Why are so many financial institutions investing in block chain innovation labs? Will the block chain, with its promise of rapid, secure and inexpensive transactions, really make many existing financial institutions obsolete as some have claimed? Thomas F. Dapp and Alexander Karollus examined the block chain’s impact on traditional financial institutions in a “talking point” article for Deutsche Bank Research, which provides macroeconomic analysis for Deutsche Bank Group. The article is titled, “Blockchain – attack is probably the best form of defence.”
The authors noted that the block chain, because it constitutes a decentralized ledger system which can manage transactions in a secure manner, has ignited a vigorous discussion in both online and offline media.
Bitcoin is the best-known example of a P2P technology application, the authors noted. However, the P2P network can also process fully automated and/or programmable agreements known as “smart contracts,” which bypass intermediaries, national borders and regulators. This capability was the idea proposed by Satoshi Nakamoto, the mysterious programmer who initiated the first bitcoin transaction in the P2P network in 2009. The log of the string of transaction chains continues to verify bitcoin transactions.
A Paradigm Shift For Banks?
Block chain theory holds that individual business divisions of banks and other players will become redundant. There could also be a paradigm shift in the financial system since the P2P network could also replace many intermediary services.
These features explain the growing interest of traditional banks and other financial sector players in the new technology. Several institutions have established innovation labs devoted exclusively to the block chain. Stock exchanges, credit card firms, clearing houses and insurers are also exploring the technology for their own uses.
“This may be because established intermediaries want to get an idea of whether the blockchain is actually a threat to their existence or may ultimately even offer numerous opportunities – now in the digital age – to implement new proprietary technologies which will raise the digital profile of traditional transaction banking, boosting its efficiency and, above all, execution times,” the article noted.
Will The Block Chain Actually Strengthen Banks?
The ability to offer financial products and services in real time globally at reduced costs could actually catapult traditional banks back to top spot in the race to devise financial innovations, the authors noted.
Traditional banks must now focus on a timely analysis of the new technological challenges and on developing strategies to claim a more active role in the innovation race. Financial institutions could defend their business models by implementing certain parts of block chain technology for their own purposes and in their own IT environment without the P2P aspect.
“Thus, it is entirely conceivable that banks could, for instance, set up a new digital booking and clearing system amongst themselves enabling them to offer client transactions featuring the benefits of the blockchain, such as speed, efficiency, internationality and cost savings.” A modern clearing system among banks would likely be even less expensive and more efficient than the block chain since there would be no need for the energy-consuming “proof of work” (“mining” in bitcoin).
Banks could configure their systems in a user-friendly manner for customers and provide them more personalized services which the block chain currently cannot do.
With a new proprietary digital IT infrastructure banks could thus quite conceivably be able to position themselves relatively well in relation to the blockchain technology.
Banks could also assume new tasks, such as acting as custodians for cryptographic keys. Such services could ensure that customers remain on the bank’s financial platform in order to use other monetization options.
“To this end, traditional banks would have to play their wild card of trust – which they (still) hold – in a much better way than has been the case so far.”
Challenges Remain For Banks
Because the technology is still in its infancy, banks and other players have time to analyze the challenges, the authors noted.
The political sector plays a key role as well. An open P2P financial system will confront regulators and law enforcement with new challenges.
To date, there has not been any regulatory restriction of P2P mechanisms in the financial system.
Traditional banks should not rely on the regulator now, though, but instead actively experiment with the new technologies in their labs and collaborate without prejudice in order to create their own digital ecosystem in the medium run.
Images from Shutterstock and Deutsche Bank.