finance final about fintech

2

Blockchain and Cryptocurrency

December 4, 2022

The financial service industry plays an important role in businesses and society at large because it offers an environment for investments and saving, and it offers protection from different kinds of risks while helping in employment creation and enterprises. (Lee & Low, 2018) Growth and development witnessed in technologies have rapidly changed the industry with time allowing for the increased number of transactions and the delivery of a diversified product portfolio. The rate at which innovation is developing in the sector has been slow, however. This can be attributed to the regulatory burden in addition to the conservative culture that is present in the industry. There has been a predictive pattern with five main innovations put in fifty years which are the computerized information system that happened in the 1950s, the automatic teller machines that happened in the 1960s, electronic stocks trading that happened in the 1960s, mainframe computers in the 1980s and finally the internet that was utilized in financial services in the late 1990s and early 2000s. (Arslanian & Fischer, 2019) There have been major changes in the industry since then as big data, third-party platforms and more gained widespread adoption in addition to both social and mobile technologies. What came to be known as the FinTech revolution by scholars was built within three pillars which are the availability of capital for new startups, new technologies, and new business models. As a disruptive technology, blockchain is at the center of the FinTech revolution. Blockchain is anticipated to have the capacity to change a huge chunk of processes and activities in the financial industry. These changes are expected to improve efficiency with the capacity to generate potential savings of up to twenty billion USD annually.

Commercial transactions have for the longest time been recorded and stored in ledgers. They have mainly relied on human input making ledgers susceptible to errors that are extra costly and ultimately lead to inefficiencies in companies and for the economic system at large. Digital ledgers provide a solution to these problems through distributed networks and cryptography. One example of distributed ledger technologies is a blockchain that was initially launched in 2008 by an anonymous person or group under the name Satoshi Nakamoto.

Blockchains are defined by Lee & Low, as decentralized transactional databases that facilitate tamper-proof transactions through a huge participants number in a particular network.

Figure 1: Characteristics of a blockchain

Blockchain’s main characteristics include bringing on board trust in the transaction process. Their systems are known to improve transparency by making information available to all the participants in a network. They also utilize cryptography in addition to peer systems for transaction validation which are solid and immutable when it comes to data integrity. They protect user privacy by pseudonyms while the reliability of the system is ensured through the storage of the databases copy in every node. Blockchains have been instrumental in processing financial and monetary transactions because they ensure that each transaction follows a particular set of rules that the parties have agreed upon which are known as smart contracts.

One potential market for blockchain is payment and remittance. The main market here is cross-border payments and interbank transfers processed by clearing organizations. For this process to be successful, numerous micro-processes are complex in nature that must take places such as bookkeeping, balance reconciliations in different institutions, and more. The outcome is normally a tedious process that consumes a lot of time and results in huge transaction times. Cross-border payment has a huge potential and payments but accompanies by a high percentage of transaction costs emerging based on the transaction volumes and revenue generated. This presents a new business opportunity that blockchain and cryptocurrencies can be utilized. Inefficient payment processing has triggered the use of blockchain systems in addition to mobile technologies that can put billions back into people’s pockets, particularly in developing countries that have the highest use of remittances and cross-border transfers.

Blockchain also causes great impacts on credit and lending. Peer-to-peer platforms that are utilized by blockchain have found innovative techniques for decreasing information asymmetry while formalizing relationships among different parties thus boosting trust among stakeholders and shareholders. Through these platforms, transaction costs decrease significantly. A great illustration is the adoption of blockchain tokens that allows crowdfunding campaigns popularly known as Initial Coin Offering (ICOs). The volume of capital injected into these platforms is low in the overall market. Gaining user trust still drags these innovations down. (Lee & Low, 2018) Blockchain can also be used to improve decision-making on the lender’s side thus cutting down on bad loans. This is through risk assessment of interested borrowers which is based on historical data of real records. Quality and availability of data have continued to be a huge challenge to credit score models. This issue is challenging when potential borrowers reach a huge number, for instance, small and medium-sized businesses or individuals with their information relating to credit scores hidden from the public domain. The outcome is inefficient capital allocation and lost growth opportunities. Data marketplaces have emerged that offer a wide array of capabilities such as aggregation, processing, data gathering, etc. About credit scoring, a marketplace for data can represent a unifying element for potential lenders and borrowers whereby valid information is exchanged securely. Blockchains can be used in credit scoring, whereby they will be helpful in the creation of disintermediate trusted data marketplace that is secure connecting borrowers and lenders guaranteeing data integrity and data provenance. This means that blockchain-enabled systems can enhance the credit scoring process, thus drastically reducing the default rate while providing economic benefits to diverse stakeholders. (Fosso Wamba et al., 2020)

Trade execution time has over the years been significantly reduced to milliseconds. However, post-trade settlements still take a lot of time and can even go for several days. Industry-standard is two to three days with complex transactions such as syndicate loans going up to three weeks.

Figure 2: Normal post-trade activities

Long settlements create unnecessary costs while creating unwarranted risks for the parties involved. The industry spends approximately $ 6 billion to $ 9 billion yearly in post-trade activities for normal assets like fixed income and equities. However, this figure can go up to $24 billion when incorporating complex assets such as over-the-counter markets. (Arslanian & Fischer, 2019)

Blockchain can impact post-trade in six ways; decreasing costs related to data management and reconciliation through the development of a synchronized secure database, settlement times that are more flexible, security and resilience automated clearing, direct ownership, and finally transparency and traceability.

Before taking blockchain mainstream in the clearing and settlements domain some challenges ought to be tackled. They include interactions between the real world and the digital world. The second challenge is the legal and regulatory challenges including proof of ownership. The third one is technology readiness such as throughput and scalability. To overcome legal barriers, some countries have decided to tackle this, and some have come up with robust laws that address these challenges. (Fosso Wamba et al., 2020)

There has been increased online shopping, food delivery, and ridesharing among others that need secure payment options since in-person exchanges are reducing by the day. Payment spaces are integral in a seamless shopping world that offers a competitive advantage to different online platforms. The capacity to utilize blockchain that gives clients faster ways of transaction settlement that are more secure due to reduced centralized verification systems is integral to the success of this industry says. (Renduchintala et al., 2022) Moreover, many transaction fees are linked with traditional banking systems in the FinTech area. For instance, for each transaction, card issues have transaction fees in addition to payment processors such as Stripe having a facility fee. The merchant also pays an extra fee to accept payments from customers. The average cost related to processing payments is 2.5%-5% for each transaction. (Renduchintala et al., 2022) In addition to transaction fees, payment processors normally have delays during every transaction. This is for verification purposes which is a lengthy process with traditional payment systems. Transactions have to be processed and validated; then sent to the relevant intermediaries for each payment. The transaction times are increased by all the intermediaries in this process. This excruciatingly inefficient process creates loopholes in the system for fraud and has seen many people suffer credit card fraud globally which runs into billions each year. Utilizing blockchain technologies will remove transaction fees through smart contracts that eliminate the intermediaries thus cutting down on costs.

Other challenges that blockchain can eliminate by solving are transaction errors rate in addition to lack of transparency. There is an instance when there are problems with the physical state of the card, the issue of lack of funds on the holder’s account, or even problems with the merchant’s terminal. Transactions going through many intermediaries are a challenge in the localization of the step where an error happens thus making it a huge problem when it comes to lose recovery. Blockchain makes it possible for the transaction to be both transparent and immutable. In a scenario where one of the people in the transaction is fraudulent, it is easy to localize the fraudulent transaction. Small and medium enterprises face the challenge of lack of traditional financial services since they are most are not linked to big financial services. Blockchains empower small to medium financial institutions to operate on a global scale by linking them up to bigger financial institutions globally. This makes it easy to either pay fiat or cryptocurrency as information and data can move around the blockchain network (Renduchintala et al., 2022).

Insurance can benefit from the use of blockchain technology. Its ability to create trust in systems that cannot be trusted through the utilization of public ledgers in addition to solid cybersecurity protocols has a positive aspect on the insurance industry and future growth in the industry. Insurance plays a major role in economies guaranteeing and securing clients’ assets from damages. Without insurance which operates by pooling risks together, businessmen would stand to lose a lot financially in case of a catastrophe such as fire, accident, or even an economic meltdown. Coupled with big data and artificial intelligence, using blockchain in insurance will open doors in this industry. The use of smart contracts and advanced cybersecurity will see more investment and business in this industry. Companies will know their customers better while clients will better be protected from risks that have the capacity of bringing about an economic recession. Insurance companies play a vital role in the economy and their well-being cannot be taken for granted.

References

· Arslanian, H., & Fischer, F. (2019). The future of finance: The impact of fintech, AI, and crypto on financial services (Corrected publication). Palgrave Macmillan.

· Fosso Wamba, S., Kala Kamdjoug, J. R., Epie Bawack, R., & Keogh, J. G. (2020). Bitcoin, Blockchain and Fintech: A systematic review and case studies in the supply chain. Production Planning & Control, 31(2–3), 115–142. https://doi.org/10.1080/09537287.2019.1631460

· Lee, D., & Low, L. (2018). Inclusive fintech: Blockchain, cryptocurrency and ICO. World Scientific Publishing Co. Pte Ltd.

· Renduchintala, T., Alfauri, H., Yang, Z., Pietro, R. D., & Jain, R. (2022). A Survey of Blockchain Applications in the FinTech Sector. Journal of Open Innovation: Technology, Market, and Complexity, 8(4), 185. https://doi.org/10.3390/joitmc8040185