6 inefficiencies in Financial Services
Today’s global FS industry is built on decades-old technology, often slow and unreliable. It’s centralized, exposing it to data breaches or outright failure. It tends to reinforce the status quo, and stifle innovation.
Attestation
Two parties who don’t know or don’t trust each other can do business with assurance. Financial intermediaries can no longer claim the sole right to verify identity and establish trust. Blockchains trust protocol, as we call it, can establish trust when it’s needed. It can verify the identity and the capacity of any counterparty through a combination of blockchain transaction history, crowdsource reputation scores, and other social and economic indicators.
Cost
Blockchain eliminates vast back office expenses. On a blockchain, the network clears and settles transfers value from peer-to-peer in real time. Its ledger is always up to date. With that capability, banks could eliminate an estimated $20 billion in back office expenses according to the Spanish bank, Santander.
Speed
A blockchain network could clear and settle transactions in minutes or seconds, when it takes days through traditional channels. Today, remittances take three to seven days to settle. This is the global diaspora, people sending money back to their relatives in their ancestral lands. Stock trades take two to three days, and bank loan trades take on an average, a staggering 23 days. A blockchain network like, say, Bitcoin, takes an average of 10 minutes to clear and settle transactions conducted during that period. Other blockchain networks are even faster. Innovations like Bitcoin, Lightning Network aim to vastly increase capacity, dropping settlement and clearing times to fractions of a second. Ripple Labs’ Chief Executive Officer, Chris Larsen, said, “In the banking world, where you have a sender in one network and a receiver in another, you have to go through multiple ledgers, multiple intermediaries, multiple hops.”
Risk management
Blockchain promises to ease several forms of financial risk. There’s settlement risk, if some technical glitch blocks your trade. There’s counterparty risk, if you’re trading counterpart defaults before settling, and that’s what almost caught us in 2008, and the most significant is systemic risk, the sum of all counterparty risk in the system, this is also known as Herstatt risk. A crisis occurred when German bank Herstatt couldn’t meet its liabilities and had shutdown. The financier, Vikram Pandit, said, the crisis revealed a significant risks. He said, “If I’m trading with somebody, how do I know they’re going to settle on the other side?”
Value Innovation
Developers are coming up with a multitude of ways to define and trade value on a blockchain. The Bitcoin blockchain was designed to move bitcoins, not really other financial assets. But this technology invites experiments, and innovators are building alternative blockchains for purposes beyond simply making Bitcoin payments. Someone to use Bitcoin blockchain size and liquidity to create spin-off coins on sidechains. These spin-offs can be colored to represent any asset or liability, physical or digital. They could be a currency, a corporate stock or bond, a barrel of oil, a bar of gold, just about any asset, a car, a car payment, receivable, payable. Others are trying to remove the coin or token from the picture, building trading platforms on private blockchains.
Open source
Blockchains nimble nature means it can keep on adapting to future needs. The financial services industry is like a towering stack of legacy systems, may be on the verge of falling over. Changes are hard to make because each improvement must be backward compatible. As the saying goes, God may have created the world in six days but he didn’t have an installed base.
Article : How blockchain is changing finance
The Golden eight
Eight core functions of the financial services industry.
Authenticating identity and account balances
Today, we trust powerful intermediaries to verify the identity and capacity of other parties in financial transactions. Intermediaries like banks and credit card companies control access to basic services like bank accounts and loans. Blockchain removes the need for these go-betweens in certain transactions. The protocols do the work of verifying that
Moving value
Each day, the financial system moves money around the world, making sure no dollar is spent twice. That applies to everything from the 0.99 purchase of a gaming app to the transfer of billions of dollars to settle an intercompany fund transfer or even the acquisition of a company. Blockchain can become the standard for the movement of anything of value like currencies, stocks, bonds, and the titles to assets. It can do so in amounts big and small, to distances near and far, and to counter-parties known and unknown.
So, blockchain can do for the movement of value what the standard shipping container did for the movement of goods. It can lower the cost, improve speed, reduce friction, and boost economic growth and prosperity.
Storing value
Financial institutions are the holders of value for people, for institutions, and for governments. For the average job, a bank stores value in a safety deposit box, a savings account, or a checking account. For large institutions, so-called risk-free investments like money market funds or treasury bills will do the trick for ready liquidity with a small return. But blockchain means individuals won’t need to rely on banks as the primary stores a value. Bank savings and checking accounts could become obsolete, and institutions will have a more efficient means to buy and hold all sorts of assets including risk-free financial assets.
Lending
Financial institutions issue or help issue credit. This can include credit card debt, household mortgages, corporate bonds, municipal bonds, government bonds, treasury bills, and asset backed securities; as well as others. On the block chain, anyone will be able to issue or trade and settle traditional debt instruments peer to peer. This will reduce costs and risks, by increasing speed and increasing transparency. Consumers will be able to access loans from their peers. That is especially significant for the world’s unbanked and for entrepreneurs everywhere.
Exchanging value
The whole business of trading. Trillions of dollars of financial assets are traded worldwide daily for many purposes, investing, speculating, hedging, and price arbitrage. Blockchain cuts settlement times from days and weeks to minutes and seconds. This creates opportunities for unbanked people to participate in wealth creation. There are many stakeholders here that could be disrupted. Let’s start with investment in wholesale bankers, foreign exchange traders, hedge funds, and pension fund managers. Add to them the retail brokers, commodities traders and clearing houses. Finally, there are all the exchanges, they’re regulators and the central banks.
Funding and Investing
Investing in an asset, company or new enterprise gives an individual the chance to earn a return in the form of capital appreciation, dividends, interest or rents. The industry matches investors with entrepreneurs and business owners at every stage of growth. Raising money normally requires middlemen like investment bankers, venture capitalists, and lawyers. The blockchain automates many of these functions. It enables new models of peer-to-peer finance such as security token offerings or initial coin offerings
Ensuring value and managing risk
Risk management aims to guard against loss or catastrophe. Individuals insure their homes, their lives, their health, and their businesses. Financial markets use derivatives and other instruments to hedge against the unexpected or the uncontrollable. At last count, the notional value of over-the-counter derivatives was almost $600 trillion. Blockchain supports decentralized insurance models. Blockchain will disrupt insurance providers and risk managers, wholesale bankers, brokerages, clearinghouses, and their regulators
Accounting and auditing
Corporate governance is a multi-billion dollar industry and it’s controlled by just four global audit firms. Their traditional accounting practices won’t survive the speed and the complexity of modern finance. New methods using distributed ledgers secured by cryptography will make audit and financial reporting transparent and occur in real time. Accounting and audit will no longer be a task we do with the cycles of the moon every month or every quarter but an auditable searchable and verifiable snapshot of the financial health of any organization all in real time.
New frameworks for accounting
Leonardo da Vinci was known to have collaborators. One of them was a Franciscan monk, Luca Pacioli. Modern accounting was born when Brother Pacioli came up with a formula now known as double-entry bookkeeping. He realized every transaction had two effects on each participant. An effect on assets, and one on liabilities, so he made a rule. Each party had to enter both the debits and a credit on to the respective ledgers. That is, they had to make a double-entry. Both entries in the end needed to balance which is why Pacioli created the modern balance sheet.
Problems with accounting :
- Greed : The current system relies on managers to swear their books are in order, yet we know management doesn’t always act with integrity.
- Human error
- Fraud
- New business models : micro transactions, change of scale, cents are not the norm in any kind of business, smaller scale and granularity are relevant
The world wide ledger
Industry insiders say that this shared World Wide Ledger has several implications for accounting.
- First, it could streamline compliance and reduce risk for banks.
- regulators would have real-time access : regulators benefit the most. Since they won’t have to rely on what he calls opaque, privately controlled ledgers and financial accounting systems to do their work. With a shared public ledger, auditors and bank examiners could have automated forms of examination, to look at the underlying health of a balance
- bakes integrity into the financial system : all fraud would be much harder, because at no point can you go back and change your records, it means you don’t have to trust the books of your partner.
- the audit business itself is overdue for a shake-up : today we spend a lot of time auditing companies, and we charge fees accordingly. Tomorrow, if that process is completely streamlined because there’s a timestamp in the blockchain, it changes the way that we audit companies
