CAN BLOCKCHAIN REVOLUTIONIZE THE BANKING SYSTEM?
Today, we live in a world where a new wave of technological transformation occurs regularly. Each day, we are exposed to new buzzwords and a plethora of news. Additionally, cryptocurrency or blockchain is a buzzword in the business world.
Blockchain is well known for its critical function in cryptocurrency systems such as bitcoin, in ensuring the security and decentralization of transaction records. Cryptocurrency has been around for more than a decade. However, countless controversies and discussions continue to swirl around cryptocurrency. Some say it is a new-age currency, while others refer to it as a hoax. Nonetheless, one thing is certain: We cannot afford to be indifferent to this movement.
An Overview of Blockchain Technology
As the name suggests, it creates a chain of blocks where each block contains a transaction ledger and the link of the subsequent transaction. This explanation might remind you of the data structure of a traditional “linked list.” However, blockchain has a more complex system, where a child block will be chained with a parent block hash while supporting the benefits of linked lists like the flexibility of dynamic data structures.
A major differentiating factor for the blockchain lies in its distributed architecture. The blockchain creates an extensive network of peer-to-peer nodes that store the transaction ledger in the form of a block in multiple data systems. These data systems can be decentralized across various data centers, which creates the chain of transactions on each of the data systems when a single transaction is initiated.
Implementation Approach & Benefits
There could be several ways to implement a decentralized payment system. However, we can discuss one of the possible implementations.
All the entities, which could be banks or even central banks of a country, participating in the implementation can either set up their infrastructure or subscribe to and integrate with the services enabled by other entities. However, the bigger question lies in the exchange values. When we try to implement payment systems between two entities, the major challenge is the exchange value. For transactions within a country, the solution will be very simple, to use the local currency or a fiat currency coin. In the U.S., the USDF consortium has implemented an interbank payment system using stable coins, and fiat currency coins. This implementation has not only helped the banks to overcome the “Fed’s working hours” limitation but also brought down the cost of transactions. As we write this paper, several countries, such as the UK and India, have been planning to launch a govt-backed crypto / digital coin. It would ease such implementations in the future.
Whenever we extend the blockchain implementation across borders, the challenge of identifying a central exchange currency arises. In such a situation, we can use a fiat-crypto coin, which would be pegged by gold value. This will not only create an alternative system for payments but also reduce the dependency on a specific currency, as well as contribute to the decentralization of economic power.
Additionally, since these multi-node clusters are maintained at different data centers as well as the messages exchanged are not just encrypted but also follow the hashing sequences, it would be very difficult to hack the entire network. This feature adds an extra layer of data security.
Limitations of the Current Banking System
As we all know, current financial sectors across the globe work on centralized data platforms. Moreover, any of the transactions between two entities are managed by a central entity, which could be like the Federal bank in the U.S. This leads to the limitations of the system, like limited working hours for interbank transactions. Although countries such as India have enabled interbank transactions (RTGS) 24×7 for all 365 days to overcome the limitation, and yet, it is difficult to implement in several different states due to infrastructure or operational issues.
Similarly, international transactions are managed by a single entity, SWIFT. This gives the power in the hands of a few people to manage the international economy by way of sanctions. These situations were seen during the recent Ukraine-Russia crisis. These sanctions lead to the deflation of the local currency and high inflation in the local market, which worst affects the normal citizens of the state.
Moreover, when we have a centralized ecosystem for the banks, it leads to a lack of transparency and balance sheet manipulation. In particular, these malpractices in the banking system can lead to a nationwide or worldwide economic crisis, particularly in some extreme cases like Lehman Brothers’ fall.
A blockchain-based decentralized banking system can also resolve issues like accounting manipulation. When all the bank-level balance sheets are maintained with central banks or similar government entities, it would be less likely to have an unnoticed crisis due to account manipulations. Besides, auditor appointments will be managed by government-owned entities and not by banks.
Challenges of Using Blockchain
As we know, blockchain, being a decentralized multi-node system, every node will hold the transaction ledgers for transactions across the network. This characteristic can subsequently lead to high data storage requirements and high carbon footprints. However, a significant challenge lies in replacing the currently stabilized “centralized financial system.”
As we see the increasing popularity of cryptocurrencies, we hope to see blockchain making a larger penetration in the global financial and banking systems, although it seems to be making baby steps at present.