Private Blockchain Vs. Banks: Will Blockchain Revolutionize Banking?
- August 1, 2023
- 482 views
- 16 minutes
When it comes to banking and financial transactions, people have always preferred to rely on traditional banks to facilitate transactions and keep their assets and money safe.
However, it is no longer a secret that the introduction of blockchain has propelled beyond praise and resulted in a growing interest of banking experts, crypto fanatics, and investors.
This groundbreaking technology and its revolutionary potential are now a part of mainstream conversations happening around the world, particularly in the finance sector. Now the question is will private blockchain be embraced by the banking industry or will it completely replace it?
Despite the skepticism surrounding it, proponents of blockchain, who are mainly banking and fintech experts, are of the opinion that this decentralized ledger technology will transform the way the banking system operates and will be a pathbreaker in financial services in the upcoming years.
In this article, we will try to explore the major differences between private blockchain and traditional banks, whether they can coexist, and how private blockchain will disrupt the banking system.
Table of Contents
- What is a Private Blockchain?
- Why is Private Blockchain Popular?
- How does Traditional Banking differ from Blockchain?
- Traditional banking or Private blockchain – Which is better?
- Can Private Blockchain and the Banking system coexist?
- How Private Blockchain Can Disrupt Banking?
- Private Blockchain vs. Bank: Compliance Requirements and Challenges
- Real-world Use Cases of Blockchain in Banking
- Potential Risks Associated with Blockchain Technology
- Future of Banking System and Blockchain
What is a Private Blockchain?
A private blockchain, on the other hand, is a “permissioned” blockchain with “trusted” or restricted access where only selected members are allowed to access the network, share information, or facilitate transactions. It is partly decentralized because access is limited and is controlled by an administrator or authority centrally.
The tremendous potential of Private blockchain has made several business organizations adopt this technology to overcome business inefficiencies and assure trust and integrity among members. We now can’t wait to see how banks and financial institutions will embrace this trailblazing technology to stay ahead in the market.
Why is Private Blockchain Popular?
Since private blockchain runs within a closed network, it builds trust among the participants. They gradually gain faith and confidence in the technology, share sensitive and business-critical information, and transact assets.
The shared trust and transparency result in the expansion of the network as members start adding more trusted partners to the chain.
Privacy and Security
Companies dealing with vast amounts of sensitive information, trade secrets, or customer data can now relax and have peace of mind that all their data is safe from potential breaches.
Since network access is restricted, the information and transactions recorded in the blockchain are protected from public exposure, thus strengthening user privacy and confidentiality.
Governance and Compliance
Most large-scale organizations function in a heavily controlled or regulated environment. This mechanism of operating in a closed network allows them to have better control and compliance with the company’s internal policies and legal necessities.
With the implementation of a private blockchain, you can access controls and define or modify governance models per the changing needs of the organization.
The absence of Intermediary
Blockchain networks, both private and public, perform their functions on consensus mechanisms which justifies the elimination of third parties or intermediaries. For instance, for a ledger to gain consensus, the majority (51%) of the members need to validate it.
Once the transaction is validated, it is stored permanently in the blockchain as a record and therefore, is immutable. This record validation is then distributed on the nodes of the permissioned blockchain.
How does Traditional Banking differ from Blockchain?
Besides sending and receiving payments, financial institutions also help people get loans for their personal needs and investment purposes. Money deposited by customers in their savings accounts is forwarded to lenders looking for loans and this way money is circulated in the economy through banks.
Banks are trustworthy institutions where people feel safe to keep their money, gold, and other precious assets. What encourages people to keep their money in banks is the interest received. The higher the amount and tenure of the deposit, the higher will be the interest.
It is difficult to point out or list differences between traditional banking and blockchain because the former is an entire system encompassing all banking and financial services, while the latter is just a technology that can be implemented in banking or any other industry to gain certain advantages.
However, in terms of stability and security, the mechanism of blockchain and traditional banking can be differentiated. Blockchain is more stable because there is no regulatory body or governing authority, unlike banks, which protect the system from strict or unnecessary regulations, manipulation, and misuse of power.
Traditional Banking Vs Private Blockchain: Compared
Transactions are facilitated by banking institutions.
Absence of intermediary.
Traditional Banking or Private blockchain – Which is better?
Therefore, in the present times, it is difficult to say whether blockchain is better than traditional banking systems. If you have to choose between the two, it will largely depend on the particular situation or the need.
For instance, if you require a simple and convenient way to make payments, banks are the best option. However, if you want your transactions to be transparent, secure, and free from third-party involvement, blockchain is the answer.
On a broader view, private blockchain is mainly a suitable option for businesses handling sensitive business data and critical transactions with partners on a day-to-day basis. The partially decentralized nature of private blockchain makes it immune from any kind of disruptions like economic shocks.
Furthermore, multiple organizations can converge into a safe unified network with the help of multichain in private blockchain development. By linking several blockchain nodes together on a decentralized P2P network, organizations can safely exchange information and transfer payments or assets while enhancing security and efficiency.
Therefore, it is hard to draw any conclusion on whether blockchain has an upper hand over traditional banking because both have their own sets of strengths and weaknesses. Individuals looking for a wide range of financial services such as credit cards and loans still have to depend on traditional banking because blockchain does not offer these facilities. Also, if you are looking for a convenient way to manage finances, conventional banking is the ideal option to go for.
Can Private blockchain and the Banking system coexist?
The interdependence between the two is something already happening and we now have to see how this groundbreaking technology disrupts the traditional banking system.
One thing for sure is that with a moderate degree of decentralization and the use of self-enforcing smart contracts, private blockchain technology automates manual processes, saves time, and leads to better coordination between banks and parties.
Further, it helps banks set up regulatory standards better and establish proper governance around data sharing, transactions, and collaboration.
By leveraging the smart contract functionality, the processing of claims, content distribution from wills, and other compliance services can be done faster and more accurately.
Read on to gain deeper insights into the ways private blockchain technology disrupts the banking industry while allowing new business models to emerge.
How Private Blockchain Can Disrupt Banking?
Let us have a look at the areas of banking services where the private blockchain disintermediates.
A decentralized ledger for sending and receiving payments facilitates speedy transactions at a fee much lower than what the bank charges. It is often considered a cheaper and more secure way to make payments by cutting down the need for third parties (Banks) for verification.
Private blockchain technology also reduces the processing times of money transfers. Traditional payment methods initiated by banks are much longer, especially for cross-border payments.
Further, bank transfers involve wire transfer fee, exchange rate fee, and other additional fees which adds up to your total cost of transfer. Even worse, the receiver gets the amount transferred or credited to the account almost a week later.
Slow payments and an antiquated system of banking result in trillions of dollars sloshing around the world. On the contrary, check the statistics below, how many cryptocurrency (Bitcoin) transactions using blockchain technology are confirmed per day.
The above graph reflects the total amount of confirmed transactions per day which has grown from just 50,000 to more than 2,49,000 in the time span of eight years (from 2014 to 2022).
Clearance and Settlement Systems
Operational costs get significantly reduced and real-time transactions between finance and banking institutions become possible. Distributed Ledger Technology (DLT) allows direct settlement and tracking of transactions faster and more efficiently.
One of the major pain points for customers in the traditional financial infrastructure is the transfer settlement time. Average bank transfer takes nearly 3 days to settle and moving money from one place to another in the world is no less than a logistical nightmare.
However, blockchain disrupts this and bypasses the need for intermediaries. Banks can implement interbank blockchain systems where they can store records of all their transactions publicly and track them transparently.
This interbank blockchain clears and settles transactions by allowing for “atomic” transactions as soon as payment is completed, thus alleviating the high costs associated with maintaining an international network of banks.
Ripple and R3 are two major blockchain service providers for banks that work with distributed ledger technology to settle large transactions and cross-border payments. R3 claims that their technology will be the future of transactions in financial markets. Ripple, on the other hand, aims to complete a transaction in a fraction of a second.
Earlier venture capitalists were the only way for entrepreneurs to raise funds for their projects after enduring countless meetings and tedious processes of negotiations over valuation.
Blockchain technology is a ray of hope for entrepreneurs as it allows them to raise funds without relying on venture capitalists or traditional investors. They can raise money through Initial Coin Offerings (ICOs), where they can sell tokens or coins. ICOs are powered by the major blockchain Ethereum.
Filecoin is a great example of a high-profile ICO where this data storage startup raised around $257 million in 2017.
Although finance regulators challenged ICOs and started monitoring sales closely, it has the potential to represent a paradigm shift by offering companies access to an exponentially huge pool of credible investors.
Blockchain technology eliminates the need for middlemen or third parties in asset transfers and lowers the transfer fees. Asset or securities exchange through blockchain provides access to the broader global market and at the same time reduces the instability associated with traditional markets.
Moving securities in blockchain saves billions per year by cutting down global trading or processing costs. It transforms the financial markets with the creation of a decentralized database of digital or unique assets. The transfer of purely digital assets or securities in a distributed ledger happens through cryptographic tokens.
Moreover, nowadays, blockchain development companies are focussing on ways to tokenize physical or real-world assets such as real estate properties, gold, stocks, etc. with the help of smart contracts.
Fraud Prevention and Customer KYC
Customers’ privacy has always remained a critical area of concern for customers as well as banking institutions. Cyber attacks for data theft, misuse of information, fraud with money, etc. are some of the common threats or vulnerabilities banks and customers have to face.
Although banks verify the identities of their customers before onboarding them and see whether all the information provided is correct and in order, the process could take more than 3 months. This Know Your Customer (KYC) process involves several stages which include verification of Photo ID, address proof, biometrics, and other details.
A delayed KYC process leads to the loss of customers’ faith in banks and ultimately termination of the relationship with the concerned bank. Simultaneously, it gives mischievous opportunities to scammers and fraudsters pretending to be bank officials and asking customers to provide their details.
Integrating blockchain technology in the KYC process reduces both the time and money of the banks. The brighter side here is that being partially decentralized, a private network will give access to customer details only to the selected participants or institutions.
Besides automating the process of validating customer information and their digital identities like a digital fingerprint, blockchain enhances fraud detection and safeguards accounts from cyber-attacks. Traditional banks store data in a centralized database which is most vulnerable to cyber threats.
Decentralizing customer information in a distributed decentralized ledger system with blockchain ensures that no hackers gain access to the information. The best part is that even an insider cannot tamper with the customer data, and delete or alter them for fraudulent purposes.
Private Blockchain vs. Bank: Compliance Requirements and Challenges
The legal and regulatory compliance issues associated with blockchain implementation in banking are linked to jurisdiction, DAO, documentation, governance, access, personal data privacy, the enforceability of smart contracts, intellectual property, liabilities, risks, and exit from the blockchain.
Also after several proofs of concept (POC) developments and experiments, traditional banks have been seen facing challenges, particularly in KYC which are as follows –
- Switching from an individual or a centralized data storage system to a decentralized shared ledger involves high costs.
- Banks need to adapt to the culture of data sharing, which is still an alien concept in the banking industry because it raises questions about data confidentiality, privacy, and accountability.
- Other practical challenges include making customers agree to upload their digital footprints and perform other additional authentication methods.
- Banks also need to create large networks that require data collaboration and standardization to achieve benefits at scale.
- Another technical challenge that hinders the adoption of decentralized ledger technology in banking is the requirement of enormous processing power to distribute data across millions of sources.
- Additionally, customers may refuse to provide information or restrict access to data for the sake of their own security and privacy.
Real-world Use Cases of Blockchain in Banking
After the crypto market, particularly Bitcoin picked up steam, blockchain and its underlying distributed ledger technology (DLT) came under the spotlight. Blockchain powers the digital currency industry and gradually it is shifting its paradigm to the banking sector as well.
In other words, apart from the creation of a Decentralized exchange (DEX) platform development to facilitate transactions of tokens and crypto coins, blockchain is implemented in private networks in a partially decentralized structure by banks. This is done to streamline banking operations, facilitate payments, and enhance operational efficiency.
Here are some real-world examples or applications of blockchain by leading edge banks of the world.
Bank of England Tests Blockchain-based RTGS Payment System-
The Central Bank of the United Kingdom collaborated with a leading payment solutions provider, Price Waterhouse & Coopers (PWC) to develop and test blockchain features for their renewed Real-time gross payment system (RTGS).
The bank announced in 2017 that they are developing a Blockchain-compatible payment service and their proof-of-concept design and development was carried out successfully.
HSBC Makes History By Processing the First Blockchain Letter of Credit Transaction In China-
HSBC achieved a milestone by executing the inaugural blockchain-based Yuan-denominated letter of credit transaction using R3’s Corda-powered Voltron platform.
The transaction involved MTC Electronics, a Hong Kong-based electronics manufacturer, exporting LCD products to its parent company, Shenzhen MTC, in a seamless cross-border operation.
It represents HSBC’s significant step in supporting RMB internationalization through fintech. As a leading player in serving trade flows and corporates in the Greater Bay Area (GBA), the bank showcases its advantage in this innovative endeavor.
Westpac Partnered with Ripple to implement cross-border payments at a low cost-
In 2016, one of the top banks in Australia, Westpac, entered into a partnership with Ripple, the leading provider of crypto and blockchain solutions, to implement a cross-border payment system.
The aim was to cut down payment costs and boost the speed of transactions made cross-border. Reports claim that Westpac has already tested its blockchain-based payment by Ripple by running a pilot project where real client money was successfully transferred from Australia and New Zealand.
Apart from Westpac, there are other world’s top banks that are using Ripple’s DLT technology to speed up cross-border payments and reduce costs.
Mastercard Partners with R3 For Blockchain-based Payment Solution-
Mastercard partnered with R3, a payment solutions provider to create a cross-border payment system. They created a groundbreaking blockchain-enabled cross-border payments solution by entering into a strategic partnership.
The primary objective is facilitating connections between various global faster payment infrastructures, schemes, and banks, utilizing Mastercard’s clearing and settlement network.
This innovative collaboration aims to enhance the efficiency and speed of cross-border transactions.
Potential Risks Associated with Blockchain Technology
Every technology needs to have a standardization behind it, but unfortunately, blockchain technology doesn’t have a proper standard yet.
With different organizations designing their “DLT” or “Own” blockchain, it becomes difficult to standardize them and this results in security, interoperability, and privacy issues.
The “trustless” concept of private blockchain makes the ecosystem complex and a new participant may find it hard to trust the network.
The process of implementation is carried out by blockchain developers and administrators and hence, can result in biased decision-making, posing a threat to the core notion of blockchain itself.
Although we all know the blockchain system is a distributed and decentralized system, data privacy is still one of the biggest concerns. This means all the information is stored and distributed in the chain across multiple geographic locations.
So, the data privacy regulations fall under which jurisdiction remains a question and thus, makes data privacy a very complex matter.
Private and public key risks
The functioning of blockchain relies largely on the public and private keys. Private keys are used in wallets to protect the user’s assets and public keys are used to encrypt messages. Hackers try to gain access to these keys by installing malware in the devices used by the users, say a mobile phone or computer.
For this reason, having good antivirus and firewall protection is necessary. Also, you should regularly update your device, and prevent storing or sending private or public keys via email.
Maximum attention should be given to the quality of code before a decentralized autonomous organization (DAO) deploys its solutions. This is because DAO hacking is a very common risk and can result in significant revenue loss for the organization.
As a precautionary measure, DLT must be tested using testnet and other tests should be run on the code to ensure flawless execution.
The specific areas of concern must be carefully addressed to make your organization prepared for the blockchain ecosystem.
You also seek the services of a professional private blockchain development company to help you with error-free coding and risk-free blockchain solutions.
Future of Banking System and Blockchain
While some areas have experienced a bigger impact like cross-border transactions and digital identification, some areas still need to be explored more.
Facilitating faster transactions, protecting sensitive information, fraud prevention, etc. are some of the plus points of this path-breaking blockchain technology.
In addition to this, traditional banks will continue to hold their importance in terms of regulation and stability in the financial system. Although it might not be as transparent and secure as blockchain, people still rely on banks to avail a varied range of financial services that are crucial for individuals as well as businesses.
To conclude, it is hard to choose between traditional banking and private blockchain technology because both have their own advantages. Also, their needs mostly depend on the preferences or specific needs of the businesses or individuals.
Despite having a lot of potential to be a disrupter in the fintech industry, some setbacks or challenges need to be overcome before embracing blockchain as the mainstream.
Ultimately, the key to strengthening the financial system is to utilize the benefits of blockchain and integrate them into traditional banking. Combining the advantages of both systems to create a more secure, safe, and reliable financial ecosystem would be the ideal thing to do.