The Potential of Blockchain Technology in the Financial Sector

October 20, 2020

By Julia Beyers

The blockchain was introduced as the underlying technology that powered Bitcoin – a brand new type of money (or at least brand back in the day when it was created). It helped many people enter the magical world of cryptocurrencies, buy Bitcoin, and start trading but many tech and finance professionals saw a much bigger potential of blockchain.

Therefore, some of the brightest minds, such as David Marcus of Calibra or Pavel Durov of Telegram, in the world started exploring blockchain and its uses in the finance world. Since Bitcoin has already broken the ice, it was only logical that blockchain would focus on finance, even though many other industries nowadays use it to upgrade their respective operations.

Increased Security
Although individual exchanges and crypto-related services were hacked in the past, this has never happened within the blockchain network. All of these services were centralized (and inexperienced, as most of the attacks took place when blockchain was still young).

In other words, blockchain offers great security levels, as it relies on cryptography (hence the name cryptocurrencies). Due to its distributed nature and encrypted peer-to-peer transactions, this technology is virtually impenetrable.

The network is operated by nodes which actually makes it distributed. To agree on the state of the network, nodes need to reach a consensus, which is conducted via consensus algorithms.
These are currently two popular consensus algorithms:
● Proof of Work
● Proof of Stake

You can read more about them in this article, to find out how PoW and PoS make blockchain a secure network.

Perhaps the most important security feature of blockchain is immutability. Essentially, if a centralized network stores data on a central server, hackers who penetrate it can alter the data forever. That’s not possible in blockchain, as data is stored in a decentralized manner all over the network. Therefore, even if the hackers alter the records, there will be data from past states
of those records. That’s why blockchain is immutable.

Therefore, it’s safe to say that by introducing it on a big scale to the financial sector means improving the overall security of everything in it.

There are plenty of startups already working on using blockchain for improving financial security, such as Chainalysis and Arwen. You can check a list of some of the most notable startups that focus on security and use blockchain

No Intermediaries
The most important aspect of blockchain is the exclusion of intermediaries in the payment process. Namely, the financial industry of the future could eliminate the need for banks, making all transactions peer-to-peer. What does this really mean?

When you send or receive Bitcoin, you don’t use banks. Instead, the payment arrives from your account to your recipient’s account (cryptocurrency wallet) without the need of the third party to be involved. The blockchain uses a set of rules & technologies (we already mentioned consensus mechanisms, but there is also encryption, smart contracts, and more) that facilitate this type of transaction between crypto users, so there’s no need to use banks’ services.

Smart contracts play a key role in excluding middlemen. These are contracts embedded in code that self-execute when both sides meet the conditions in the contract. These are now being explored big time by Ethereum and can be used in the future for all kinds of contracts that you now have to use the bank for. Here’s a simple three-step explanation of how smart contracts
work:
1. An agreement between two people is created in the form of code, dubbed a smart contract. This contract is on the chain,              and cannot be changed in any way.
2. Blockchain processes the transactions that should happen in the smart contract.
3. When both sides meet the conditions, the smart contract is executed and the transaction
happens.

But, why having intermediaries is a bad thing? Well, the costs of transactions would be much lower compared to traditional bank transfers, as no party would charge for its services. In other words, if you send money using bank transfer, banks will charge a fee for helping you make the transaction. No banks (or other financial institutions) are included in peer-to-peer blockchain transfers. Still, there’s a small fee charged by the blockchain network, which is still much smaller compared to banks.

Also, transactions will be much faster. Peer-to-peer Bitcoin transfers already take much less time compared to transactions where banks are involved. You can compare transaction times of most popular cryptocurrencies in this article. There’s nobody on the way between you and yourrecipient to confirm the transaction. Instead, blockchain technology uses various consensus
algorithms for that.

International money transfers

You know that cross-border transactions are much more expensive than those that take place within the country. This happens because if you live, for example, in the US, and want to send money to someone in Japan, there will be a lot of intermediaries along the way, including at least two banks (sender’s and recipient’s) and the company that utilizes the transaction (such as
Western Union), which results in slow and often unsuccessful transactions. All these intermediaries charge fees for their services.

Moreover, this type of payment takes time (usually up to five business days, but sometimes more) and brings a lot of additional paperwork on the table.

In this article, a study was conducted, with money being sent from the USA to Hong Kong, with the average fees being calculated for a $1,000 transaction. It turns out that you need to pay approximately $58 to transfer that much money in fiat, whereas you’d have to pay less than $1 for crypto to crypto transactions.

This blockchain transaction is much cheaper as cryptocurrencies know no borders. They are fast, reliable, and secure, and you can send them to any person on the planet. An average P2P blockchain transaction takes less than ten minutes. The fees are the same whether you send money to your first neighbor or a person from another side of the planet.

Right now, the three fastest cryptocurrencies are EOS, Ripple, and Stellar Lumens.
● EOS – 1.5 seconds
● Stellar Lumens – 5 seconds
● Apollo currency – 2 seconds

As you can see, Apollo is the fastest one so far, but it’s not as popular as some other blockchain-based cryptos that are currently most popular in the world, such as Bitcoin. The good news is that blockchain technology is still being upgraded, and we get better transaction times almost every year, as block size is increasing as well.

This makes things a lot easier for e-commerce. Online shops can accept payments from around the globe and expand their sphere of influence to other countries. E-commerce platforms, such as Shopify and Magento, already accept Bitcoin as a payment option, meaning all sites that use them for their online shops can accept BTC payments. Overall, the global economy can gain a significant boost if blockchain technology takes over.

Loans
Blockchain will allow the lending process to take place with a higher security level. Many people have lost their trust in banks, especially after the 2007/2008 financial crisis, when banks engaged in excessive risk-taking, bursting the housing bubble.

A distributed ledger can change all of that, and if you want to learn more about the advantages of this technology when it comes to loans, make sure to check out this comprehensive guide.

Loans can be much faster on the blockchain, meaning you can receive money in a matter of hours due to the very nature of this technology, as opposed to banks that need 19 days to approve a loan.

Therefore, borrowing money in a safe and secure environment with low-interest rates seems like something that blockchain can pull off, but the technology first needs to undergo mass adoption for this type of activity to become common. There are already services such as CoinLoan and Nexo that focus on crypto loans.

Conclusion
Despite being very new, blockchain has already managed to penetrate the financial industry and disrupt many existing operations and processes. A distributed ledger is a real game-changer and can help many financial institutions not only offer better services but also enhance the overall security levels.

The technology is still being researched by many companies and finance professionals, including successful people, such as Vitalik Buterin and Justin Sun, to determine its true scope. One thing is sure – a blockchain-governed finance industry seems like a possible scenario for the future. Until then, we can sit back and enjoy new blockchain-related breakthroughs, which have become quite common nowadays, with hundreds of startups delving into the intricacies of this technology.

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