The global financial system moves trillions of dollars daily, serves billions of people, and supports a global economy worth more than $100 trillion. It’s the world’s most powerful industry, the foundation of global capitalism, and its leaders are known as the Masters of the Universe. Closer up, it’s a Rube Goldberg contraption of uneven developments and bizarre contradictions. First, the machine hasn’t had an upgrade in a while. Consider the bank offering Internet banking but still issuing paper checks and running mainframe computers from the 1970s. When one of its customers taps her credit card on a state-of-the-art card reader to buy a Starbucks grande latte, her money passes through no fewer than five different intermediaries before reaching Starbucks’s bank account. The transaction takes seconds to clear but days to settle.
Then there are the large multinationals like Apple or GE that have to maintain hundreds of bank accounts in local currencies around the world just to facilitate their operations.
Another bizarre paradox, Traders buy and sell securities on the world’s stock exchanges in nanoseconds; their trades clear instantly but take three full days to settle. Local governments use no fewer than ten different agents — advisers, lawyers, insurers, bankers, and more — to facilitate the issuance of a municipal bond.
Another absurd contradiction, why does Western Union need 500,000 points of sale around the world, when more than half the world’s population has a smart phone? Erik Voorhees, an early bitcoin pioneer and outspoken critic of the banking system, said “It is faster to mail an anvil to China than it is to send money through the banking system to China. That’s crazy! Money is already digital, it’s not like they’re shipping pallets of cash when you do a wire!”
Here is how Blockchain disrupts financial services:
Exchanging Value: Daily, markets globally facilitate the exchange of trillions of dollars of financial assets. Trading is the buying and selling of assets and financial instruments for the purpose of investing, speculating, hedging, and arbitraging and includes the posttrade life cycle of clearing, settling, and storing value. Blockchain cuts settlement times on all transactions from days and weeks to minutes and seconds. This speed and efficiency creates opportunities for unbanked and underbanked people to participate in wealth creation.
Speed: Today, remittances take three to seven days to settle. Stock trades take two to three days, whereas bank loan trades take on average a staggering twenty-three days to settle. The SWIFT network handles fifteen million payment orders a day between ten thousand financial institutions globally but takes days to clear and settle them. The same is true of the Automated Clearing House (ACH) system, which handles trillions of dollars of U.S. payments annually. The bitcoin network takes an average of ten minutes to clear and settle all transactions conducted during that period. Other blockchain networks are even faster, and new innovations, such as the Bitcoin Lightning Network, aim to dramatically scale the capacity of the bitcoin blockchain while dropping settlement and clearing times to a fraction of a second.
Monopoly: Finance is a monopoly business. In his assessment of the financial crisis, Nobel laureate Joseph Stiglitz wrote that banks “were doing everything they could to increase transaction costs in every way possible.” He argued that, even at the retail level, payments for basic goods and services “should cost a fraction of a penny.” “Yet how much do they charge?” he wondered. “One, two, or three percent of the value of what is sold or more. Capital and sheer scale, combined with a regulatory and social license to operate allows banks to extract as much as they can, in country after country, especially in the United States, making billions of dollars of profits.” Historically, the opportunity for large centralized intermediaries has been enormous. Not only traditional banks (e.g., Bank of America), but also charge card companies (Visa), investment banks (Goldman Sachs), stock exchanges (NYSE), clearinghouses (CME), wire/remittance services (Western Union), insurers (Lloyd’s), securities law firms (Skadden, Arps), central banks (Federal Reserve), asset managers (BlackRock), accountancies (Deloitte), consultancies (Accenture), and commodities traders (Vitol Group) make up this expansive leviathan. The gears of the financial system — powerful intermediaries that consolidate capital and influence and often impose monopoly economics — make the system work, but also slow it down, add cost, and generate outsized benefits for themselves. Because of their monopoly position, many incumbents have no incentive to improve products, increase efficiency, improve the consumer experience, or appeal to the next generation.
Storing Value: Financial institutions are the repositories of value for people, institutions, and governments. For the average Joe, a bank stores value in a safety deposit box, a savings account, or a checking account. For large institutions that want ready liquidity with the guarantee of a small return on their cash equivalents, so-called risk-free investments such as money market funds or Treasury bills will do the trick. Individuals need not rely on banks as the primary stores of value or as providers of savings and checking accounts, and institutions will have a more efficient mechanism to buy and hold risk-free financial assets.
Funding and Investing: Investing in an asset, company, or new enterprise gives an individual the opportunity to earn a return, in the form of capital appreciation, dividends, interest, rents, or some combination. The industry makes markets: matching investors with entrepreneurs and business owners at every stage of growth — from angels to IPOs and beyond. Raising money normally requires intermediaries — investment bankers, venture capitalists, and lawyers to name a few. The blockchain automates many of these functions, enables new models for peer-to-peer financing, and could also make recording dividends and paying coupons more efficient, transparent, and secure.
Moving Value : Daily, the financial system moves money around the world, making sure that no dollar is spent twice: from the ninety-nine-cent purchase of a song on iTunes to the transfer of billions of dollars to settle an intracompany fund transfer, purchase an asset, or acquire a company. Blockchain can become the common standard for the movement of anything of value — currencies, stocks, bonds, and titles — in batches big and small, to distances near and far, and to counterparties known and unknown. Thus, blockchain can do for the movement of value what the standard shipping container did for the movement of goods: dramatically lower cost, improve speed, reduce friction, and boost economic growth and prosperity.
Lending Value: From household mortgages to T-bills, financial institutions facilitate the issuance of credit such as credit card debt, mortgages, corporate bonds, municipal bonds, government bonds, and asset-backed securities. The lending business has spawned a number of ancillary industries that perform credit checks, credit scores, and credit ratings. For the individual, it’s a credit score. For an institution, it’s a credit rating — from investment grade to junk. On the blockchain, anyone will be able to issue, trade, and settle traditional debt instruments directly, thereby reducing friction and risk by increasing speed and transparency. Consumers will be able to access loans from peers. This is particularly significant for the world’s unbanked and for entrepreneurs everywhere.
Insuring Value and Managing Risk: Risk management, of which insurance is a subset, is intended to protect individuals and companies from uncertain loss or catastrophe. More broadly, risk management in financial markets has spawned myriad derivative products and other financial instruments meant to hedge against unpredictable or uncontrollable events. At last count the notional value of all outstanding over-the-counter derivatives is $600 trillion. Blockchain supports decentralized models for insurance, making the use of derivatives for risk management far more transparent. Using reputational systems based on a person’s social and economic capital, their actions, and other reputational attributes, insurers will have a much clearer picture of the actuarial risk and can make more informed decisions.
Accounting for Value: Accounting is the measurement, processing, and communication of financial information about economic entities. It is a multibillion-dollar industry controlled by four massive audit firms — Deloitte Touche Tohmatsu, PricewaterhouseCoopers, Ernst & Young, and KPMG. Traditional accounting practices will not survive the velocity and complexity of modern finance. New accounting methods using blockchain’s distributed ledger will make audit and financial reporting transparent and occur in real time. It will also dramatically improve the capacity for regulators and other stakeholders to scrutinize financial actions within a corporation.
Credits to Blockchain Revolution by Dan Tapscott