Blockchain technology is a core, underlying technology with promising application prospects in the banking industry. On one hand, the banking industry in China is facing the impact of interest rate liberalization and profit decline caused by the narrowing interest-rate spread. On the other hand, it is also affected by economic transformation, Internet development, and financial innovations. Hence, the banking industry requires urgent transformation and is seeking new growth avenues. As such, blockchains could revolutionize the underlying technology of the payment clearing and credit information systems in banks, thus upgrading and transforming them. Blockchain applications also promote the formation of “multi-center, weakly intermediated” scenarios, which will enhance the efficiency of the banking industry. However, despite the permissionless and self-governing nature of blockchains, the regulation and actual implementation of a decentralized system are problems that remain to be resolved. Therefore, we propose the urgent establishment of a “regulatory sandbox” and the development of industry standards.
Blockchain is currently a concept that has received significant attention in financial technology (FinTech). It combines several computer technologies, including distributed data storage, point-to-point transmission, consensus mechanisms, and encryption algorithms. It has also been identified as a disruptive innovation of the Internet era. However, as blockchain is a major breakthrough in data storage and information transmission, it might fundamentally transform the existing operating models of finance and economy, which might lead to a new round of technological innovations and industrial transformation within the FinTech industry (Mu Qi-Guo 2016).
Recently, international institutions, including the United Nations and the International Monetary Fund, (The First Digital Currency Report of the International Monetary Fund [EB/OL]) as well as developed nations, such as the US, the UK, and Japan, have paid close attention to the development of blockchains and explored their application in various fields. Furthermore, China, Russia, India, South Africa, and other countries have also successively initiated research on blockchain technology. In February 2016, the governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, mentioned during a discussion on issues related to digital currencies that blockchain technology is a possible option. As such, PBOC has spent considerable resources researching the application of blockchain technology. On October 18, 2016, the Ministry of Industry and Information Technology published the “Chinese Blockchain Technology and Application Development White Paper (2016),” which analyzes the current status of blockchain technology and proposes recommendations for future development.
Blockchains are decentralized and permissionless, which can lead to major disruptions in the financial sector, especially in payment clearing. Since 2015, a number of major international financial institutions have begun to formulate plans for the blockchain sector. Goldman Sachs, J.P. Morgan, UBS, and other banking giants have all established their own blockchain laboratories, working in close collaboration with blockchain platforms, and published a series of studies on this topic. Goldman Sachs even filed a patent for transaction settlement based on blockchain technology. Additionally, various national stock exchanges, such as the Nasdaq Stock Market and the New York Stock Exchange have also conducted in-depth research on blockchain technology. On December 30, 2015, Nasdaq announced that it had completed its first securities transaction using the blockchain transaction platform Linq. Furthermore, the US Depository Trust & Clearing Corporation, Visa, the Society for Worldwide Interbank Financial Telecommunication, etc. have also expanded their plans in the blockchain technology sector.
Different types of blockchain industrial consortiums have emerged in order to promote the development of blockchain technology and its applications, the R3 blockchain consortium being the most influential among them. It has brought together over 40 of the world’s leading financial institution, including Bank of America, Citigroup, Morgan Stanley, Deutsche Bank, and Barclays Bank. As of May 2016, Ping An Bank and China Merchants Bank (CMB) have also joined the R3 blockchain consortium, thus strengthening the exchange and cooperation of top financial institutions in the blockchain technology. Additionally, WeBank, Ping An Bank, CMB Network Technology, among others, have formed the China Financial Blockchain Consortium. The major financial institutions have a relatively positive attitude toward improving the back-end processing efficiency of blockchain technology, and place significant emphasis on its potential to reduce operational costs.
There has also been widespread optimism regarding the application of blockchain in the banking industry. In May 2016, McKinsey conducted a survey on global banking executives, finding that approximately half of executives believe that blockchain will have a substantial impact within 3 years, with some even considering that this will happen within 18 months. Footnote 1 Another survey of 200 global banks predicted that, by the following year, blockchain technology will be extensively implemented by 15% of banks. Furthermore, IBM has stated that, in 4 years, 66% of banks will have commercial blockchain at scale. Footnote 2
As such, an increasing number of banks have begun to be pay greater attention and place emphasis on blockchains. Therefore, why is the current banking industry focusing on the deployment of blockchain strategies? Which specific scenarios can blockchains be applied to? What are the existing problems in the implementation process of blockchain technology? This paper discusses these questions in turn in the following sections.
The banking industry in China is currently facing multiple pressures, including a decline in profits and an increase in risk, and has entered a new state of change and development. The sudden Internet finance boom has also led to numerous challenges in the traditional banking business. Consequently, commercial banks need to rely on new technological growth to accelerate product and service innovations, thereby adapting to new customer demands and competitive environments.
Since 2015, China’s macroeconomy has entered a “new normal,” wherein economic growth continues to decelerate, while interest rate liberalization is essentially complete, and their combined effects are becoming increasingly apparent. On one hand, there has been a trend towards narrowing interest-rate spread and declining the profitability of commercial banks. On the other hand, there has been increasing credit risk and non-performing assets (Wang Wei 2016). The changes are shown in Figs. 1 and 2. Moreover, following a series of changes, including easing market access for foreign banks and the internationalization of the RMB, the survival environment of China’s commercial banks has become particularly harsh.
In recent years, booming Internet finance has accelerated the marketization of the financial sector. The endless emergence of Internet financial products has led to the substantial diversion of household saving deposits and increased banks’ cost of debt. According to monitoring data for national Internet FinTech platforms, as of the end of August 2016, the number of Internet financial platforms had reached 8490 and the number of active users 618 million. The latest data released by the China Internet Network Information Center indicated that, as of June 2016, the number of Internet users in China was 710 million. As such, the percentage of Internet finance users accounts for 87% of total Internet users in China. Footnote 3
The great success of Internet finance within a short period of time is due to four vantages: infrastructure, platforms, channels, and scenarios. Moreover, some details are shown in Table 1.
Currently, a number of financial institutions started to test transactions on blockchain platforms. Standard Chartered uses Ripple, an enterprise-level blockchain platform, to implement its first cross-border transaction. For example, the platform took 10 s to complete a settlement process that currently takes the banking system and network 2 days to complete. Footnote 9 The National Australia Bank (NAB) has also used Ripple’s ledger technology to successfully transfer USD 10 from an NAB employee account to another employee’s account in the Canadian Imperial Bank of Commerce. The process also took 10 s. Footnote 10
The ineffectiveness of bank credit information systems is mainly due to the following: first, the scarcity and poor quality of data makes it difficult to judge the situation of personal credit; second are difficulties in inter-institutional data sharing; third is the unclear ownership of user data, leading to difficulties in circulation due to concerns for privacy and security. Although the solutions to these problems will require the cooperation and participation of different stakeholders, blockchain technology can provide some assistance in addressing these issues.
Every individual produces massive amounts of data on the Internet, which is extremely valuable as proof of their credit situation. Nevertheless, these data are currently being monopolized by large Internet companies. Hence, individuals are unable to establish their ownership or utilize these data. Additionally, in order to protect user privacy, data flow is difficult to achieve between these companies, which leads to the formation of data islands.
Blockchain technology can perform data encryption, which can help us control our own big data and establish ownership. This can further guarantee that the information is genuine and reliable, while also reducing the costs of data collection by credit agencies. Using blockchain technology, big data can become credit resources with clear personal ownership, and even establish the foundation of future credit systems.
Blockchain can facilitate the automatic recording of big data by credit agencies, while also storing and sharing encrypted forms of the customer’s credit status within institutions. This enables sharing credit data. The following blockchain credit solution has been proposed: during the “know your customer” (KYC) process, banks should store customer information in their own database, and then employ encryption technology to upload summary information for storage in the blockchain. When there are query requests, the original data provider can be notified using the blockchain and a query can be performed. Therefore, all parties can search external big data, while also not divulging their core business data (Blockchain 3.0 (12): Restructuring existing credit information system by blockchain credit [EB/OL]).
Encryption technology can ensure that the summary and original information are consistent, thereby preventing the provision of false information that can mislead their counterparts. Within the framework of customer information protection regulations, the blockchain is able to realize the automated encryption and sharing or customer information and transaction records. This helps eliminate redundant work involved in KYC between banks.
Supply-chain finance involves an extensive amount of manual inspections and paper-based transactions. The process also has numerous intermediaries, a high risk of illegal transactions, high costs, and low efficiency. Blockchain technology can drastically reduce manual interventions and employ smart contracts in order to digitize procedures that rely heavily on paperwork. This would greatly improve the efficiency of supply-chain finance and reduce manual operational risks. With the supplier, buyer, and bank as the main trading parties, and the sharing of contractual information on a decentralized distributed ledger, smart contracts can ensure that payments are made automatically once a predetermined time and result is reached.
The application of blockchain technology in supply-chain finance can help reduce the costs to banks and trade financing enterprises. According to calculations by McKinsey, blockchain technology is expected to help banks reduce operational costs by USD 13.5–15 billion annually and cost of risk by USD 1.1–1.6 billion annually. Both trading parties will also be able to reduce their cost of capital by USD 1.1–1.3 billion annually, and operational costs by USD 1.6–2.1 billion annually. Footnote 11 Furthermore, transaction efficiency improvement ensures a smoother flow of overall trade financing channels, which greatly increase the income of the overall trade chain.
Barclays Bank and an Israel-based startup have completed the first-ever blockchain-based trade transaction in the world. This transaction guaranteed the export of cheese and butter products worth around USD 100,000 from the Irish company Ornua to the Seychelles Trading Company. The transaction was performed on a platform set up by Wave, a partner company of Barclays Bank. Using blockchain technology, a transaction process that usually takes 7–10 days was drastically reduced to 4 h. Footnote 12
Additionally, UBS has planned to establish a trade finance system using a distributed ledger, which can simplify global import and export transactions. In current large transactions, when the products are still in transit, the buyer’s bank can use a letter of credit to eliminate the seller’s credit risk. A letter of credit can weigh up to 500 g and include 36 documents that take 7 days to process, during which other risks may be generated. Conversely, blockchain technology can be used to program this procedure into a smart contract, thus reducing the processing time for letters of credit to 1 h and decreasing operational risk. Footnote 13
True disintermediation requires complete decentralization as its foundation. Decentralization from a purely technical perspective does exist in some models. For example, for Bitcoin and other digital currencies, complete decentralization enables them to perform operations without the need for intermediaries. However, in the real world, many scenarios need to be safeguarded by a certain extent of centralization, especially when applied in the financial sector. Hence, we need to shift from a technical to a regulatory perspective. Achieving true decentralization is extremely challenging and could even be impossible; thus, true disintermediation cannot be achieved. Therefore, this point should be given due consideration when implementing blockchain technology. In order to meet the needs of reality, more centralized consortium and private blockchains can be derived from completely decentralized public blockchains. Table 3 shows the comparison of the different categories of blockchains.
Table 3 Categories of blockchainsNumerous banks and other financial institutions have come together to create the world’s largest blockchain consortium, R3, which is a multi-centralized consortium blockchain. This is currently the most promising model in the banking industry.
Although blockchains have a technological advantage over banks as credit intermediaries, it is still too early for this technology to completely disrupt the existing financial system. Therefore, a “multi-center, weakly intermediated” scenario is likely to emerge (Chang and Han 2016). This is where banks use blockchain technology to improve their payment clearing systems and overcome certain obstacles in information communication, while also forming consortiums, thereby consolidating their position.
The efficiency problem of blockchains will need to be discussed in two parts. The efficiency of single transactions is influenced by technology and the degree of centralization. As transaction and clearing occur simultaneously, each transaction will need to be verified by all the nodes in the entire network, which is detrimental to its speed. This impact will become especially prominent when the nodes of the blockchain increase. On the other hand, the decreased in the efficiency of single transactions would improve transaction security. Moreover, the simultaneity of transactions and clearing would eliminate the problems of subsequent reconciliation. Overall, this brings undeniable improvements to the overall efficiency of banks.
More importantly, the transaction speed of Bitcoin is deeply influenced by its decentralization. As for consortium blockchains, which are more suitable for the banking industry, the lower level of decentralization implies that the loss in speed is not too significant. Current tests have already shown that cross-border transactions only require less than 10 s.
As blockchain technology is still in the development stage, the US Chair of the Federal Reserve remarked that regulatory rules will not be formulated yet in order to ensure sufficient freedom for innovation (US Federal Reserve Chair: Blockchains are potential shares, regulatory rules will not be formulated as yet [EB/OL]). However, the Chinese government has a cautious attitude towards this technology. The former director of the Bank of China, Li Li-Hui, stated that, “regulators should be involved in the formulation of technical and legal rules for financial blockchain technology, and now is the best time.” ([Summit] Former Director of Bank of China Li Li-Hui – Opening Statement on the New Economic Horizons for Blockchain [EB/OL]).
The decentralization and self-governance of blockchains dilutes the concept of regulation, and has a critical impact on the existing system. However, any beneficial technology is accompanied by risks. Therefore, blockchain regulation is necessary, and should be formulated sooner rather than later.
The regulatory sandbox originates from the UK, which intends to give a more flexible space for innovations. The sandbox delineates a restricted scope with simplified market access standards and procedures. Given that consumers’ rights are safeguarded, FinTech innovation enterprises or businesses are permitted to rapidly implement operations, and are allowed to expand within the testing conditions of the regulatory sandbox. Currently, the UK, Australia, and Singapore have announced the establishment of FinTech regulatory sandboxes (Hu Jin-Hua. Calls for regulating blockchains continues to increase, industrial bigwigs urges establishment of sandbox mechanisms [EB/OL]). Although China has proposed similar ideas for “flexible regulation,” these have not been sufficiently standardized. Hence, their development should be accelerated in order to provide a controlled testing environment for the growth of blockchain technology.
As a core, underlying technology, more caution is required in the regulation of blockchain technology. Although the Bitcoin system has not been hacked in the 7 years since its establishment, the hacking attack on the DAO raised alarms. Several companies are now researching blockchain technology, and the security of this technology still needs to be tested using authoritative standards.
Recently, Standards Australia has submitted a request to the International Organization for Standardization to develop global standards for blockchain technology. The R3 blockchain consortium is also exploring the formulation of industry standards for interbank applications. In China, the blockchain technology research group of the Interbank Market Technology Standards Workgroup was established in August 2016. This workgroup is to conduct prospective research on interbank market blockchain technology, regulations, and legal framework.
The immutable nature of blockchain systems is a guarantee of its authenticity. That is, once a piece of information enters the system, it cannot be modified. This eliminates the subsequent problems of fraud, but also implies that preliminary inspection of information needs to be more cautious. Therefore, stricter information access mechanisms need to be established, and the data on each node will need to be reviewed to ensure that fraud behaviors do not emerge. Once a transaction is initiated, it cannot be reversed. Hence, its authenticity and reliability needs to be verified in order to avoid accidental losses.
Blockchains could revolutionize the underlying technology of the payment clearing and credit information systems in banks, thus upgrading and transforming them. Blockchain applications also promote the formation of “multi-center, weakly intermediated” scenarios, which will enhance the efficiency of the banking industry.
It is worth noting that the problems of regulation, efficiency, and security have always sparked extensive debate in the process of each new financial innovation. However, history is not stopped by current obstacles, as the technical, regulatory, and other problems of blockchain technology will ultimately be resolved. Hence, the prospect of integrating blockchain technology into the banking industry will most likely occur in the near future.
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YG set up the logic frame, reviewed the now available researches, and make an analysis. CL collected the data and drew the figures and tables. Both authors read and approved the final manuscript.
The authors declare that they have no competing interests.