The more interesting trend underway is how blockchain opportunities are starting to materialise for fintech, writes Niels Pedersen.
There is a lot of buzz surrounding Bitcoin’s price, which has more than doubled since early December before falling this week. While Bitcoin may have further to go, both ways, the most exciting part of the blockchain story is that fintechs can play a key role in decentralising finance.
The last time Bitcoin peaked was in December 2017 amid extreme hype about blockchain’s potential to transform the financial system. Unfortunately, these expectations were ahead of their time. This resulted in a cryptocurrency bear market that saw Bitcoin crash by more than 80 per cent.
Given Bitcoin’s surging price, it appears that another hype cycle is well underway. However, this time around fintechs are busy developing solutions to help consumers participate in the blockchain revolution. For example, payments start-up Wirex recently announced a multicurrency card that allows users to make purchases with both fiat and cryptocurrencies.
What’s more, fintech investors are getting on-board. In December, blockchain infrastructure platform Paxos raised $142m. More recently, investment trust Augmentum Fintech made its first move into decentralised finance via an investment and partnership with blockchain-focused ParaFi Capital.
More broadly, institutional investors are waking up to the disruptive potential of blockchain technology. To understand this disruption, one must appreciate a surprising and often overlooked, fact about Bitcoin and other cryptocurrency tokens: they do not exist.
What does exist, however, is a record of information flows between users. Just as your email account holds messages, sent and received, a cryptocurrency balance is the net result of a user’s transactions on a blockchain network.
Moreover, both technologies employ similar security protocols: just as you need a password to send messages from your email account, you need a private key to ‘send’ cryptocurrency tokens on a blockchain.
When someone makes a blockchain transaction, their private key is transformed into a digital signature, which is then used to authenticate transactions. This is like the imprint of a rubber stamp, in that you can see where it came from without looking at the stamp itself. As a result, the digital signature can be shared without revealing the underlying private key, just as we can share email addresses without giving away our passwords.
This allows the network to publish everyone’s transactions without compromising its security. As a result, nobody can falsely claim that they have, or have not, been party to a transaction. However, transparency does not stop there: many blockchain networks make their source code freely available. Can you imagine a bank publishing all of its policies, procedures, and controls?
In addition, blockchain networks are decentralised, which makes them extraordinarily robust. As their transactions are stored in many different locations, they are almost impervious to attack or corruption. Like peer-to-peer file-sharing networks, blockchains are practically impossible to take down.
The inherent robustness and transparency of blockchain systems ensure their integrity, allowing network participants to rely on observable rules – as opposed to financial intermediaries – to manage user interactions. This lack of intermediation reduces transaction costs in the system.
In this way, blockchain technology can help make financial services more efficient. For example, the Saldo app lets Mexicans in the US pay their relatives’ utility bills back home. Saldo runs on Stellar, an open-source blockchain that allows users to affix fiat currencies to the network’s token, the Lumen. This enables them to make international payments for a fraction of the normal cost.
However, not all blockchain transactions require a token. As these are merely transfers of information, blockchain networks can be used to streamline workflows that involve sign-offs and verification checks.
This was the case when HSBC recently used a blockchain-based app to facilitate a letter of credit for an international petroleum shipment. As part of such transactions, banks guarantee payment to exporters on behalf of importers. Consequently, these involve multiple checks and sign-offs along the way. By using a blockchain, HSBC cut the transaction time by more than 60%.
Although HSBC and Saldo focus on different domains, their blockchain solutions both contain a graphical user interface. This saves users the hassle of having to engage directly with the underlying blockchain networks, which can be difficult.
Furthermore, both solutions rely on the security and openness of blockchain-based authentication mechanisms to reduce admin costs behind the scenes. In this way, blockchain has applications in areas where transparency is commonly an issue, such as re-insurance, auditing, and loan syndication − to name a few.
By reducing paperwork and increasing accountability in a multitude of sub-sectors, blockchain can help make financial services cheaper and more accessible. As part of this, fintechs can become conduits between conventional finance and the most promising blockchain networks. That part of the blockchain story is more important than the price of Bitcoin.
Niels Pedersen is a senior lecturer at Manchester Metropolitan University and the author of Financial Technology: Case Studies in Fintech Innovation. The views and opinions expressed are not necessarily those of AltFi.