Over the past few decades, society has witnessed an enormous amount of change in the way people conduct their daily lives. Technological advances have completely altered the way consumers communicate, work, travel, shop, eat and educate themselves. There have been major disruptions in various industries across the global landscape.
Without question, the biggest trend across all industry groups is the adoption of blockchain technology. This is particularly true in the banking industry, which has been in existence since the Bank of England issued paper banknotes in 1695. This marked the beginning of modern banking. Since that point, very little has changed within this industry.
Banks have no incentive to change the underlying structure of their business model because it is how they make money.
The core component of the modern banking industry is the use of intermediaries. Over time banks have discovered that this is an incredibly profitable business model. Intermediaries are in the middle of all banking transactions. The intermediary stands between the customer and their money.
Banks charge fees for their services. Thanks to the use of intermediation, banks enjoy a constant stream of revenue. This explains why banks have no incentive to remove intermediaries.
Blockchain has the capacity to be a major disruptive force in the banking industry because this technology can remove intermediaries. In fact, the removal of intermediaries offers one of the greatest long-term potentials in regard to blockchain use cases. Removing intermediaries from the banking industry would reduce cost and improve efficiency.
There are other ways blockchain technology will disrupt the traditional banking sector.
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As you know from our previous discussions, cross-border payments usually involve the unbanked population who reside in developing countries. These citizens have limited access to basic financial services. Consequently, they are required to use cross-border payment services when sending funds to family members in other countries.
These types of transactions are generally very expensive because the payments involve foreign currency fees. It’s not uncommon for fees to exceed 10% of the transfer amount.
During the past few years, an increasing number of the unbanked population have been reducing their dependence on money transfer agents (MTA) when conducting cross-border payments. Instead, they are using crypto wallets stored on a public blockchain. They have enjoyed a substantial reduction in transfer fees. A typical crypto fee is 3% compared to 10% with a money transfer agent.
Historically, one of the most lucrative businesses for banks has involved the financing of international trade. International trade is the buying and selling of goods and services between countries. It allows countries to expand their markets and gain access to other products that are not available domestically. An example of international trade would involve Wal-Mart purchasing a shipment of bananas from a South American farmer. Another example includes a United States restaurant purchasing several bottles of wine from a French vineyard.
The trading of goods and services between countries is the driving force behind the global economy. Without economic trade between countries, the growth rate of the global economy would be incredibly small. Based on data provided by the World Trade Organization, the total amount of international trade between countries in 2017 was $22.0 trillion. The number increased to $25.3 trillion in 2018. As you can see, these numbers are staggering, and it explains why international trade is such a profitable business for banks.
Paper Trails and Traditional Banking
Despite major advances in technology, banks have failed to modernize international trade. For example, the vast majority of trade between countries is still conducted using antiquated paperwork. This includes documents such as bills of lading, invoices, letters of credit, banker’s acceptance, and bank drafts.
During the past few years, blockchain technology has dramatically improved international trade between countries. Blockchain technology has removed the bulk of paperwork, which is quite common when dealing with foreign countries. Additionally, blockchain technology provides all participants with a secure network for monitoring each transaction in a real-time fashion. This allows each participant to know the location of all merchandise throughout the entirety of the transaction.
The blockchain network is a substantial improvement over the outdated system used by the legacy banking system. International trade conducted in this way suffered from lost merchandise, costly delays, inaccurate paperwork, and poor communication between the participants.
Banks Adopting Blockchain Technology
Over the past two years, several banks have started adopting blockchain technology. This was because they were losing their international trade clients to the shadow banking system. Shadow banking consists of financial institutions with access to large pools of available capital for lending purposes. Examples of shadow bank institutions include peer-to-peer lenders and private equity funds.
Over the course of the past decade, shadow banks have slowly been stealing market share from traditional banks. Beginning in 2018, shadow banks used blockchain technology as a way to differentiate themselves from legacy banks. Companies established working relationships with shadow banks because they discovered that blockchain technology was cheaper and more efficient. This explains why traditional banks are now keen to adopt blockchain technology.
Each year, banks devote an incredible amount of time and resources to regulatory compliance. Commercial banking is one of the most heavily regulated industries within the global economy. The area that generates the greatest expense is the KYC identification policy. KYC is an acronym for “Know Your Customer.”
This policy was introduced on 26 October 2001, as part of the USA Patriot Act in response to the 911 terrorist attack. KYC requires banks to obtain the name, address, identification number, photo ID, and a brief financial profile. The main objective of KYC is to prevent money laundering and fraud.
Unfortunately, particularly for small financial institutions, implementing KYC is very expensive and labor-intensive. Thankfully, blockchain technology is capable of eliminating redundant KYC procedures. This is accomplished by allowing customers to register their identity on a secure peer-to-peer network.
Banks and other financial institutions have access to the network when approved by the customer. Thanks to the blockchain, customers are only required to provide KYC information one time.
Brief Summary of Blockchain and the Banking Industry
- There have been major disruptions in various industries across the global economy.
- The biggest disruption is the adoption of blockchain technology.
- Blockchain technology will have the biggest impact on legacy banking.
- The core component of the modern banking industry is the use of intermediaries.
- Blockchain can remove intermediaries from legacy banking.
- Banks are reluctant to adopt blockchain because the current model is very profitable.
- Banks are slowly embracing blockchain because they are losing customers.
- Blockchain networks are lowering the cost of cross-border payments.
- The unbanked population is selecting Bitcoin wallets over money transfer agents.
- International trade is a multi-trillion-dollar industry.
- Legacy banks initially made no effort to modernize international trade.
- In 2018, the shadow banking system combined blockchain with international trade.
- Customers preferred dealing with shadow banks because of blockchain technology.
- Many traditional banks are now conducting business on the blockchain network.
- Commercial banking is one of the most regulated industries.
- KYC was introduced in response to the 911 terrorist attacks.
- KYC is very expensive to implement, particularly for small banks.
- Thanks to blockchain, legacy banks are finally beginning to modernize.