Blockchain Technology: Revolutionizing the Way We Invest, Borrow, and Lend

How Blockchain Technology Is Changing the Finance Industry

Technology is advancing at an extraordinary rate. Yet, the financial industry has resisted adapting. It operates in a restrictive regulatory environment.

Limited adoption must coexist with old systems and protocols. They remind us of a time when people had to move physical paper to complete a transaction. For example, banks trading whole loans still require a fax confirmation. A stock trade may take a fraction of a second, but clearing and settling that trade may lag significantly.

Technology has and will continue to disrupt what remains of these legacy systems and protocols. The capital markets are defined by the creation and transfer of financial assets, and the recognition of ownership. But, blockchain technology is quickly changing each of these.

What’s the Difference Between DLT and Blockchain?

DLT

DLT is a decentralized database across several locations or among multiple participants. Its decentralized nature means it needs no central authority to process transactions or intermediaries to validate them.

Blockchain

Blockchain is a type of DLT. It records transactions and digital interactions. It aims to make businesses more transparent, efficient, and secure. Its time-stamped structure, or ’blocks,’ makes it hard to fake transactions. Blockchain, unlike DLT, is usually public, so anyone can participate, meaning users can access, validate, and operate it more democratically. Blockchain technology creates a verifiable, auditable consensus on financial assets across ledgers. It allows low-cost, real-time transfer of asset value.

Blockchain is changing financial markets by allowing for secure, anonymous transactions via a tamper-proof public ledger. The technology also enables many computers to keep and update identical records without a master copy of the data, thereby removing inefficient intermediaries. This feature is particularly helpful in markets with traditionally bureaucratic processes and poor intermediation.

Transforming How We Invest

Blockchain’s rise in finance could transform the fixed-income market. It offers the efficiency, transparency, and liquidity to modernize outdated practices. Blockchain can greatly improve clearing, custody, and trading of bonds. The main long-term value of blockchain in fixed-income markets is tokenizing fixed-income securities.

For example, traditional securities transactions can take up to three days to settle. This is because all books, from the brokers to the banks, must be updated and reconciled, often manually. Many parties are involved in transactions, and each charge a fee.

Blockchain technology creates a decentralized database of unique digital assets. It allows for the transfer of assets via cryptographic tokens. You may be familiar with cryptocurrency tokens, such as Bitcoin and Ethereum, which are purely digital assets. However, blockchain companies are now working on ‘tokenizing’ tangible assets like stocks, real estate, or gold.

Shortly, we’ll see a tokenization of fixed-income securities as well. This means tokenized securities will eliminate the middleman in asset rights transfers. Cutting out intermediaries such as custodian banks will lower asset exchange fees. Additionally, tokenizing real-world assets like fixed-income securities will provide broader global market access. It could also help to reduce the instability of the traditional securities market.

Transforming How We Lend

On the flip side, blockchain will benefit debt issuers. It will improve the origination, structuring, and credit functions of fixed-income securities. For bond sales, blockchain could enable faster, cheaper automation. It would eliminate the need for manual bookkeeping.

For a prototype of how this might work, consider Bond-i — the first-ever public blockchain bond issued by the World Bank in 2018. The fixed-income securities were priced to yield at 2.25% and would mature after two years. Though just a prototype, Bond-i represents what automation of bond sales, at reduced costs, might look like.

Blockchain-enabled lending lets lenders securely offer personal loans to more consumers. It can also make the loan process more efficient and cheaper than it is currently.

When consumers apply for a loan now, lenders must check the potential borrower’s credit score, debt-to-income ratio, and home ownership status. Blockchain tech lets consumers apply for loans. It is based on a global credit score from a secure, decentralized registry of payment history.

One example is the company Bloom, which aims to bring credit scoring to the blockchain. It’s currently building a protocol for using blockchain technology to manage identity, risk, and credit scoring.

Transforming How We Borrow

Blockchain tech has let borrowers quickly access funds on many peer-to-peer lending sites. They don’t have to deal with the complex and costly process of borrowing from a bank. Blockchain technology connects borrowers and lenders worldwide without the need for intermediaries. Also, smart contracts can auto-generate fixed interest rates based on the borrower’s profile.

Blockchain technology also allows for the distribution of new private debt issues. These will be brought to market on established exchanges.

These exchanges will lean into the electronic future and innovative digital platforms. This also means we’ll see the adoption of a new form of token that represents private debt issues.

Consider SALT Lending, which lends cash using a blockchain. Users of SALT Lending can borrow money against any bitcoin, ether, or blockchain asset as collateral. Loans are then approved based on the value of the collateral. SALT focuses on creating liquidity through loans around people’s existing crypto assets. To use the platform, a user must buy the platform’s cryptocurrency, SALT, which allows the user to take out loans.

Additionally, blockchain in finance provides lenders and borrowers a more secure transaction. It allows for simultaneous computing and verifying of events. It authenticates identity and transfers funds. This helps dramatically decrease the opportunity for fraud or alteration of records ex post facto as the protocols that convey information are cryptographically secure.

The Challenges of Blockchain Technology in Finance

In earlier blockchain transactions, the focus was on bilateral trade and maintaining anonymity . Larger transactions involve multiple sellers, bidders, buyers, and parties, which will demand larger, more complex datasets and thus more advanced versions of the technology.

Blockchain transactions trigger stricter regulations on identity, anti-money laundering, and exempt transactions. Although tokenized assets are promising, regulation remains a big hurdle. Tokens remain an ambiguous term without much legal standing, and it’s unclear if blockchain ownership is legally binding.

In fixed-income securities, complex issues can’t be modeled effectively. These issues include structuring, risk, and performance. Blockchain and smart contracts alone can’t solve them. These challenges will drive the financial industry to adopt a mix of on-chain and off-chain elements. The events, like the structuring and review of fixed-income securities, will be similar from a data perspective and recorded in a distributed ledger.

Blurring the Lines Between Public and Private Markets

For centuries, we have lived in a world split between public and private markets. The tokenization of fixed-income securities will fundamentally alter our view of markets.

For example, public markets are characterized by intermediating institutions such as clearinghouses. Private markets, on the other hand, are generally bilateral. Public markets have more regulation. Private markets are constrained by a regime of rules and practices. Public offerings facilitate mass distribution, while private securities are sold more carefully. This two-dimensional view of markets will not last. Blockchain and tokens that refer to financial assets will change that. ‘Tokenization’ is efficient, reliable, and easy to use. It promises private debt markets a larger, more liquid market and economic benefits. I want to see public and private debt markets become more alike in pricing and liquidity for institutions.

Blockchain in finance is here to stay. It’s changing how we invest, borrow, and lend, and markets will never be the same.

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This is an updated version of an article originally published on March 2, 2021. This article was most recently updated by the Financial Poise Editors.] 

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