Blockchain in financial services and the rise of digital assets

We’re at an intersection between the old world of finance — traditional banks — and the new era of blockchain-enabled innovation, such as the rise of digital assets in the financial services industry, both at established institutions and challenger banks.

This technology and the innovations it has enabled will fundamentally change the way people interact with money, manage their wealth, trade on markets and invest in assets.

Blockchain in finance

Certain challenger banks, such as Revolut, are adopting blockchain technology and embracing the new world of digital assets — physical commodities represented in the digital.

“Revolut effectively allows its customers to buy Bitcoin as part of their portfolio,” explained Francesco Roda, chief risk officer at Koine Finance and co-founder of Starling Bank.

“There are a number of initiatives in the FCA regulatory sandbox that actually truly merge the world of financial services with the world of digital assets and the world of blockchain technologies; using blockchain to enable cross-border payments, for example.”

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Digital assets in finance

The digitalisation of value — digital assets — is a growing trend that’s enabled by the blockchain. In this process, existing financial assets, or real assets are digitalised on the blockchain with the advantage of removing intermediaries in their distribution, lowering transactional cost and also addressing the issue of counterparty risk.

Digital assets are one of the most interesting innovations that blockchain has introduced into the financial services industry

Beyond Bitcoin and other cryptocurrencies

Initially, blockchain was famously known as the technology behind Bitcoin and all the other cryptocurrencies out there in the ether. But, this is just “the tip of the iceberg,” said Roda. “Whether you believe that Bitcoin is going to go up in value or not, it is a niche use case in the world of blockchain.”

Digital assets, instead, are a much more robust and interesting use case for blockchain. The world of digital assets — value which is represented by tokens issued on a public blockchain that can then be distributed in the same way that other cryptocurrencies are — creates more opportunity in this increasingly digital world: it’s in the digital that we communicate and work now, so why not how we transact?

A recent example of a digital asset is Libra, the Facebook currency. “Libra is a basket of currencies, but rather than be handled by the traditional financial intermediaries, it’s distributed, handled and managed on a blockchain,” explained Roda. “It removes the requirement and need for intermediaries, or at the very least, reduces their role, reshaping them to a function that potentially is more suited and more effective.”

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The future of blockchain in finance

The future of blockchain and finance is “being drafted as we speak,” continued Roda. “I see the digitalisation of value as the bright future of blockchain.”

More and more, traditional intermediaries and new entrants into the financial services industry are realising that the potential of blockchain, its widespread distribution of financial products, is the benefit of liquidity.

Roda explained: “Liquidity is very crucial in financial markets; the lack of it is very costly and very problematic for both the issuers and the holders of the financial assets — it presents another way to distribute and get your product out there to those that want it.”

Liquidity is hindered by barriers to distribution. And so, illiquid assets typically have very restricted markets — they are not listed on exchanges or other public markets and they do discount quite a lot of cost and risk.

Roda pointed to Neil Woodford, the UK fund manager, who had to block a fund because of the lack of liquidity in the underlying investments — “the regulator is now taking a very keen eye and they are more attentive on this liquidity risk,” he said.

“So, summing up, that’s where I see the bright future for blockchain; in effectively enabling and making distribution of financial products fairer, cheaper, more cost effective and therefore, enhancing the liquidity profile of what typically has been very illiquid assets.”

A decentralised world

The world of blockchain is decentralised, where all of the participants are made equal by the cryptographic controls that exist and are in force on the blockchain. Here, transactions don’t need intermediaries. Consumers, therefore, are effectively their own bank. They can actually execute payments and store value directly on their account without the need of any intermediary.

“Theoretically, this is a very strong construct, but the reality is that individuals, corporates and institutional investors still require intermediaries to operate effectively,” claimed Roda.

There are some companies that are starting to emerge as interesting intermediaries and mainly, these cater primarily to the world of institutional investors. Fidelity, for example, have launched a custody service for digital assets — as these can’t be owned, they belong to the individual.

There is another parallel world in blockchain — Hyperledger, SETL or R3 — which are the consortia or technology providers that enable corporates to issue their own private blockchains.

A private blockchain is an interesting concept because it takes the technology that underpins bitcoin — so a public blockchain — and restricts it, by building a wall of permission around it so that it can be controlled by a single corporate or a single consultant. This is somehow at odds with the philosophy that makes blockchain so interesting, which is decentralisation.

“The fact that there is no single guardian or intermediary means the blockchain (in finance or elsewhere) acts like the internet,” said Roda. “You don’t have a single intermediary which guarantees the operations of the internet, you have just a multitude of nodes and each node is at the same level, it’s a peer compared to the other nodes, and that’s what makes the internet so widespread, but also so reliable and so resilient.”

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Nick Ismail

Nick Ismail is a former editor for Information Age (from 2018 to 2022) before moving on to become Global Head of Brand Journalism at HCLTech. He has a particular interest in smart technologies, AI and...