Blockchain, the technology behind Bitcoin and other cryptocurrencies, has been in the news a great deal in recent months. Headlines about the volatility of cryptocurrencies and their relative lack of regulatory oversight have generated widespread skepticism about the technology. But the uses of blockchain go well beyond cryptocurrency. And its potential benefits for banks have led many to believe that blockchain is poised to transform the industry.
What is blockchain?
The technology that powers blockchain is complex. But the concept is relatively simple: A blockchain is a distributed database (or “ledger”) that’s shared among thousands or even millions of computers or servers, called “nodes,” maintained by independent third parties (individuals or organizations).
The lack of centralized storage or control makes it extremely difficult for someone to tamper with the ledger. It can accept new transactions only if they’re verified by these third parties through established consensus protocols. As a result, the ledger is highly resistant to errors or fraud. In addition, the technology uses encryption and digital signatures to protect participants’ identities.
How can it be used in banking?
Blockchain generates validated, immutable records that are readily available to all parties. This helps establish trust while minimizing the need for intermediaries to authenticate or certify transactions. It’s well suited, therefore, for a variety of banking functions. Here are a few examples:
Processing payments and transfers. Payments and bank transfers, especially international transactions, can be costly and time-consuming. A simple bank transfer must wind its way through a complex system of correspondent banks, custodians, and other intermediaries to reach its destination, adding time and fees to the process. Blockchain makes it possible to clear and settle these transactions almost instantly, often outside traditional banking hours, without the need for multiple intermediaries. Most blockchain-based payments and transfers are made using stablecoins — cryptocurrencies that are tied to the value of a fiat currency, such as the U.S. dollar, thereby limiting volatility.
Verifying customers’ identities. “Know your customer” requirements can make it costly and cumbersome for banks to verify their customers’ identities. By storing customer information on a blockchain, the process can be streamlined. It allows various financial institutions, as well as business units within those institutions, to access and verify customer information while protecting customer privacy.
Processing mortgages and other loans. Blockchain has the potential to streamline loan processing. Using “smart contract” technology to create, store and execute documents, blockchain avoids confusion and errors by ensuring that everyone is working off of the same version of a document. It also prevents anyone from modifying it without alerting others. And if a change or correction is required, it’s added to the blockchain, together with supporting documentation, creating a permanent audit trail.
Blockchain also can greatly speed up the transaction process by automating some tasks. For example, funds can automatically be released from escrow upon verification of specific preconditions, such as title clearances or loan approvals.
Ready for prime time?
These examples are just a few potential uses of blockchain in the banking industry. The technology is still relatively new and might not be quite ready for prime time, especially for community banks. But given the potential benefits — in terms of efficiency, security, and cost savings — it’s definitely worth exploring further.
Contact one of our experts if you have questions about blockchain.