Fintech being a leading light of the startup ecosystem over the years, has played crucial roles in development of the financial services industry. Strong ecosystem level changes are opening up opportunities for new business models. Introduction of blockchain technology in this evolving sector has a considerable impact and advantage.

Blockchain technology is a “chain of blocks” where each block holds timestamped digital data and it’s own previous blocks’ unique identity. The unique features of blockchain have potential to benefit the financial sector significantly.

In this blog we will cover following topics:

• What is Blockchain?
• How Blockchain is transforming the financial ecosystem
• Fintech and Blockchain-Use Cases
• Future of Blockchain in Finance

What is Blockchain technology and its features?

Blockchain is a decentralized database management system. The name signifies itself, a series of blocks containing transaction data, a hash identity, and node details are connected to form a chain. Blockchain is distributed ledger technology (DLT) which allows data to be stored globally on thousands of servers.

Below are the key features of Blockchain for its deeper understanding:

• Security and Transparency

Financial services all across the world are still centralized and multi-folded. Financial data is mostly stored in centralized databases, and it has to go through multiple intermediaries like front-back offices etc which results in lack of transparency across the system, wherein safety being solely dependent on intermediaries and their level of security.

This lack of transparency within the system fosters security threats or data breaches across the organization.

With the introduction of blockchain technology, transparency and security can be ensured simultaneously. Its distributed consensus based architecture facilitates the security towards data breaches, security threats etc. 

• Privacy

Blockchain system provides operable keys-a public one and a private key. Public key is available to all users in the network. However, the private key is only accessible to the stakeholders of the transaction. This enables transparency wherein the transaction will be visible to all users in the network with public key whereas the stakeholders and the transaction details will only be visible to those who have access to the private key. This process enables transparency within the system while securing the confidential information of the stakeholders.

How does Blockchain work?

Blockchain records validate and store the data in its database. So, it leverages to validate a transaction happening across the network. Each block in the block chain contains follow information

• A hash pointer (link to previous block)
• A timestamp
• Transaction data

Future of Blockchain in Fintech Technology

Andy Martin, a world-class blockchain expert, recently forecasted market changes based on the token economics forced by blockchain and described what exactly it provides:

“Decentralized communities provide certainty of identity, “who am I dealing with”, the certainty of provenance, “what am I buying” and smart contracts give certainty of execution, “if I do this, then I get paid” in these new marketplaces.”

Let’s understand better how Fintech and Blockchain can be chained together to build a FinBlock ecosystem.

Blockchain in the fintech industry can provide us a more seamless and effective way to banking, built around concepts of equity and decentralization. Blockchain-based fintech enables seamless transfer of funds, top of the line security and transparent financial tracking.

Reduced Costs and Transactions in Minutes

With blockchain integration in fintech applications, sending money, regardless of the amount, is much faster. Blockchain-based transactions occur in real time, so the recipient will not have to wait for days or weeks to get the money.

In addition to this, fintech applications powered by blockchain technology can drastically reduce the transaction costs enabling direct, P2P transactions that eliminate any middleman, meaning all unnecessary expenses and fees.

Use Cases of Blockchain in Fintech

Some use cases of blockchain in fintech services are: Cross Border Payments, Lending Platforms, Credit Score, Invoice Management and Billing Solution, Fund Investment, Government Expenses, Financial Record Keeping, Stock Exchange and Initial Public Offering

Let’s discuss Cross Border Payments and Lending Platforms use case in details:

Cross-Border Payments

Banks always charge an additional fee for every transfer or payments across borders, which in a way becomes expensive and slow. 

E.g If you want to transfer money from India to the USA, the transfer goes through one or more financial institutions before it reaches the receiver.

Introduction of Blockchain allows individuals to send and receive money with minimum interference of different intermediaries, which enhances the payment settlement quickly and efficiently.

Lending Platforms

When it comes to lending, one is required to establish trust and make a transaction happen. However, with blockchain technology in fintech, borrowers can directly deal with the lenders on the rate of interest, installments, and duration of the transaction with the help of immutable smart contracts.

Conclusion:

Blockchain in financial services can offer multiple benefits, which can help transform the finance industry. According to KPMG, “blockchain can reduce errors by up to 95%, increase efficiency by 40% and reduce capital consumption by up to 75%”. Blockchain in finance is an exciting concept with the potential to transform the finance industry.

Blockchain can help different financial institutions and government entities to improve trust, bring transparency and cut down costs. 

E-Commerce has broken the political borders and offers products & services across different country borders. This has resulted in a high volume of cross-border goods and payment flows. 

Cross border payments have become an integral part of the day-to-day activities of global businesses. Small Businesses’ zeal to expand their business beyond their country boundaries has been well supported by ongoing digitalisation and high-end technological capabilities across multiple sectors and industries. However, it continues to face significant challenges owing to complicated cross-border mechanisms. The Small businesses face challenges in making or receiving payments internationally because of dealing in different currencies and country specific rules and regulations for international payments. This has created a need for a more agile and frictionless cross border payment framework making cross-border payments as simple as domestic transactions.

What are Cross-border payments?  

Cross-border payments are defined when both the parties i.e. buyer and sellers involved in the transaction are registered in different countries. Most popular cross border payments methods are wire transfer, credit cards and alternative payment methods- mobile wallet, low value payment method. All interaction for payments happens between buyers and sellers through their respective Banks. The Banks communicate with each other through the SWIFT mechanism when it comes to international transactions. 

In Traditional cross-border payments of correspondent banks, the number of intermediary banks depends on the relationship of the buyer’s and seller bank’s with the correspondent bank. As the number of intermediary banks increases, costs associated with fees and commissions also increase. A Bank can track the transactions till its immediate bank. It becomes difficult for the originating bank to track the transaction once the payment goes to the next bank in the sequence. There is no standard procedure for cross-border payments due to different rules and regulations of each country.  Evolving customer requirements, instantaneous fund transfer, cost reduction, complete transparency and technological innovation has initiated the process to improve cross-border payments as a whole.

Cash Flow in Cross-border Payments

When a customer makes a purchase, there’s a complete back-end process wherein money gets transferred from the buyer’s bank account to the seller’s bank account. This process becomes very complex when it comes to cross-border payments. In international transactions, currency exchange rates and foreign transaction fees are also involved along with the fees or commission charged by the different bank in the value-chain. In cross border payments domestic and international financial institutions are working together to make the transfer of funds.

When a purchase is made, if the buyer’s and seller’s bank have a direct relationship payment is done very easily and seamlessly but in the absence of direct relationship intermediary bank’s role becomes important. These intermediary banks are called correspondent banks.

Major Banks across the globe have their own branch or correspondent bank’s branch in another city. In such cases, the funds will first move from the Buyer’s bank branch to the Bank’s own branch or its Correspondent bank’s branch in the seller’s country. This fund is further transferred to the seller’s bank who will then credit the seller’s account. There are many entities, different currencies, exchange rates and transaction fees involved in the single international transaction which make the process slow and opaque in nature. The more the number of correspondent banks in the chain, cost and complexity of transaction keeps on increasing

In the Era of Globalised Digital Economy, international payments still felt backward and analogue.

A Revolution in Cross Border Payments  

The future of cross-border payments is clear wherein the world requires ability to move funds instantaneously, seamlessly with full transparency and 24*7 access. As the payment industry started moving forward on this journey, an array of new industry initiatives and emerging technologies are transforming the payments process. Fintechs using emerging technologies like blockchain, artificial intelligence, machine learning have started offering faster, agile and seamless solutions to the financial institutions to cater the emerging needs of customers.

Currently multiple paths are being used by the payment service providers such as Real-time payments, SWIFT gpi, SWIFT’s transaction manager, artificial intelligence, blockchain and digital currencies- cryptocurrency, central bank digital currency and stable coins. These new ways in cross-border payments would provide opportunities to make cross-border transactions faster, more frictionless, efficient, transparent and cost-effective like domestic transactions. Fintechs act as catalysts for innovation and bring global payments together through various approaches. Banks have started collaborating with fintech to mend their strengths and optimize their offerings by enhancing the payments infrastructure with latest technologies.

This revolution will transform the landscape of cross-border payments and empower the end user with full control on sending and receiving international payments at any point in time with complete transparency related to fees/ commissions charged and traceability of transactions in the system.

As per Deloitte report – B2B and P2P payments with blockchain would result in a 40% to 80% reduction in transaction costs and take an average of four to six seconds to finalize (compared to two to three days using the standard transfer process).

Digital currency would shift the world’s economy towards a cashless economy. Digital currency has the capability to change the perspective of individuals towards money. The continuous rise of cryptocurrencies such as Bitcoin, Ethereum has led the global central banks to explore the benefits and challenges of a regulated Digital Currency – Central Bank Digital Currency (CBDC). Few countries have even started work on the same and most of them are at the R&D stage and China is in the pilot stage of CBDC.

What is Digital Currency?

The Digital currency has all the intrinsic properties of cash/ physical currency except the form. Cash/Physical currency has both physical and electronic form, however Digital currency exists only in electronic form. Digital currency can be accessed with computers or mobile phones. Digital currencies can be used to purchase goods or pay for services like cash/physical currency. For example, Instead of using cash or making e-payments, customers can make the payment to retailers by transferring digital currency using a mobile phone. 

Success Stories from the Past

In the early 80s, all the trading of equity stocks and the Government securities was done offline through paper-based certificates but in today’s world of technology, all the trading of stocks and government bonds is being done only digitally. The digitalisation of the complete trading process has been seamless and created more growth opportunities and transparency. Similarly, digital currency can remove the intermediaries and perform direct peer to peer transactions with higher speed, accuracy, transparency and traceability. 

Distributed ledger technology-based cryptocurrency such as Bitcoin,  Ethereum exist and are being used around the globe. Their production is completely digital and is not regulated by any government authority or central banks. Central banks around the world are also researching regulated digital currency (CBDC).

How Digital currency differs from Virtual and Cryptocurrency

From a broader perspective, virtual and cryptocurrency are subsets of Digital currency. Virtual currency is an unregulated digital currency mainly controlled by its developer, the founding organisation, or the defined network protocols such as cryptocurrencies and coupon- or rewards-linked monetary systems. 

Virtual currency that uses cryptography to secure, control and manage the creation of new currency units and finally verify the transactions is commonly known as cryptocurrency. Bitcoin and Ethereum are the most popular decentralised cryptocurrency and Facebook’s Diem is an example of centralised cryptocurrency. 

Concept of CBDC and how it would work?

Digital currency that will be issued and regulated by the country’s central bank is known as a central bank digital currency (CBDC). For example, think of a cryptocurrency being managed and backed by the full faith and support of the country’s central bank like RBI in the case of India. This cryptocurrency would be stated as CBDC. At present, no central bank across the world has its own digital currency. 

CBDC would work in a similar fashion as the cash/ physical currency. Only difference is that, once a payment is made using CBDC then the counter-party can neither cancel nor reverse the transaction, However, in regular online payment, such transactions can be reversed and cancelled. This is because CBDC uses blockchain technology which does not let users make alterations in past transactions. This is one of the key features of Digital currency. CBDC would be legal in the country and can be used for any purpose.

Benefits of Digital currency

Faster payments – All inbound and cross border transactions gets completed on a real-time basis

Cost-effective– Digital currency reduces intermediaries in peer to peer transactions especially in the case of cross border payments causing significant reduction in terms of fee charged.

24*7 Accessibility– At present, Post working hour financial transactions take more time but with digital currency, the transactions can be performed at any time with the same speed.

Transparency & Traceability – Digital currency brings more transparency and easy traceability of transactions to all the parties involved in the financial transactions particularly in the case of cross border transactions.

Support for unbanked or underbanked– CBDC helps all unbanked individuals to pay bills and make payments online using the digital currency with no extra charges.

More efficient government payments– It also helps governments to make the payments to individuals in a quick and seamless way especially in the case of an emergency like the Covid-19 pandemic. It is very difficult to help the gig workers financially in this situation when lockdown is imposed everywhere and no source of earning for them. Digitally currency (CBDC) would have helped them by enabling governments to transfer the fund on a real time basis even in case of unbanked workers. 

Digital currency Disadvantages

High efforts to learn how to use digital currency- To learn all the basic tasks of digital currency like how to open a wallet account, store digital currency is a bit challenging especially for uneducated or illiterate users. 

Blockchain transactions can be expensive-  Current digital currency like Bitcoin uses blockchain where electricity cost is very high because computers are used to solve complex equations to record and perform the transactions. Cost charged Per transaction, independent of transaction value so it is not an efficient option for  small value transactions.

The large swing in digital currency price-  Current digital currency value is very volatile due to consumer sentiment and psychological triggers. However, CBDC is expected to be more stable like current fiat currency.

Developing CBDC is a very time-consuming process – Currently global central banks are exploring the opportunities with CBDC and even if some central banks decide to create CBDC, it would be very costly and time consuming to develop, implement and replace the current Fiat currency.

In countries like ours which is predominantly a cash dominated economy where most SME and MSME transactions are done through either cash or cheques. The anonymity and untraceability of cash transactions make it even more challenging to completely accept digital currency (CBDC) in India. 

However, India has always been ahead of other countries in terms of adoption of technology and digitization. So, Now is the time for our central bank to start exploring the opportunities in central bank digital currency to launch the World’s first CBDC.