Assessing the adoption of blockchain in financial services

Blockchain has been somewhat of a quiet revolutionary. Essentially a distributed database containing an ever-growing list of ordered records – blocks – its introduction as the enabler of crypto asset trading heralded the beginning of decentralised finance. 

But, while blockchain and cryptocurrencies may appear synonymous with one another, the truth is blockchain’s reach is far more extensive – and can be used to monitor supply chains, create digital IDs and enable data sharing. 

So, while blockchain’s association with crypto is well-established, the question remains: is it being used to its full potential in the wider financial services sector? 

Understanding blockchain

To gauge blockchain’s potential in finance more broadly, it’s important to first understand how it works. 

A board member at the Casper Association, Ralf Kubli likens blockchain to a series of remote computers “working together to create a trustless independently verifiable, decentralised ledger”.

He continues: “Every computer on the network, or ‘node’, can see every transaction that has ever occurred, and all of this information is encoded cryptographically, decentralised so that any participant can simply run the maths themselves, and confirm that all values are correct.”

While for cryptocurrency, certain nodes on the network – miners – are tasked with ordering batches of transactions into blocks (rewarded for their efforts with newly created crypto assets), Kubli notes that blockchain doesn’t have to be used this way. “It can be a ledger for virtually any type of data.”

Blockchain’s reach across the financial industry

Kubli continues: “While financial institutions such as BlackRock, Siemens and even HSBC are touting tokenisation as a paradigm shift for the economy, with vastly improved systems for delivery versus payment (DvP) settlements, current tokenisation platforms are not digitising the underlying liabilities or cash flows tied to the assets themselves.”

Most tokens have a simple embedded PDF that defines its terms and conditions, meaning human intervention is still required to calculate cash flows, which, according to Kubli, “can introduce errors and discrepancies, and also prevents this digital capital from being truly automated”. 

As a result, Lab49’s Principal Consultant Yuvraj Sidhu admits the mass adoption of blockchain in traditional financial services is still far off, “especially in the institutional landscape, [where] regulatory uncertainty and questions regarding unproven tools and infrastructure have created barriers”.

Yet, despite these barriers to adoption, Sidhu feels a need for secure, accurate and instantaneous settlement in the financial services industry is driving many banking institutions to explore ways of leveraging the benefits of blockchain. 

He adds that blockchain adoption can proliferate across traditional services once four key barriers are overcome: privacy preservation, regulatory clarity, standardisation, and scalability.

For Peter Greiff, Data and Analytics Team Leader EMEA at DataStax, the issue of blockchain’s slow cross-market extension is simpler; it’s a matter of trust, or more specifically, too much trust. “Using blockchain is ideal when there is less trust between the parties involved.

“In finance, the number of use cases where all those transactions take place without trust is actually small. Banks and financial institutions rely on compliance regulations and backing by governments, which is why they are trusted.”

So, while Greiff can see blockchain being useful for records over time and providing tracking for transactions, its use for secure monetary transactions isn’t strictly necessary at established financial institutions. 

Bringing blockchain to finance

Given blockchain’s use in traditional financial institutions could look markedly different from its function as a fraud safeguard when it comes to crypto, financial services firms are understanding the wider potential of blockchain “slowly but surely”, according to Sidhu. 

However, before this potential can be truly actualised, Kubli feels “the implementation of open banking standards, ultimately introducing ‘smart financial contracts’ as a means to remedy” the current barriers to adoption, will enable legacy institutions to begin implementing blockchain-based innovations. 

He adds: “Ensuring standardisation via smart financial contracts will enable things like an entire mortgage process, including the underlying obligations, to be placed on the blockchain and become machine-readable, executable, and automated. 

“This will bring about the true financial potential that is currently missing, and even bring new stability to the existing finance world.”

The possibilities blockchain can bring to traditional financial services don’t stop there. Sidhu believes asset tokenisation will become “an effective way to automate the security issuance process and democratise access to previously illiquid asset classes”.

“Private equity is a good example – currently, private firms such as start-ups have limited options when raising capital. Tokenisation provides a pathway to open new markets and liquidity to these types of firms,” he adds. 

Post-trading clearing and settlement, too, is something Sidhu feels blockchain can help innovate, calling the current process highly inefficient and fragmented. 

“The industry currently spends over US$130bn annually in this area, so, unsurprisingly, organisations such as the Federal Reserve and Bank of England are experimenting with blockchain technologies to automate these processes.”

For Greiff, combining blockchain technology with distributed databases and streaming technologies will allow financial institutions to “get real-time updates for on-chain transactions, and the ability to apply analytics to that data in real-time as well”. 

Scaling blockchain: the drawbacks

While the scope for blockchain’s use at traditional financial institutions is evident, should barriers to adoption be overcome, it will need to scale significantly from its current models of use. 

With this comes problems, though. Crypto data mining has faced criticism for the amount of energy it consumes through the traditional Proof of Work (PoW) model employed by the likes of Bitcoin and other crypto networks. 

However, the more energy-efficient Proof of Stake (PoS) mining model could be the way forward for financial institutions. Crypto trading platform Ethereum recently switched from the traditional PoW to a PoS model and reported a 99% drop in the amount of energy needed to secure the network. 

Notwithstanding the perks of PoS models, a switch in mining models is just one barrier to scalability. As Greiff notes: “Blockchain can’t meet some of the transaction throughput or analytics requirements that companies have. 

“For example, Bitcoin has around 19.3m coins and sees 500,000-650,000 global transactions per day. Ethereum reached a maximum of 1.9m transactions on one day but tends to be around the 1.2m transactions per day level globally.

“In comparison, banks, retailers and payment systems providers cover billions of transactions per day, which is an order of magnitude higher.”

To reach the next level of scale, blockchain platforms must innovate ways to carry out real-time analysis on a far greater number of transactions, to meet anti-money laundering and anti-fraud requirements. 

The future of blockchain

So, while blockchain’s path to mass use in traditional financial services is still a bit murky, the standardisation of blockchain-powered financial assets, such as CBDCs, is something Kubli feels we are destined to see. 

He adds: “As regulations tighten, any assets that don’t embrace standardisation will be at risk of non-compliance. There could be exceptions, of course, but any projects that want to be adopted by major financial players will likely adopt this approach. 

“Once implemented, tokenised financial assets can bring in improved liquidity and new forms of financing for the entire economy.”

Sidhu agrees, saying the timing of when tokenised financial assets hit the market will depend on the institutional sector. “Wall Street firms such as JP Morgan Chase, BlackRock, Fidelity and Goldman Sachs are defining their approach to blockchain technology, while 114 countries including the UK and US are exploring CBDCs. 

“Tokenisation of real-world assets could one day be a multi-trillion-dollar market. However, if blockchain and crypto are to become the norm in the future, strides in regulatory harmonisation, standardisation and technology are required.”