Technologies like blockchain have the potential to change the game in the financial services industry by not only speeding up and providing complete visibility into financial transactions, but also significantly reducing costs. Let’s take a look at why this is so.
Blockchain is one of the more exciting – and often misunderstood – technologies being explored today. Essentially, blockchain offers the ability to record and track transactions in a decentralized database (often referred to as a “ledger”). When a transaction occurs, everyone who has permission on the network knows about it. It’s tamper-proof and everything happens in real-time. This has disruptive implications for the banking industry and the way it keeps records of each financial transaction today.
Blockchain is particularly relevant to the lending market. Lending is a contract-intensive process with an extensive lifecycle; it carries significant risk and limited trust across its value chain – from origination to funding through to the fulfillment and servicing of the loan. Many financial institutions today still rely heavily on paper for their lending practices. The documents involved in these processes – mortgage notes, vehicle loans and equipment leasing contracts – have cash value tied to them, often in the hundreds of thousands or millions of dollars, and if these documents are destroyed, their value is completely lost.
Even in the digital world, the same process requires stringent checks and balances to ensure that a single authoritative digital copy of the loan documents exist at all times. These documents ultimately represent digital currency (like how bitcoin reinvented the concept of cash) and there has to be one original copy of the loan documents in the possession of the lender or holder. This is extremely important in the peer-to-peer lending space, where loans are transferred regularly to other lenders and institutional investors throughout the lifecycle of the loan funding process. In the U.S., ESIGN, UETA and UCC Article 9 provide the legal basis for how these types of loans and financing contracts are managed and serviced by financial institutions. These laws stipulate the need for the secure chain-of-custody and ownership of electronic loan documents. This vital to the integrity of a loan and the overall lending process.
But how do banks, lenders and investors track and manage digital assets as they’re transferred between one another in today’s complex and compliance-driven lending environment?
Blockchain could be one answer. Banks and lenders are under increasing regulatory compliance pressure and need the ability to quickly demonstrate how processes take place. One of the most exciting features of blockchain from a legal and compliance perspective is its “immutability”, meaning that as soon as transactions are recorded into the blockchain ledger, they cannot be altered or deleted. Blockchain has the potential to further strengthen compliance and audit by demonstrating a secure chain-of-custody for the transfer of any digital asset (e.g., secured loan or lease) to anyone that has permission on the network. The decentralized approach ultimately changes the dynamics in today’s financial ecosystem – shifting the power from institutions to users. Because this process inherently involves digitizing business transactions between parties, validating these transactions on the blockchain by permissioned users can provide increased transparency for audit and compliance purposes.
Moreover, the integration of blockchain with digital lending ensures transactions are tracked in an open and transparent way. Banks and lenders get direct visibility into exactly what happened during the lending process – who was involved, who had control over the authoritative copy of the digital assets and ultimately, who owns the value of those assets, as required by law. When combined with the power of e-signatures and e-vaulting technologies, blockchain can help reinvent the entire process of how paper-based assets are securely sold and transferred in the digital world between banks, lenders and institutional investors.
Speed also plays an important role in this process. Blockchain can execute peer-to-peer transactions in seconds versus days and weeks in the paper world. Everything happens in real-time – for example, loan applications completed by borrowers can be transferred instantaneously to lenders and investors, who ultimately fund the loan. The added benefit of this approach is that it can crack down on any attempts to manipulate the system thanks to the minimal lag time in processing digital loan documents that are registered on the blockchain.
Beyond speed and strengthening audit and compliance, distributed ledger technology has the potential to dramatically reduce costs related to the manual processing of loan documents. Organizations understand that keeping content digital as long as possible speeds up transactions. And because blockchain fundamentally eliminates the need to manage paper-based assets, financial institutions can significantly reduce manual intervention when transferring digital assets to parties in the lending ecosystem. As a result, paper becomes a thing of the past because every action is tracked and registered on the blockchain, and every document linked to a financial asset is managed as a transferable record.
Digital technologies like blockchain offer a new means of transacting, funding and investing. The debate continues on how banks and other financial institutions can best capitalize on blockchain. For many in the field, particularly those working in “innovation labs” and skunk works operations, these are exciting times because the possibilities are endless. Organizations are actively engaging in blockchain initiatives across a variety of use cases –– from online identity management to smart contracts to digital asset management.
As with most innovations, “crossing the chasm” and capturing the hearts of the majority takes a number of successful implementations before technologies like blockchain are perceived as viable and future-proof. There are still a number of technical challenges that need to be addressed before blockchain can achieve critical mass in the market. These issues include resolving data privacy concerns (i.e., in an open, distributed environment), security concerns (i.e., with public vs. private blockchains), and how the technology applies to current laws and regulations.
Despite some of the unknowns and technical challenges that surround the technology, the future of blockchain in financial services is undeniably bright. The endless number of applications, increased popularity, as well as pilot implementations by some of the largest financial institutions, is proof that blockchain is here to stay.
