Blockchain and the Financial Industry
By Kaleb E. Rumicho and Noah M. Huisman
Since arriving on the scene, blockchain has been a hot topic in the banking and financial services industry (Financial Industry). This is, in large part, due to its most widely-known currency spawn – Bitcoin – and the boom and bust nature of Bitcoin’s value. As summarized in our previous article, “Blockchain Unchained,” a blockchain is a peer-to-peer digital ledger of transactions that may be publicly (or privately) distributed to all users. It is a new type of database system that enables multiple parties to share access to the same data at virtually the same time. The combination of blockchain components – like cryptographic hashes, distributed databases, and consensus building – create a powerful new form of data sharing and asset transfer that is capable of eliminating intermediaries, central third parties, and expensive data reconciliation processes.
Many have forecasted the use of blockchain will usher in a new age, while others have predicted blockchain’s demise. So which is it? Well, in typical lawyer fashion, the answer is: it depends.
The Financial Industry, that many claimed (and continue to claim) would crumble as a result of the new technology, seems to have embraced a wave of adaptation that would make Darwin proud. The enticing potential for cost and efficiency gains, along with the possibility of new revenue streams, continues to fuel interest and investment in blockchain technology. Many in the Financial Industry continue to pour significant resources and investment into applications that the Financial Industry can leverage to turn the disruptive blockchain technology from foe to friend. With the full force and weight of the Financial Industry behind it, it would seem that blockchain’s heaviest hitting opponent may soon be its greatest champion. This suggests that it is only a matter of time until lobbyists pound the pavement on behalf of the Financial Industry and push through blockchain-favorable legislation, paving the way for the technology’s widescale adoption. So while there are still a number of obstacles to overcome, it looks like blockchain is here to stay.
For evidence of blockchain’s staying power, one need look no further than J.P. Morgan’s successful testing of its JPM Coin. The JPM Coin is a digital token created by JPM engineers to allow for instantaneous settlement of payments between clients that is based on blockchain technology, enabling the instantaneous transfer of payments between institutional accounts. In one recent article on the JPM Coin, CNBC highlighted three main uses, albeit still in the trial phase, for the JPM Coin:
- The first is for international payments for large corporate clients, which now typically happens using wire transfers between financial institutions on decades-old networks like Swift. Instead of sometimes taking more than a day to settle because institutions have cut-off times for transactions and countries operate on different systems, the payments will settle in real time and at any time of day.
- The second is for securities transactions. In April 2019, J.P. Morgan successfully tested a debt issuance on the blockchain, creating a virtual simulation of a $150 million certificate of deposit for a Canadian bank. Rather than relying on wires to buy the issuance (resulting in a time gap between settling the transaction and being paid for it), institutional investors could use the J.P. Morgan token, resulting in instant settlements.
- The final use would be for huge corporations that use J.P. Morgan’s treasury services business to replace the dollars they hold in subsidiaries across the world. Currently, unseen by retail customers, J.P. Morgan handles a significant chunk of the world’s regulated money flows for companies from Honeywell International to Facebook, moving dollars for activities like employee and supplier payments. This business generated $9 billion in revenue last year for the bank, and use of the JPM Coin could further streamline the exchange process.
At a general level, the potential of blockchain for the Financial Industry can be distilled into this (oversimplified) list:
- Dramatically lower cost, improve speed, reduce friction, and boost economic growth and prosperity by offering a peer-to-peer alternative;
- Provide new accounting methods using blockchain’s distributed ledger, making audit and financial reporting transparent and occur in real time; and
- Provide a new world of financial services to the previously unbanked.
Based on surveys of banks, most banks are still in the early stages of understanding, adopting, and formulating their blockchain strategy or just beginning to look into it. As more and more banks roll out experimental applications, confidence will grow and its utility will be hard to deny. Once the adoption hits critical mass (the tipping point), we suspect that widescale adoption will spread quickly.