In my last blog, I argued that blockchain can furnish banks with a reliable and immutable way to verify financial data, addressing the longstanding pain point of fragmented and inconsistent information across siloed systems. For example, in February, Lloyds Bank became the first UK bank to allow its clients to transfer blockchain-based electronic Bills of Lading (eBLs) across 136 countries, unlocking new trade efficiencies and sustainability benefits.[i]
To reap these benefits, however, banks will need a nuanced understanding of blockchain’s capabilities and limitations. In this article, part of our "Future of Money" series inspired by UCL's initiative, I’ll lay out some practical steps for leveraging blockchain technology in banking, with insights from Dr. Geoffrey Goodell of the UCL Centre for Blockchain Technologies.
Rethinking Blockchain's Role
Some people may still think about blockchain itself as the source of financial data. However, Dr. Goodell underlines a key point here:
"Distributed Ledger Technology (DLT) is not another way of creating accounting ledgers. It offers a way to share responsibility for rule-making among a set of peers. The consensus view of the truth about which transactions have taken place should reflect the agreement of this community. DLT backs up the authoritativeness of ledger records you might want to claim as true or false."
This way of thinking aligns with the Electronics Trade Documentation Act, focusing on digital assets that hold their own state. While the provenance of these assets might be verified using DLT, the transactions themselves aren't entered into the ledger. Blockchain's strength lies in its ability to verify claims about transactions. Dr. Goodell explains:
"We want to use the ledger less for asset management and more for truth verification and constraining the ability of system operators to equivocate in their claims."
Steps for Implementation
For banking executives, it's crucial to conceptualise blockchain not just as a technological upgrade, but a transformation in how financial data is verified and trusted. If you’re looking for a way to implement blockchain, balancing innovation with the stringent requirements of the financial sector, here’s a list of initial steps to follow:
1. Assess Current Infrastructure
Focus on data-heavy processes like cross-border transactions, trade finance, and KYC. Identify pain points such as reconciliation delays, data inconsistencies, and fraud vulnerabilities. Quantify current costs and inefficiencies to establish a baseline for measuring blockchain's impact.
2. Develop a Clear Strategy
Align blockchain initiatives with your bank's digital transformation roadmap. Set specific goals, such as reducing settlement times by 50% or cutting compliance costs by 30%. Consider how blockchain could enable new products or services, like real-time cross-border payments or tokenized assets.
3. Choose the Right Platform
Compare enterprise-grade platforms, assessing their performance in banking-specific use cases, regulatory compliance features, and scalability. Consider the ecosystem and developer support for each platform to ensure long-term viability.
4. Pilot and Test
Start with a narrow use case, such as intra-bank reconciliation or KYC data sharing. Set clear success metrics like reduced processing time or improved data accuracy. Involve a small group of real customers to gather feedback. Plan for a 3-6 month pilot with defined go/no-go criteria.
5. Ensure Regulatory Compliance
Engage with regulators early in the process. Address specific regulations like GDPR (data privacy), PSD2 (open banking), and AML directives. Develop a compliance framework that covers data residency, right to be forgotten, and audit trails. Consider joining industry consortiums to help shape blockchain regulations.
6. Integrate with Existing Systems
Develop a detailed integration roadmap. Focus on critical touchpoints like core banking systems, payment networks, and risk management tools. Use APIs and middleware to create a seamless data flow. Plan for a phased integration to minimize disruption to ongoing operations.
7. Focus on Security
Implement multi-layer security including network security, consensus mechanisms, and smart contract audits. Develop robust key management protocols, possibly, but not necessarily, using Hardware Security Modules (HSMs). Conduct regular penetration testing and vulnerability assessments. Create incident response plans specific to blockchain-related threats.
8. Train Staff
Develop a comprehensive blockchain education program for different roles. Provide technical training for developers on smart contract programming and blockchain architectures. Offer high-level workshops for executives on blockchain's strategic implications. Create a certification program to recognize and retain blockchain expertise within the organisation.
Potential Use Cases
To illustrate the practical applications of blockchain in banking, let's explore two potential use cases:
Trade Finance
Blockchain can help firms to create a shared, real-time view of trade transactions. All parties - banks, importers, exporters, and regulators - can verify the truth of a transaction using DLT. This could significantly reduce paperwork, speed up processes, and minimise the risk of fraud.
For example, if implemented correctly, a letter of credit process, usually taking over a week, could be completed as quickly as a few hours. The blockchain would aid in verifying each step of the transaction, from the initial agreement to the final payment, helping all parties create an up-to-date, verifiable record.
Syndicated Lending
In syndicated loans, blockchain can streamline the complex coordination process. A blockchain-based system could:
- Automate the distribution of loan documents.
- Provide real-time visibility into the loan's status.
- Facilitate faster, more transparent settlement of loan participations
This could reduce the average settlement time for syndicated loans to potentially just a few days, significantly improving liquidity for both lenders and borrowers.
Balancing Privacy and Transparency
A key consideration in blockchain implementation is how to achieve both privacy and regulatory oversight. Dr. Goodell emphasises:
"We want privacy for payers to protect their transaction details, while recipients' privacy can vary depending on their client base. We need a way to ensure that system operators don't misuse information while maintaining verifiable claims about transactions, and privacy-enhancing technologies, such as zero-knowledge proofs, can help."
This approach differs significantly from current crypto markets, which Dr. Goodell describes as:
“Basically, a large share of the market for cryptocurrency involves businesses that happen to use tokens as a financing tool. Tokens are the future of digital payments, but we need to think differently about their implementation."
Moving Forwards
Implementing blockchain in banking isn't about replacing existing systems wholesale, but rather enhancing them with powerful verification capabilities. By focusing on provenance and truth verification rather than transaction storage, banks can leverage blockchain to improve data integrity, enhance regulatory compliance, and increase operational efficiency.
As we navigate this new frontier in financial technology, it's crucial to approach blockchain implementation with a clear understanding of its strengths and limitations. If you'd like to understand how blockchain can improve your organisation's banking operations, book a free consultation with our experts today.
[i] https://www.lloydsbankinggroup.com/media/press-releases/2024/lloyds-bank-2024/lloyds-bank-partnership-with-wavebl.html