Why blockchain is disruptive for banks?

Blockchain technology was predominantly recognised as the engine on which crypto currencies got exchanged.

The rise in popularity of currencies like Bitcoin and Ethereum also brought the spotlight on blockchain as a powerful and secured network which could be used by multiple industries to disrupt their traditional way of functioning.

Blockchain has made significant inroads across key sectors like government and regulatory bodies, pharma, FMCG, etc. However, banking as a sector is yet to fully embrace it.

The vast number of blockchain projects for the banking sectors are still at the nascent stage with solutions reaching at maximum POC (proof of concept) or MVP (minimum viable product) levels only.

Current stats on blockchain in banking

Ask core banking CTOs of the possibility of blockchain replacing the core banking system, they will readily brush off the idea.

The fact that the blockchain technology has not been able to make any considerable visible changes to the mainstream banking systems till date and that the transactional throughput of DLTs (Distributed Ledger Technology) are much lower as against the centralised systems, do support their convictions.

Even though some banks have tested and implemented blockchain technology for cross-border remittances, trade finance and shorter settlement processes, no major changes have been brought on to the core banking process till date.

Having said that, some of central banks have been heavily investing in technological R&D to substantiate the possibility of issuing CBDC (Central Bank Digital Currency) through blockchain solutions, owing to its transparent and immutable nature.

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Misconception of the regulatory bodies

However, the technology is still severely misunderstood by the policymakers and the mainstream bankers.

The resistance by the regulators to adopt cryptocurrencies and the potential money laundering aspect associated with the anonymity of cryptocurrency transactions are cited by the bankers as the main reasons for centralised core banking system to prevail.

What the bankers do not realise is that it is not the cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH) that will disrupt the existing banking system, but it will be the central bank’s CBDCs and stable coins that can shake up the tradition banking ecosystem.

With over $30 billion in daily traded volume, stable coins are slowly and steadily moving away transactions from the banking systems. People’s Bank of China (PBOC) is at the forefront of CBDC experiment and if the efforts become a reality, a structural disintermediation of banks are on the cards.

The risk to the traditional banking system could accelerate if smart contract projects and decentralised finance (DeFi) applications gets market adoptions in the near future. With national currencies tokenised and physical assets digitised, an end-to-end asset transaction can happen between two parties without the involvement of banks at all.

Any digital asset exchange will be able to do almost all of the transactional services which the traditional banking can offer.

How can blockchain disrupt banking?

The reasons why blockchain is disruptive to the banks are because blockchain eliminates middlemen and encourages peer-to-peer interaction. The information stored via blocks are permanently recorded and reconciled in a secure way.

The ledger is distributed to all the parties and it gets stored in the respective computers making it difficult to tamper or manipulate the data. The blockchain network follows certain protocol and the system is set with initial standards. The block alteration too cannot happen as it requires alteration of the subsequent blocks.

Another possible contender to banks is decentralised exchanges (DEX). Decentralised exchanges allow the users to hold assets on their personal wallets and trade them in a decentralised marketplace.

Currently these transactions are limited to tokens within a single blockchain. Most of the DEX operate on Ethereum and tokens issued on Ethereum blockchain, popularly known as ERC20 tokens. Researches are extensively carried out on interoperable DEX that will allow assets holders of two different blockchains to transact with each other in a decentralised manner.

If the interoperable DEX materialises as envisioned by the crypto think tank, people will be able to transfer value across multiple blockchains, without giving custodial rights of their money to an intermediary.

If CBDC becomes a reality, central banks will be able to exercise complete control of the monetary system much better than the existing FIAT system and users will have the liberty to store the CBDC at their preferred blockchain wallet service provider.

The COVID pandemic will further push central banks to adopt a cashless economy which will in turn aid the blockchain adoption and making bank branches obsolete for transactions.

Way forward for blockchain and banking

No matter what technological advancement that we go through, banks are still going to be an integral part of our monetary system. However, if they do not adopt modern technologies and embrace transparency and flexibility, a new breed of digital bankers will encroach their market share at a much faster pace than ever.

Banks did not see the fintech revolution coming and lost a good share of business transactions to the fintech firms. However, since the fintech firms have built their service layer over and above the existing core banking system, banks were still an essential component of the ecosystem.

Whereas, the block-tech firm build solutions and transact them on completely alien platform that do not require a core banking support. This fact would make it difficult for the banks to keep its relevance in a decentralised transaction.

In order to avoid a Kodak moment, it is imperative that the banks acknowledge the disruptive capability of the blockchain technology and readjust themselves to align with the blockchain-based cashless-economy.

If acted rightly and timely, it is an opportunity for the banks to take back the market share that they lost to the fintech firms.