How blockchain will change traditional finance

By Juan S. Gallegos On Nov 23, 2022

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Since the inception of organized commerce, centralized financial systems have dominated the market, generally functioning as a black box in the eyes of their customers. Apart from a lack of transparencythey conducted business monopolistically, building empires along the way by simply acting as middlemen.

However, as the next iteration of the Internet unfolds, these conventional economic and financial systems are being reinvented like never before. With this next generation Internet, known as Web3, concepts such as block chain, cryptocurrency and decentralization are advancing rapidly in the traditional economy. This paradigm shift marks the advent of a new trading arena that can fundamentally restructure our global financial system as we know it today, making it a more transparent, inclusive and safe place to transact. Below are five examples of how blockchain can enhance and replace the legacy financial systems we rely on so much as a society today.

1. Trade finance

Trade finance is a fundamental part of the global financial system to mitigate risk, expand credit, and ensure that importers and exporters can engage in cross-border trade. Like most industries, trade finance suffers from logistical bottlenecks due to outdated manual documentation systems. For example, physical letters of credit are still often issued and transferred between various intermediaries to secure payment.

The versatile nature of blockchain can enable exceptional support for international business transactions that would otherwise be far too costly due to business and documentation processes. By storing and securing these processes on-chain (on the blockchain), businesses can digitally prove transaction details such as country of origin and product information in a reliable and cost-effective method. This would greatly increase the trust between exporters and importers in the market through transparency and data security. Additionally, it could mitigate the most significant risks facing trading parties today, including discrepancies in documentation and oversight surrounding the flow of goods, among various other uncertainties.

2. Decentralized Identity

To onboard customers, TradFi (traditional finance) institutions must verify their identity through a process called “Know Your Customer” or “KYC”, which requires customers to submit personal information such as their passport, driver’s license and various supporting documents. TradFi systems take a average of 24 days on this KYC process, leading to poor customer experience and reducing user retention. Banks store customer information on centralized systems, which makes this data vulnerable to various hacks.

Conversely, customers could upload their KYC information to a blockchain once and grant institutional access permission on an ongoing basis. The KYC process can be completed in just a few seconds by storing the KYC information on chain as a “decentralized identity” or DID. Additionally, financial institutions would no longer be responsible for the long-term security of customer data, reducing costs and liability.

3. Settlement infrastructure

Today the transfer funds around the world is a logistical nightmare. A simple bank transfer from one country to another has to pass through a cumbersome set of intermediaries, ranging from custody services to correspondent banks before reaching its destination. Each intermediary adds their costs, increasing processing time and introducing another security risk. On top of all this, the two account balances must be reconciled in a complex and fragmented financial system.

In contrast, institutions could leverage blockchain technology to serve as a decentralized ledger to securely track all transactions. This single source of truth could effectively eliminate the network of intermediaries used today by allowing transactions to settle directly on-chain – a 10x improvement over SWIFT. Additionally, it could enable “atomic” transactions that clear and settle instantly with a verified payment, eliminating the several days transfer time on international transfers and 24-hour deadline for national transfers imposed by financial service providers.

4. Modernized accounting

TradFi institutions such as MasterCard, JP Morgan and Blackrock deal with massive amounts of sensitive financial data on a daily basis that needs to be transferred, reviewed and audited. Today, it is expensive and difficult to maintain and reconcile records with absolute certainty in a secure manner.

Instead, institutions can publish this data on a private blockchain which would fundamentally improve internal processes by allowing the flow of information in a chronological, immutable and transparent manner. This could significantly improve security through the traceability feature of the blockchain which can help detect fraud and develop a credible audit trail.

5. Personal Finances

Today, banks offer a negligible amount 0.21% APY interest on customers’ savings accounts. Meanwhile, behind the scenes, banks are much more interested in customers’ money, keeping the lion’s share of profits made.

On the other hand, blockchain relies on creating a user-driven market. When users instead put their savings into blockchain apps such as Aave or Compound, they can earn 8-15% APY or more in some cases.

One of the biggest reasons people have bought cryptocurrency so far is to fight the runaway inflation that most countries are facing. Today, the global average inflation is staggering 8.8% and almost certainly growing. With inflation far exceeding the APY provided by the banks, people have no choice but to find better alternatives or watch their money dwindle.

For these two reasons, the general public will likely move more of their savings into crypto in the long run, which will reduce the savings stored in banks and ultimately lead to lower TradFi revenues.

Conclusion

Many expect blockchain to completely replace the TradFi industry. Others believe blockchain technology will simply serve as additional infrastructure to existing TradFi systems. Overall, it remains to be seen precisely how and to what extent the financial industry will adopt blockchain technology. However, one thing is certain; blockchain will bring a new era of transparency, fairness and security for finance.