The Value of Blockchains in Financial Services

At their core, blockchains/DLT allow multiple parties to agree on a shared truth.

Private consortium blockchains, especially blockchains that only have financial institutions as participants, will have a huge impact in financial services. Modern finance is highly interconnected, and trying to keep track of relationships and transactions between parties is both crucial and complicated. Even industry efforts like SWIFT, while fulfilling a valuable purpose, come at a high cost to implement and maintain. By moving to a blockchain and encoding business logic as a shared application layer, FIs can essentially outsource a large chunk of not just the cost of maintaining and reconciling databases and interfaces to the blockchain, but also the core processing systems themselves, while enjoying faster speeds and better data quality.

However, the impact of these blockchains will be dwarfed by the impact of hybrid blockchains, where non-instituional entities are allowed to join, albeit usually with a different set of permissions. The removal of friction at each step of the process will allow each specialized entity to go directly to the customer instead. For example, when trading a cryptocurrency on a decentralized exchange, the functions of execution, clearing, settlement and custody can all be accomplished simply by viewing and issuing transactions on the blockchain. “Starting an exchange” is as simple and forking and deploying some code, and “joining an exchange” is as simple as signing read access to your wallet. Banks have already started challenging exchanges with dark pools. If they were able to pool liquidity between their customers onto a decentralized exchange, and open that up directly to traders and institutional investors in the form of a provably fair ECN, that would cause enormous pressure for centralized exchanges – and of course exchanges could do the opposite, by building closer relationships with their end-users. Meanwhile buy-side players like BlackRock could issue and trade ETFs on non-exchange networks of their choosing, cutting out significant costs by increasing competition amongst venues and issuers. (2019 note: from a market structure perspective, the trend of direct market listings show direct market participation and disintermediation continue to be a major trend, with or without blockchain).

However, even the impact of hybrid blockchains pales compared to the impact of permissionless blockchains, where any entity is allowed to join, and every entity can transact in the same way. One of the fundamental functions Bitcoin gives each user is custody and money transfer, essentially allowing them to be their own bank. Bitcoin is, partially by design, an extremely limited blockchain, however newer blockchains are capable of strong privacy, tremendous scale, and flexible programmability, opening up new possibilities in lending, escrow, insurance, fund-raising, even complex products like derivatives. For example, and for better or for worse, initial coin offerings allow blockchain startups to either bypass traditional funding routes and raise capital directly from the public, or for more established companies to bypass an IPO and do a pseudo direct listing with a global audience.

In summary, any form of financial instution and service could hypothetically be replaced with a purely decentralized bundle of code that is directly accessible to the end-user – with the caveat that there may still be a market for people who are especially competant at writing, modifying or utilizing this code. The conclusion is that there could still be demand for bankers, but no more need for banks. This might stretch belief, but the important thing to focus on is for everyone in the financial services industry to re-examine the value they bring to their customers, as ultimately that is what will allow them to stay relevant.

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