How Blockchain Will Transform Traditional Finance As We Know It Traditional finance has grown to become a multi-trillion dollar industry, predominately by acting as an inefficient intermediary by today's standards. The advent of blockchain technology presents an alternative to traditional finance that can create a more equitable financial ecosystem.
By Arnav Pagidyala Edited by Micah Zimmerman
Opinions expressed by Entrepreneur contributors are their own.
Since the inception of organized commerce, centralized financial systems have dominated the market, generally operating as a black box in the eyes of their customers. Aside from a lack of transparency, they have conducted business in a monopolistic manner, building empires along the way by simply serving as an intermediary.
However, as the next iteration of the internet unfolds, these conventional economic and financial systems are being reimagined like never before. With this next-gen internet, known as Web3, concepts such as blockchain, cryptocurrency and decentralization are making rapid headway into the mainstream economy. This paradigm shift marks the advent of a new commerce arena that can fundamentally restructure our global financial system as we know it today, making it a more transparent, inclusive and safe place to transact. Below are five examples of how blockchain can improve and replace legacy financial systems that we have grown so heavily reliant upon today as a society.
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1. Trade finance
Trade finance is a foundational part of the global financial system to mitigate risks, broaden credit and ensure that importers and exporters can engage in cross-border trade. Like most industries, trade finance suffers from logistical bottlenecks stemming from old, antiquated manual documentation systems. For example, physical letters of credit are often still issued and transferred between various intermediaries to ensure payment.
The versatile nature of blockchain can enable exceptional support for international trade transactions that would otherwise be far too costly due to trade and documentation processes. By storing and securing these processes on-chain (on the blockchain), companies can digitally prove transaction details such as country of origin and product information in a reliable, cost-efficient method. This would drastically increase trust between exporters and importers in the marketplace on the strength of exceptional transparency and security of data. Further, this could mitigate the most significant risks present to trade parties today, including discrepancies in documentation and oversight surrounding the flow of goods, among various other uncertainties.
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2. Decentralized identity
To onboard customers, TradFi (traditional finance) institutions need to verify their identity in a process called "Know Your Customer" or "KYC," which requires customers to submit personal information such as their passport, driver's license and various proof documents. TradFi systems take an average of 24 days on this KYC process, resulting in a terrible customer experience and reducing user retention rate. Banks store customer information on centralized systems, making that data vulnerable to various hacks.
Conversely, customers could upload their KYC information to a blockchain just once and grant permission for institutional access on an ongoing basis. The KYC process could be executed in just a few seconds by storing KYC information on-chain as a "Decentralized Identity" or DID. Additionally, financial institutions would no longer be responsible for the long-term security of customer data, which would decrease costs and liability.
3. Settlement infrastructure
Today, transferring funds across the globe is a logistical nightmare. A simple bank transfer from one country to another must pass through a cumbersome set of intermediaries, ranging from custodial services to correspondent banks before it reaches its destination. Each intermediary adds its costs, increasing the processing time and introducing another security risk. On top of all this, the two account balances have to be reconciled across a complex, fragmented financial system.
In contrast, institutions could leverage blockchain technology to serve as a decentralized ledger to securely keep track of all transactions. This single source of truth could effectively eliminate the network of intermediaries used today by allowing for the settlement of transactions directly on-chain — a 10x improvement over SWIFT. Further, this could allow for "atomic" transactions that clear and settle instantaneously with a verified payment, thus eliminating the multi-day transfer time on international transfers and 24-hour transfer time for domestic transfers imposed by financial service providers.
4. Modernized bookkeeping
TradFi institutions such as Mastercard, JP Morgan and Blackrock handle massive amounts of sensitive financial data daily that needs to be transferred, reviewed and audited. Today, it is costly and difficult to maintain and reconcile ledgers with absolute certainty securely.
Instead, institutions can post this data to a private blockchain which would fundamentally improve internal processes by allowing the flow of information in a chronological, immutable and transparent manner. This could drastically improve security due to the traceability feature of the blockchain that can help detect fraud and develop a credible audit trail.
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5. Personal finance
Today, banks offer a negligible 0.21% APY interest on customers' savings accounts. Meanwhile, behind the scenes, banks are making significantly more interest in customers' money, keeping the lions share of profits earned.
On the other hand, blockchain is predicated on creating a user-first market. When users instead place their savings in blockchain applications such as Aave or Compound, they can earn 8-15% APY or more in some cases.
One of the primary reasons people have purchased cryptocurrency to date is to combat the rampant inflation that most countries face. Today, the global inflation average is a staggering 8.8% and almost certainly growing. With inflation far outpacing the APY provided by banks, people have little choice but to find better alternatives or watch their money dwindle.
For both reasons, the general public will likely transfer more of their savings into crypto in the long term, decreasing savings stored in banks and ultimately leading to a decline in TradFi revenues.
Conclusion
Many expect blockchain to replace the TradFi industry altogether. Others believe blockchain technology will simply serve as supplementary infrastructure to existing TradFi systems. Overall, it remains to be seen precisely how and to what extent the finance industry will embrace blockchain technology. However, one thing is sure; blockchain will bring about a new era of transparency, fairness and safety to finance.
