin network in the spring of 2018 cost the same amount.

  1. Impossibility to fake data

Almost everyday you can hear about some hacker stealing money from some bank accounts. This happens mostly because the information is easy to access. Blockchain in banking makes accessing data and stealing information impossible. A hacker can’t insert a fake block between the existing ones, because it will be instantly visible. The thing is that the code of the new block is different from the sequence of the others. So the system will notice the substitution. Blockchain is a distributed database with information stored simultaneously on thousands of computers. That’s why it is not possible to rewrite the entire chain. In case you change information on one computer – other users will notice this because they have retained the original data. 

  1. The ability to automate processes and quickly process transactions.

This allows you to reduce costs and staff. Blockchain makes it possible to get rid of complex document flow, because any operation can be traced. The technology itself guarantees the invariability of data, and the human factor is excluded. There are already projects on the blockchain in the field of lending, customer identification, and corporate financing.

  1. Ensuring the immutability of transactions. 

This means the impossibility of making changes retroactively and forging reporting. The banking system is not transparent. The blockchain will make all operations more transparent and increase the level of trust between all participants.

Cons of Blockchain in Banking 

Actually, the introduction of blockchain into the banking sector is a bit of a paradox. The essence of the blockchain is in decentralization, while the essence of the banking system is in complete centralization and total control. Bitcoin (as the main example of the application of blockchain technologies) was created as an alternative to the traditional payment system, that is, in opposition to banks. In other words, banks are trying to integrate into their system something that was intended to destroy it.

Investment in blockchain can destroy the existing business model of banks. If the blockchain lives up to expectations, banks will be able to provide services faster, cheaper and easier, which will lead to a drop in their revenues – and this is not profitable for them. In addition, millions of jobs could be at risk.

Despite the serious shortcomings of the existing banking system, it has its advantages: there is a developed regulatory framework, deposit insurance, the ability to cancel an erroneous transaction, and receive a refund in case of a hacker attack. Blockchain networks do not have all this yet. Instead, they have issues that need to be solved: problems with scalability, bandwidth, and security.

Blockchain in Banking Today

Despite the lack of trust in the blockchain, banks have not given up researching this technology. Financial institutions are actively registering patents for the blockchain: the People’s Bank of China has 40 such patents, Bank of America has more than 50. Western Union, Visa and MasterCard have patents as well.

Considering all the advantages and pitfalls of blockchain in banking mentioned above, there can be two main approaches to using the technology in this sector:

  1. Niche use for a specific task, be it a cheap transaction, the ability to conclude a contract automatically, or something else. In the future, banks will be able to use blockchain both for settlements in fiat currencies and for transactional products in cryptocurrency. Now for banks this is a “blind spot”, where a lot depends on regulators and customers.
  2. The idea is to revolutionize banking, and in the long term – to overshadow the government and give people the ability to freely transfer money without the involvement of intermediaries. In the case of mass adoption, blockchain could make such a revolution, but it’s still too early to talk about it.

Blockchain has long been considered a revolutionary technology, but any technology has significant value only if it represents the simplest solution to a problem. The pitfalls of blockchain can be eliminated or at least minimized, but this requires a clear understanding of what blockchain is and how it can become your ideal solution.

Banking is not an area where risk can be tolerated. Before implementing innovations, consult fintech experts who will help you leverage the latest technologies to optimize operations, improve security, and manage risks.