“Banking is necessary, banks are not”: Bill Gates.
As the world grappled with the chilling effects of the economic crisis of 2008 and with the collapse of behemoths like Lehman Brothers, people began to lose faith in the banking industry. But with no alternatives, they were forced to continue to depend on traditional banks for all their banking needs.
But as the crisis unfolded, several people had already begun to ask a question: what option do people have if banks are not to be trusted?
A man (or a group of people) named Satoshi Nakamoto came up with an answer: a peer-to-peer, ‘trustless’ electronic cash system based on a technology called blockchain.
For the uninitiated, blockchain is a decentralised technology; a global network of computers uses this to jointly manage the database that records cryptocurrency transactions. That cryptocurrencies are managed by a network (not any one central authority) is what makes its distinctive from banks. What it means is that blockchain removes the need for an intermediary for transactions between two entities/people.
As we know, a bank’s main function is to act as a trusted intermediary between people or entities. So can blockchain replace banks?
Expert speak (Part I): The biggest disruption in blockchains and cryptocurrencies is yet to come
As blockchain proliferates, many in the banking industry are afraid that banks may become redundant, or at least their role will diminish to a great extent, in the long term.
But is this concern justified? Is blockchain an existential threat to banks? What will be the role of the bank once blockchain becomes prevalent?
Banks, more than just an intermediary
As is it, banks have many functions beyond intermediating transactions. They facilitate trust, ensure regulatory compliance, structure financial products, provide financial advise to customers, etc. As a key component of the financial system, banks allocate funds from savers to borrowers in an efficient manner, and these financial services help to make the overall economy more efficient. They facilitate trade and finance.
To put it succinctly, banks — which have been around since the early ages — will still be relevant in future.
Having said that, the advent of cutting-edge technologies is pushing banks to change the way they operate. While they have been able to survive many revolutions in the past, they cannot remain aloof to blockchain, one of 21st century’s biggest revolutions.
“The central role of banks in the entire ecosystem has been to play the trusted source of your funds and an ultimate source of truth for the economic system,” said Gaurang Torvekar, Co-founder and CEO of Indorse, an ethereum-based social network for professionals. “Blockchain removes the need for intermediaries in the transaction process. It removes the need for a “trusted third party”, which is more often than not a bank.”
“Having said that, it’s also important to know that although bank as an institution is not as nimble and fast-paced to adopt the latest changes as a startup, they have nonetheless survived and adapted, albeit slowly, to several changes over the decades. Banks have already started adopting blockchain technology as a means to make their processes more efficient, and will continue to do so as the technology evolves,” he noted.
Although it is true that banks will slowly adapt and embrace the new technology, there is a vast majority of the world population that still remains unbanked. This is where blockchain gains weight. The promise of blockchain, and the ability to remove the need for a central trusted party, will take the technology a long way towards this. A number of technology companies in Asia, such as OmiseGo, WeTrust and Humaniq, are already leveraging it to access savings and credits which are essential building blocks of the economy.
“Several new blockchain companies are also starting to look at financial inclusion as a viable market and concentrating on the bottom of the pyramid in a bid to find their niche,” he elaborated.
Pankaj Jain, a blockchain expert and former Partner at 500 Startups, could not agree more. In his view, there will continue to be a need for banks even with blockchain and cryptocurrencies, but their services need to evolve with time.
“Most people feel a justifiable amount of frustration when they can’t access their money sitting in a bank and do what they need to with it because of restrictions like daily withdrawal limits. Cryptocurrencies in particular allow individuals, groups, and businesses to retake control of their money to do with as they need when they need to. However, businesses and individuals will continue to need trusted counterparties for a variety of services e.g. medical equipment leasing, large corporate loans, etc. Banks will still be required for many existing services and I believe many banks will evolve to provide new services, not yet imagined, for a blockchain and cryptocurrency world,” Jain said.
Denial of cryptocurrency will not help
As Jain mentioned, most of banks and financial services businesses have already started understanding the need to evolve and have begun projects testing various solutions on blockchain. Operational services — from trade settlement to credit reporting to bank-to-bank transfers and escrow — are services banks are already experimenting with on this technology.
“I believe the challenge exists when cryptocurrencies are added to the mix. Most banks are in denial of cryptocurrencies. However, cryptocurrencies are already serving as a store of value and as a medium of exchange. The banks, like the telcos before them with the internet, will continue to push for regulations through deep-pocketed lobbying that will protect their monopolies for a time, but unless they begin to embrace cryptocurrencies and start thinking about building businesses on top of cryptocurrencies, I fear that many banks may never quite move into the 21st century and a great deal of them will never make it into the 22nd century,” Jain observed.
Amidst the cryptocurrency and blockchain buzz in the market, several banks are already on their way to embracing the new tech. Big names like Singapore-based OCBC Bank have started the process of implementing it to streamline the entire banking process.
Said Altona Widjaja, Vice President (Fintech and Innovation Group) of OCBC Bank: “2018 is likely to be the year for blockchain technology to be adopted in the financial market more pervasively. It will impact the way banks operate beyond its potential to facilitate payments, but also in system efficiencies, de-centralising networks, and securing information exchange.”
Globally, many industries – including governments – have taken a keen interest in the blockchain technology and are experimenting with various applications. Where blockchain is different from other emerging technologies is that it cannot be developed in silos. The key benefits of a secure, permissioned, open architecture can only be realised with scale, and with that, the rules for participants of the network has to be clear.
“Trade finance,” Widjaja underscores, “is one of the most promising use cases for blockchain technology, with its cross-border nature, inherent counter-party risk, and need for secure payments. How blockchain is used for that segment will be quite telling for its growth. It would still take time for the game-changing promise of the technology to be realised, and early adopters of the technology are more likely to gain a competitive advantage.”
OCBC has been experimenting with this technology with success, and it is arguably first bank in Southeast Asia to leverage the technology for both local and cross-border transfers. This new-age tech has made payments more secure, faster, more transparent and less costly, he said.
“We also played a key role as part of the first consortium in Southeast Asia (together with HSBC, MUFG and IMDA) to develop a prototype for a Know Your Customer (KYC) blockchain. This development will contribute towards blockchain’s use to secure financial processes while combating anti-money laundering (AML) and the financing of terrorism (CFT),” he explained.
Banks are inefficient and not environmental-friendly
It is beyond doubt that in the current setup, banks wield excessive control and power. They are the backbone of any country and they closely work with central banks in their respective countries. While banks don’t want to be left out in the race to adapt to the changing environments, most banks are exercising caution.
“It is imperative on their part to adapt to the changing time and they should take new approaches to embrace the blockchain technology to avoid the Kodak moment. Those unwilling to accept and embrace tech will be gradually phased out,” said co-founder of an emerging blockchain startup on the condition of anonymity.
“Banks could use blockchain to streamline all its processes and become leaner. Coming from the banking industry, I know that there are too much works, processes and documentations within banks. It is an extremely inefficient and non-environment friendly industry. They need to create a blockchain processing unit to serve itself and other banks, and there are many new business model to explore. But the only question is: are they willing to learn and change?,” the person asked.
According to Philipp Pieper, Partner at Swarm Fund, an online platform aiming to bridge digital currency and real assets, while blockchain is posing a challenge, the death of banks is greatly exaggerated.
“There are areas where banks will face challenges. For instance, we are already seeing some use cases, such as trans-border remittance payments, where cryptocurrencies on the blockchain are doing a better job than banks, at a lower cost. Peer-to-peer lending is another very realistic use case, one where smart contracts could very effectively be used to codify agreements and terms between individuals,” he said.
But to bring retail consumer banking functions to the normal consumer using the blockchain will take much longer, because of the complexity of the user interface, experts feel. It will be a long time before transacting seamlessly will be easy enough for non-tech savvy customers to use it. Part of that is a technology challenge, and part of it is a challenge of working with or around the different gate keepers in the technology and banking space.
“In terms of short-term success, it is more interesting to look at specialty banking functions and infrastructure use cases. We are already seeing banks running blockchain trials for anything that crosses a border, such as intra-bank settlements and bills of exchange. Other specialty functions, such as securities settlements, merchant banking, and underwriting will benefit from efficiency gains and the transparency that result from using the blockchain,” said Pieper.
There are huge opportunities for the industry to gain efficiencies, but for that to be the case, it will require the players within the established banking system to create newly-designed services around how the model of blockchain works, while realising that the role of the services industry is changing.
From “to rule” to “to serve”
“Blockchain is a technology that empowers the individual. As such, it will force financial services to be more customer-focused. Thus, banks will have less of an opportunity to promote agendas that benefit them, but not their customers. In my view that’s probably a good thing, for consumers as well as the society,” Pieper observed.
Banks need to understand and get themselves educated more in this space, rather than read the news and educating themselves on the fud and get to know what blockchain can do for the banks.
“Before banks can do anything, they have to change their mindset from “to serve” rather than “to rule”. But it does take time. At the end of the day, the slow adoption within the banking system (including regulation) is due to the mindset differences, rather than the technology,” said Anson Zeall, Co-founder and CEO of CoinPip, a blockchain-powered money transfer service for businesses.
Dr. Julian Hosp, Co-founder & President of TenX, a platform that “makes cryptocurrencies spendable anytime anywhere, echoes similar views.
“It is a threat to bad banks, to those who don’t deliver good service and products,” he said. “I think people will still need banks. But at the moment, it’s very difficult for banks to use the blockchain to their advantage. In the future when blockchain will become faster and more scalable – it’s all about transparency. It’s about users understanding what it actually gets you do with the funds. And then obviously it’s also for interconnection so that banks can communicate faster and more accurately with other banks.
Obviously, banks are at an inflexion point. They need to embrace this tech as soon as possible to remain relevant in the market. While blockchain is going to shrink their space in the global financial system to a great extent, they can still survive with the adoption of the technology.
“If we go away from cryptocurrencies, the big thing is going to be the smart contracts. At the moment, banks have all the control, all the power and users have very low power. With smart contracts, it will turn around, so it will be a bilateral approach, bilateral respect. That’s where blockchains with smart contracts will be very important,” Hosp concluded.