FinTech is transforming the financial industry, and the blockchain organizations in this space are making considerable developments to drive the FinTech industry much further. Currently, many fintech organizations like insurtech, crypto payments, DLT platforms, and other banking start-ups have already integrated this cohesion of Blockchain in FinTech into their business models.
The speed and scale of this change primarily depend on the user’s adoption of a blockchain economy. With the growth of a more tech-savvy population, most individuals are tired of black boxes and want to know what goes on behind their financial transactions. Eventually, this may lead to the mainstream adoption of blockchain technology in the financial sector. Therefore, understanding how Blockchain use in financial technology fits into FinTech is crucial.
This article sheds some light on Blockchain in FinTech key concepts and some of the use cases of Blockchain in the FinTech sector.
What is Fintech?
As stated by CNBC, Fintech is short for Financial Technology. It comprises of a wide range of financial products, technological products, and business models that are changing the financial service industry. It refers to anything from cashless payments, crowdfunding platforms, and Robo-advisors to virtual currency.
At its core, Financial Technology is used to help companies, business owners, and consumers better manage their financial transactions, operations and lives in general by utilizing specialized software and applications.
Until 2009, the fintech sector offered various services under centralized institutions limited to very few investors. However, the creation of Blockchain technology introduced a more customer-centric decentralized platform that opened up the financial sector to the public. The first financial product was Bitcoin, which currently holds the largest market cap in the cryptocurrency space.
The value of Blockchain in the FinTech sector
According to Forbes, Blockchain is an open and distributed ledger that records transactions in the form of code. Within the blockchain ecosystem, data is stored in blocks linked together by cryptographic hash functions to form a series of chains.
Transaction data within the Blockchain is also distributed to all entities in the network to maintain an immutable and consistent record of transaction data. Any alterations to the data require the consent of all other members of the network. It is crucial to note that amending data on a blockchain does not alter the previously recorded state, but instead updates the state to the newly approved state. Therefore, any transaction data or changes are recorded on the Blockchain.
Moreover, since the transaction data is distributed to all entities with the necessary authentication, blockchain technology provides a transparent ledger that authorizes access to companies, business owners, and customers to any transaction information on the Blockchain.
Another critical feature of blockchain technology is decentralization. This means that decisions in the network are made by a few chosen leader entities (Private Blockchain) or all involved entities (Public Blockchain) depending on the type of Blockchain. Consensus on the Blockchain is achieved through fault-tolerant mechanisms such as Proof-of-work (POW), Proof-of-stake (POS), Proof-of-capacity (POC), or Practical Byzantine Fault Tolerance (PBFT), to mention a few.
Therefore, blockchain technology can transform traditional financial processes into fully transparent operations with highly secure and efficient transactions. While impressive, the mentioned applications of Blockchain do not capture the gist of what Fintech and Blockchain applications can do. Below are some of the key applications of Blockchain to Financial Technology.
How Blockchain Fits in the FinTech space
Blockchain enhances security in Financial Identity Management
One of the most crucial aspects of financial institutions is security. Financial institutions have to ensure that the transaction they are carrying out is highly secure and validated. Most financial institutions have their own mechanism to enhance security and validate the identity of users. However, to customers, this is often an unpleasant process that includes multiple security checks and KYC processes for simple tasks such as checking their account balance.
Moreover, most institutions require customers to provide their KYC details. As a result, a customer’s data ends up being siloed and distributed within many institutions. This raises security concerns as, at times, customers cannot keep track of their data, let alone the institution holding the data.
In order to counter this challenge, Blockchain technology is implemented. Blockchain technology allows users to create their own digital identity and store it on the Blockchain. The technology also allows users to control their data and keep track of where their data is used. If the data is shared with an institution, the user can keep track of the data and control access as every transaction is a recorder on the Blockchain. Since the data is stored on an immutable ledger, it can be reused for identification purposes with institutions and locations.
Blockchain improves the auditing process by acting as an Electric Notary
Financial auditing hinges on time consumption and expert workforce input to ensure accurate reconciliation of records. The traditional auditing process also follows regulatory protocols that add to the time taken. For instance, double-entry bookkeeping requires auditors to always have two entries; for every debit entry made, there has to be a credit entry that ensures the book’s balance. This process is time-consuming, and in cases where the auditing services are billed hourly, it becomes very costly.
Moreover, with double-entry bookkeeping, record alteration is straightforward as all that is required is for the books to balance. Even with current software like QuickBooks, fraudulent record alteration is still pervasive.
Since Blockchain is a ledger, it is used to record financial transactions. One key aspect of Blockchain is that it adds on an extra element to double-entry bookkeeping: recording the state of the data after every transaction without changing the previous records. Each block contains a timestamp, transaction data, parties involved, and a cryptographic hash function to maintain immutability. This creates an integrated trail of transactions that auditors can easily verify through electronic signatures and blockchain addresses.
As we head to a single network available to anyone with an internet connection, building Blockchain-based Apps will enable the fintech sector to create first-tier auditing protocols.
Blockchain use in financial technology is able to automate transactions with Smart Contracts
Traditional financial transactions are chained to paperwork, and most of the processes have to be handled manually. For instance, shipping transactions require client-side handling like lading bills, invoices, letters of credit, keeping track of shipments, and confirming the arrival of products. With insurance transactions, customers also have to claim their compensation manually with insurance companies, which is a very paper-intensive and time-consuming process. Despite the various financial institutions leveraging SaaS as a solution, the entire process still experiences delays and backlogs.
Blockchain infrastructure can be used to settle transactions efficiently through smart contracts. Smart contracts operate on the same concept as programs on a computer. If the pre-set conditions are met, then the program executes the specified task. However, if the conditions are not met, no transaction occurs.
Within the financial sector, paperwork tasks can be implemented digitally through smart contracts. The terms of the contract are coded within the smart contract, thereby automating the process. When a financial institution or customer meets the contract’s requirements, the smart contract automatically executes the task, e.g., fulfilling a payment or funding a project in crowdfunding.
Blockchain use in financial technology eliminates third parties in transactions
Cross-border payments and remittances are a chronic pain point for financial institutions and their customers. In most cases, global bank transfers take up to one week or more. On the other hand, financial institutions charge very high fees that limit SMEs and individuals from sending funds. Similarly, various regulations exist depending on a user’s geographical location and jurisdiction.
Blockchain technology, particularly public Blockchain, has been proposed as a viable solution. In a blockchain network, transactions are verified by distributed peer nodes, and any node can leave or join the network without disrupting the consensus mechanism on the transactions. According to Deloitte, blockchain technology enables business-to-business and person-to-person payments worldwide with a 40-80% reduction in transaction cost.
Blockchain use in financial technology improves Crowdfunding processes
There are five key benefits to crowdfunding platforms; efficiency, built-in PR and marketing, more straightforward presentation, reach, and near to immediate validation of the concept. According to BBVA Open Mind, $34 billion has been raised through crowdfunding initiatives as of 2020. However, despite the success, challenges still exist; high fee for listing a project, limiting rules and regulation within platforms, intellectual property risk, and inefficiency.
With all these limitations, Blockchain provides tangible solutions that enhance efficiency. As Blockchain is decentralized, start-ups do not have to rely on central authorities for approval or pay any fees to list their project. ICOs combined with DEXs allow start-ups to raise funds in a completely decentralized and distributed manner. Smart contracts are also an essential aspect of decentralized crowdfunding platforms as they enforce funding terms and provide greater accountability throughout the development phase.
Furthermore, Blockchain introduced a Token Economy that opened up a new world of investing. Currently, anyone with an internet connection can be a willing investor in a blockchain project of their choice. Decentralized exchanges took this a step further by ensuring every project can list their tokens without incurring any fees.
Blockchain’s use in financial technology enhances Fraud detection
According to The ACFE cost of fraud report, almost 5% of revenues generated annually are lost to fraud. Online transactions are filled with fraudulent activities, including transactions, manipulation, multiple payments (double spending), and numerous Ponzi schemes that aim to steal funds from unwilling customers and investors.
The nature of blockchain technology assumes a distributed ledger that is shared across the network. Each record has a timestamp and is linked to the previous entry using cryptographic hash functions. This makes the transaction data immutable, transparent and makes it difficult for malicious parties to deceive the system. Additionally, Blockchain allows users to transact anonymously, thereby preventing targeted attacks.
Companies at the forefront of the Financial Revolution
Capital Markets – Tecra Space
Tecra provides investors with a chance to invest in Blockchain start-ups and promising start-up ideas listed on their platform. It implements Blockchain-based solutions such as tokenization, smart contracts, Non-fungible tokens, an original crypto coin, TecraCoin, and Decentralized Exchanges (Uniswap), to mention a few. The platform mainly focuses on transparency, low fees, global reach, automation through smart contracts, and enhanced security of intellectual property
Asset Management – Consensys Codefi
Codefi Assets allows asset managers to create, issue, and manage the lifecycle of digital assets, associated markets, and digital financial instruments on public or permissioned Blockchain. It is an end-to-end digital asset management platform that securely digitizes a wide range of financial products and transactions through tokenization. Codefi also improves workflow and reduces transactional cost and associated fees with automated processes (Smart Contracts) and Blockchain native data accessibility.
Payment and Remittance
Project i2i is an Ethereum Enterprise payment network developed with Union Bank of the Philippines to integrate National Financial services with rural banks. The project provides more access and efficient domestic transactions for local citizens.
Amaano integrates Blockchain technology and a social platform to enable its users to send money across borders instantly and reliably. This integration of the underlying Blockchain infrastructure enables users to buy, spend, store and share digital assets. Amaano platform also significantly reduces the fees associated with remittance services and offers instant transfers.
Trade Finance – Komgo
Komgo is a blockchain-based trade financing platform based on JP Morgan Quorum. Network-base. Komgo is also connected to VAKT an Ethereum-based post-trade processing platform for commodities. The platform has a proprietary document sharing system, Kite, that allows the secure and private transfer of documents. Komgo’s framework utilizes DLT to tackle fraud, enhance efficiency, digitize trade and increase transparency within the commodity trade finance network.
Insurance – Etherisc
Etherisc is an open-source platform that aims to provide decentralized insurance applications. Etherisc develops Blockchain-based solutions to insurance companies with the goal of eliminating high processing fees and prolonged claim processing times. Currently, the platform has developed more than six decentralized insurance-related applications for various applications, such as crop insurance due to bad weather and protection against crypto wallet hacking.
To wrap it all up
Blockchain in the Fintech industry has the potential to provide far more seamless and efficient alternatives to most of the financial services being offered. However, while Blockchain is efficiently being applied to sectors like supply chain management and real estate tokenization, it will take more time for Decentralized Ledger Technology to be a fully mainstream financial model. Nevertheless, it’s hard to deny the impact Blockchain has had in the financial sector.
Real-time fund transfers, low transaction fees, top-tier security, transparent financial transactions, and elimination of intermediaries; all of this can be made possible with Blockchain technology.