R. Srikumar is Senior Vice President, Head Portfolio Group at Mphasis.
Hierarchies are vital to both our sense of value and safety. Whether in politics or economics, the idea of a central command that is in charge is as old as institutions themselves.
However, the advancement of technology and its applications is offering an alternative to this tried and tested arrangement. Consider, for example, cryptocurrency’s flag bearer, Bitcoin. After the Lehman financial crisis of 2008, the digital asset was created as an alternative decentralized medium for daily transactions.
Since then, Bitcoin has had a checkered history. Among them are the dramatic effects that billionaire Tesla CEO Elon Musk’s tweets about the digital currency have had on Bitcoin’s valuation — in either amplifying it or bringing it crashing down.
However, what is of far more interest and relevance to the future of finance than Bitcoin itself is the technology that underwrites it — distributed ledger technology, or DLT.
Basically, DLT is a technological infrastructure that enables “simultaneous access, validation and record updating” across a network, spread across multiple locations or entities. It enables the safe operation of a decentralized, digital database, thereby eliminating the need for a central authority that needs to keep constant checks against fraud or manipulation.
This has multiple, exciting implications for financial services — in how organizations in this space can operate and who they can serve. Let us take a look at some examples.
Making Banking More Modern
Even before the pandemic hit, legacy banks were dealing with growing customer expectations for more personalized, digitized services. Fintech firms were making steady inroads into banking territory, and Covid-19 has only further accelerated this trend.
One of the most effective ways that banks can recover lost ground as custodians of value in the new normal is by embracing advanced technology like DLT to enhance customer experience. Banks can, for example, optimize their know your customer (KYC) processes by saving customer data on decentralized blocks. This would help banks eliminate repetitions and enable them to share information about existing and prospective customers between financial institutions in real time.
DLT can also improve the process and experience of payments. Blockchain technology, which is built on DLT, can enable speedy payment processing services. It can do this because encrypted distributed ledgers provide real-time verification of transactions without the need for intermediaries such as banks or centralized clearinghouses. This ensures that a process that would typically take a few days can get done in a matter of a few hours.
Yet another area in which DLT can help banks is in improving their clearance and settlement mechanisms. Sending or receiving money across international borders continues to be both expensive and cumbersome as the process involves multiple parties, intermediaries, banks and often different financial systems. All of this means that international payments can take up to three days. By leveraging DLT, a decentralized blockchain can make redundant the need for any intermediary and enable banks to process international transfers almost as soon as they are initiated — a big benefit for both customers and banks.
But DLT in financial services is also exciting because it improves financial access and equity. Lending urgency to this task is the havoc wreaked by Covid-19, which has eroded incomes, jobs and industries.
Boosting Financial Inclusion
Even before the onset of the pandemic, about 1.7 billion adults were reported to be unbanked globally. Advanced technologies built on DLT can offer affordable and scalable solutions with adequate data transparency, safety and accuracy to bolster financial inclusion.
When deployed to provide financial services to the unreached, DLT offers to lower transaction costs, thus making banking attractive to those who have been underserved. The low fees of DLT also make it possible for financial service providers to plan an expansion of their operations to locations and customer cohorts who have so far not been serviced.
More than anything else, what businesses must recognize is that DLT/blockchain is a disruptive technology. It has the potential to transform businesses in every industry, including financial services. But it is crucial to not get lost in all the noise around it, especially on crypto, and focus on the underlying technology instead.
One way that enterprises can approach the technology’s adoption is by assessing and evaluating its use cases. While doing this, it is important they look for applications that extend beyond their organization to their partners, thus helping to form, when possible, a network of peers, providers, third parties and regulators.
Many enterprises are currently trying out the technology by running their own PoCs — so getting help from them will be relatively easy and learning from their experience could prove to be beneficial.
With the new knowledge gained, businesses can try to get involved in a blockchain project. They can do this by defining their own PoC that can be designed with the help of partners and roping in an appropriate set of participants. The other approach is for organizations to participate in consortia-based solutions that are specific to their industry. These can provide businesses with firsthand experience of use cases of relevance to their enterprise.
These are but a few examples of how DLT can expand and improve the scope of the financial services industry. Although DLT, like any other advanced technology, comes with its own set of challenges, including its vulnerability to public impressions, I believe it is one of the most promising new technologies to have emerged in the last few years.