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Blockchain in Finance: What Does it Mean for Fintech?

By Brian Nibley · July 30, 2021 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Blockchain in Finance: What Does it Mean for Fintech?

While investors and asset managers have mixed opinions on the future of cryptocurrencies, many agree that blockchain–the technology that enables crypto trading–holds the potential to transform many different industries.

Blockchain technology is the infrastructure that makes trading Bitcoin and thousands of other cryptocurrencies possible. Invented in 2009 by a person or group known as Satoshi Nakamoto, a blockchain is one example of what’s known as distributed ledger technology (DLT).

Distributed ledgers keep records of transactions spread across different servers in multiple locations. Blockchains are special types of distributed ledgers that are immutable (they can’t be changed) and decentralized (they’re outside the control of a single entity).

Understanding Blockchain Basics

Blockchain technology processes transactions into groups referred to as “blocks.” Each new block gets attached to the block that came before it, creating an ever-growing chain of blocks. This is where the term “blockchain” comes from. Altering the data inside any single block would require changing the entire chain, something which requires massive amounts of computing power and is almost impossible in most cases.

However, the data held in blocks can take many forms, not just financial transactions. The ability to create an immutable, transparent, decentralized ledger of data creates many new possibilities. In addition to altcoins, several other industries outside of cryptocurrency are looking at different blockchain applications, including Fintech.

Blockchain Applications in Fintech

There are myriad ways that financial services can make use of blockchain technology. Most of them currently exist in a proof-of-concept or pilot phase, meaning their real-world applications have yet to be consistently utilized or widely adopted.

Payments

Payment systems represent the most tried-and-true use case for blockchain in finance, since that’s essentially how crypto trading works. Sending money across national borders using the traditional financial system takes a long time, and can get costly as each intermediary that facilitates the transaction receives a fee. Blockchain has the potential to make this process faster and more affordable by enabling things like:

•  Fast and secure cross border payments

•  Multiple forms of payment – cryptocurrency, stablecoin cryptocurrency, etc.

•  Reduced fraud risk through digital Know Your Customer (KYC) and Anti-Money Laundering (AML) data

•  Smart contracts, digital agreements between two parties that get stored within the blockchain.

Insurance

Blockchain could allow insurers to more efficiently handle claims. IBM reports that it is already using blockchain technology to help clients automate underwriting, settle claims, and reduce fraud.

Asset Management

When it comes to asset management, blockchain financial services can help real estate funds, private equity firms, venture capital firms, and similar institutions. These groups often find themselves to remain compliant with changing regulations and improve risk management. Blockchain security could also offer an additional layer of protection for their assets.

Blockchain improve efficiency in asset management through:

•  Tokenization of securities, leading to greater liquidity and market access

•  Customizable privacy settings for confidential transactions

•  Reduced human errors in shareholder voting

•  Improved governance with greater transparency for investors

•  Automation of other tasks

Regulatory Compliance

Keeping up with the pace of regulatory change can be challenging for some financial institutions. That’s especially true when an organization conducts business across national borders and exposes itself to regulatory frameworks in multiple jurisdictions. Blockchain can help in ways such as:

•  Programming digital assets with specific governance attributes

•  Eliminating human errors that occur in manual processes

•  Improving network governance

Potential Drawbacks of Blockchain in Finance

As you can see, there are a variety of ways that fintech and blockchain could improve many cumbersome tasks that people and organizations deal with today. The main benefits have to do with increases in speed, automation of complex processes, and “trustless” processes, meaning a central entity doesn’t have to be trusted with information or transactions.

There are also a few potential drawbacks, though. They mostly have to do with the impracticality of creating and maintaining an independent, decentralized blockchain.

Maintaining Decentralization

Decentralization democratizes blockchain by making it resistant to central authority and makes things more secure by eliminating any single point of failure. But when a single organization creates its own blockchain for specific purposes, they might be the only ones with an ongoing incentive to maintain it. This could lead to the nodes becoming centralized, somewhat defeating the purpose of having a blockchain in the first place.

Recommended: 51% Attack: A Threat to Decentralized Blockchain

Trust Issues

With the Bitcoin blockchain, users trust the transaction data because Bitcoins are “born” on that blockchain. From the moment Bitcoin is mined into existence, everyone can see where coins go and what wallets they’re in. However, most of the potential use cases for blockchain finance involve assets that were not born on-chain (insurance claims, securities, loans, titles, etc.). For this reason, it’s possible that the data being put onto a blockchain in this manner could contain mistakes or inaccuracies.

Environmental Concerns

The blockchain requires massive computing power, which makes it an inefficient industry from an energy standpoint.

Recommended: How Much Energy Does Mining a Bitcoin Consume?

The Takeaway

Creating a blockchain in finance, while appealing in principle, might be hard to do in practice while still preserving the unique features that make a genuine blockchain desirable. Still, the technology holds significant promise for improving the way that many financial transactions occur.

Regardless of your thoughts on the blockchain, a great way to get started building a portfolio including cryptocurrency is by opening an account on the SoFi Invest brokerage platform. Using the platform, investors can buy cryptocurrency online, including Bitcoin, Litecoin, Ethereum and others, right from their SoFi app.

Photo credit: iStock/Eoneren


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