Blockchain technology was introduced in 2008, and since then many industries have started using the technology because of its many advantages.
Although blockchain is used in cryptocurrencies, which were developed to solve bank decentralization and international money transfer issues, banks have started using the same technology.
In this blog, we’ll go over a brief introduction to the technology, its advantages, potential use cases in banking systems, how banks use blockchain technology, and which banks use blockchain.
What is Blockchain?
Blockchain is a distributed ledger technology that can store any data or information. In their system, they use cryptography and hashes to verify the data, which would make it hard to hack, change, or alter.
Blockchain is commonly known for cryptocurrency uses as it maintains a secure and decentralized record of transactions. But that’s not their main application, as they are used for decentralized finance applications, non-fungible tokens, and smart contracts development.
The technology’s main features are security, immutability, traceability, and transparency.
Benefits of Using Blockchain in Banking
Blockchain applications in banking could have many positive outcomes in the finance industry. Banking systems could benefit from blockchain’s features which are, as we mentioned, security, immutability, traceability, and transparency.
Here we go over a few of the main benefits of using blockchain in banking systems:
Security and Transparency
When banks use blockchain, they improve their ability to provide a secure and transparent method of keeping track of transactions. If a bank uses blockchain, all of the bank’s transactions are recorded instantly in a decentralized and tamper-proof database.
Banks and customers can always trust the data because when a transaction is recorded on a blockchain, it cannot be changed or altered. Any transaction gets sent to the entire network for verification; this large number of users makes it difficult to hack, alter, or shut down.
What makes blockchain technology in banking more secure is its cryptography. Verifying the transactions on the network involves using cryptography and unique digital signatures, which reduces the risk of fraud.
Efficiency and Cost Reduction
According to a statistic published by the World Bank in June 2023, sending money internationally, or remittance flows, reached $647 billion in 2022 and is expected to reach $656 billion in 2023. International money transfers can get expensive, and blockchain in banking could be the key to decreasing these costs.
Traditional banking systems use intermediaries and other third parties, which can add significant costs and time. By eliminating intermediaries, transactions can be processed faster and in a more cost-effective manner. Both banks and customers can save some money by using blockchain.
Decentralization and Trust
Decentralization is one of the key features of blockchain, and the method of verification on the network ensures that it remains decentralized. Individuals on the blockchain can process transactions without the need for a third party, which increases the level of trust in the transaction.
By using blockchain, customers don’t have to “trust” the bank because they know the transactions are all decentralized and don’t depend on an intermediary.
Blockchain in Banking Use Cases
After mentioning the benefits of blockchain technology in banking and its main features, here are the top bank use cases for blockchain.
International Money Transfer
Sending money worldwide is a difficult issue nowadays, as there are many countries with restricted banking services and many individuals who are bankless. Also, sending money across borders is expensive.
By using blockchain, individuals can easily transfer money internationally in a matter of seconds, as opposed to waiting for a few days on a non-blockchain network.
KYC and AML Compliance
Know-your-customer or KYC, is the process used by banks to identify and verify the customer’s identity when opening an account. This is an important step to verify that the customer is actually who they claim to be. Some banks have specific KYC requirements and could refuse to open an account if a customer fails to meet them.
KYC proceedings consist of many identifications, including photo verification, biometric verification, address proof checks, and so much more. KYC can cost the bank time and money to perform, which is why using blockchain can help. By storing the customers’ data on the network, the bank can easily access the information required instantly while trusting that the data is accurate.
Anti-money laundering, or AML, is the process of converting illegal money to legal money. Money laundering is done by placing illegal money into a financial system while hiding its source through a series of transactions. The money could be broken into small transactions to make it difficult to trace back.
To use blockchain to detect AML, a smart contract could be used, which is a self-automated computer code that has the ability to carry out the terms of a contract. The smart contract could have inbuilt algorithms to automate the process of AML regulation, which could detect fraud and money laundering activities.
As an example, a smart contract could automatically flag a transaction for review if it met some conditions, such as exceeding a certain amount or involving a high-risk jurisdiction.
Another good benefit of using blockchain for AML compliance is that it could reduce costs. Smart contracts won’t need an intermediary or a human being to implement, which could lead to fewer costs.
Traditional banks evaluate the risk of a loan in the event of non-payment. Banks go through the client’s credit history, debt-to-income ratio, income verification, and many other documents, depending on the bank.
This procedure is considered centralized and unfair to some customers. Blockchain applications in banking could propose an alternative lending system, peer-to-peer loans. These types of loans work without the need for intermediaries, which provides a cheap and secure way of giving loans to customers.
Customers can ask for loans through peer-to-peer lending platforms, and one lender or several can take up the request and provide the money. Loans are executed using smart contracts.
Which Banks Use Blockchain?
The global financial services firm and bank announced in April 2021 that they are using blockchain to improve fund transfers between banking institutions globally. J.P. Morgan has said it has invested millions of dollars into developing blockchain technology to streamline cross-border payments and make transactions cheaper and faster.
J.P. Morgan created Liink, a peer-to-peer blockchain network that facilitates the sharing of information. Confirm is one of the first applications done on the network, and it’s a secure application to pre-validate customer account information.
The bank used the network to help banks communicate with others more quickly and efficiently, filling any data gaps if that happens. A participant can submit an inquiry to the network to verify data and information, such as the account owner’s name and transaction history. Confirm potentially reduces the number of rejected or returned transactions caused by mismatched payment details. Another benefit is lowering costs for both the sending and receiving banks.
J.P. Morgan also mentioned that Confirm could add an extra layer of security against fraud. By using the application, institutions can verify that the intended beneficiary matches the account owner before sending a transaction.
HSBC, one of the world’s largest banking and financial services organizations, shared that they are instrumental in the development of the digital ecosystem and have been experimenting with many blockchain applications. The company created FX Everywhere, a distributed ledger that’s used to facilitate payments across HSBC’s internal balance sheets.
According to the bank, implementing blockchain in banking provided transparency and immutability. It transformed the process around intra-company foreign exchange activity, automating several manual procedures and reducing dependency on third-party settlement networks.
Another blockchain for banking applications was Digital Vault, which was created in 2019. Digital Vault services are used to facilitate storage and access to certificates of private assets. It enables HSBC custody clients to access their private assets, which could be equity, debt, or real estate, directly instead of having to request a paper record.
HSBC said they firmly believe in the transformative potential of tokenization and digital assets, and they are working with partners on developing what’s needed to support a variety of digital assets.
Wells Fargo and HSBC
Wells Fargo is another bank that uses blockchain technology in its systems. The two banks, Wells Fargo and HSBC, are jointly using a shared settlement ledger to process US dollar, Canadian dollar, British pound sterling, and Euro transactions.
The platform enabled the banks to agree with their counterparties on when and how often they settle. This can allow for multiple settlements a day, in which the settlement process can be completed within minutes.
DBS is a Singaporean multinational banking and financial services corporation. The bank has established two blockchain-based businesses, which are DBS Digital Exchange (DDEx) and Partior.
DDEx is one of the world’s first bank-backed exchanges that provides participants with access to security tokens and digital currencies. Participants could be investors, financial institutions, or family offices. The exchange also provides an ecosystem where issues can gain access to alternative forms of fundraising.
Partior is an open industry platform where banks around the world can join to access real-time cross-border multi-currency payments. On its website, the bank said the technology would be used in the future for Delivery vs. payment (DVP), Payment vs. payment (PVP), tokenized asset borrowing and lending, and could serve as a complementary platform for its ongoing central bank digital currency projects.
Blockchain technology has offered various advantages across various industries since its inception. While it initially gained prominence through its association with crypto, banks, and financial institutions have recognized its potential and have begun incorporating blockchain into their operations.
Blockchain applications in banking are numerous, as the technology can facilitate international money transfers, making them faster and more accessible. The technology could be used for KYC and AML compliance processes, which can be more cost-effective. Additionally, blockchain enables peer-to-peer lending, providing an alternative and fairer lending system.
There are hundreds of banks worldwide that use blockchain, but for a bank to use the technology in its best way, they would need a blockchain development services provider.
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