Table of Contents
The Traditional Banking System: A Brief Overview
Before understanding how blockchain is revolutionizing the banking industry, we need to understand the structure and manner of operations of the traditional banks.
Traditional banks are intermediaries in the financial business dealing in taking deposits, giving loans, money transfer services, and investment opportunities.
Banks are an essential element in the financial system, deeply integrated, whatever the distribution, for they offer access to capital and credit to individuals, businesses, and governments.
For the most part, traditional banks are centralized, in which all financial transactions go through an authority.
1. Transaction Fees: Banks will charge fees for all different types of services, such as international transfers, ATM withdrawals, and account maintenance.
2. Slow Transaction Times: Since there are multiple intermediaries, such as correspondent banks, in a bank transaction, cross-border payment transactions may take days.
3. Limited accessibility: Dependent on traditional banks, customers are required to have a physical presence or internet access to bank online, thus denying people geographically in remote or underdeveloped regions the ability to engage in basic financial services.
4. Security concerns: In general, it is secure, but this also means that they are vulnerable. One security breach at a bank would potentially affect millions of customers and disclose personal and financial information.
Blockchain: A Game Changer in Financial Transactions
The creation of Bitcoin, that is, blockchain technology, happened in 2008 by an anonymous person named Satoshi Nakamoto.
But blockchain is a decentralized and distributed ledger system of information that keeps data from a system across a network of computers, which provides information in a secure, transparent way and is also immutable.
The blockchain is a chain of blocks; each “block” contains a set of data transactions, and each block is linked to the previous one.
The structure of this allows hardly any changes to be made to the data once it has been recorded.
Blockchain is a completely different kind of process than traditional banking systems. Like any other distributed system, Bitcoin is also maintained through a peer-to-peer network of participants (known as nodes) instead of any central authority (like a bank) maintaining a trusted list of transactions.
The key differentiator of blockchain and the centralized banking system is this decentralization.
Key features of blockchain technology
1. Decentralization: No longer requires an intermediary because the blockchain networks verify it. As a result, this reduces the need for other authorities, for example, banks or payment processors.
2. Transparency: transactions are immutable; they cannot be added to, changed, or removed.
3. Security: To protect the data, which makes it extremely hard to hack and commit fraud. Consensus mechanisms add a level of security for each transaction.
4. Immutability: once a transaction is made, it cannot be deleted. This protects the transaction’s transaction record integrity as well as its trustworthiness.
5. Smart contract: It executes on its own when particular predetermined conditions are met, and we do not require human interaction.
Blockchain gives traditional bank services a new face and style
After the last step, we understand what the fundamental characteristics of the blockchain are, and now we will challenge and disrupt the traditional banking system with the help of blockchain.
1. This is Decentralization of Financial Services
Decentralization of financial services is one of the biggest things’ blockchain disrupts. Banks traditionally play the role of intermediaries in nearly all financial activity—saving, lending, paying, etc.
In blockchain, these intermediaries don’t exist anymore, and peer-to-peer transactions are possible without a third party.
However, in a traditional system, the verification, clearing, and settlement of the transactions are done by a normal bank. In one example, if a person transfers money to another person, the bank ensures that the sender has enough and the recipient’s account is credited. This can take time and many times also cost money.
Instead of intermediaries, blockchain validates and executes transactions within the network, slashing costs and time down.
Some of these blockchain-based systems, such as Bitcoin or Ethereum, process peer-to-peer payments directly between the users.
In one example, users can transfer money back and forth to each other in a few minutes without having to go through the normal banking infrastructure and its attached fees.
2. Disruption of cross-border payments
One of the most inefficient parts of the traditional banking system has long been cross-border payments. International money transfers are slow and expensive because there are multiple banks, correspondent banks, and foreign exchange services in global markets.
These services are often provided by banks and come with high fees, and that can take several days if you are doing a transaction between two different currencies.
Cross-border transactions become faster and cheaper using blockchain. With cryptocurrencies, payments can be made straight to recipients scattered all around the world.
There is already support for faster, cheaper international transfers from blockchain-based payment systems such as Ripple (XRP). These eliminate intermediaries, lower costs, and speed transactions.
3. Blockchain and DeFi
Decentralized finance, or “DeFi, as it is often called, has emerged with blockchain as an ecosystem of financial services on blockchain platforms without any intermediaries like a bank or brokerage.
Imagine an application that facilitates borrowing, lending, trading, and receiving interest on crypto assets without relying on centralized banks: this is what the DeFi application is.
Smart contracts are used to develop these services and automate the transaction process without the need of a human or intermediary.
The DeFi space is seeing explosive growth as we speak and will continue to become a more and more integral part of the practice.
DeFi has the advantage over traditional banking by offering access to financial services to the unbanked and underbanked populations and cheaper and faster processing time.
4. Security and Fraud Prevention
In the traditional banking system, however, storage of centralized data naturally gives rise to security concerns. Because they hold huge amounts of personal and financial information, banks are tempting targets for hackers.
Successful breaches can result in identity theft, financial damages, and devastating reputational damage to their institutions.
With technological attributes like the decentralized nature and cryptographic security of blockchain, this has determined the more robust solution for securing the financial data.
To validate these (and thereby save the network’s state), they leverage a consensus mechanism such as proof of work or proof of stake, where many other network participants verify transactions.
In addition, blockchain, often seen as a Byzantine problem solution, can simplify fraud by providing verifiable and transparent records.
This transparency serves to prevent financial operations from being tampered with and is therefore transparent.
5. Tokenization of Assets
We tokenize physical and digital assets through blockchain, giving birth to the digital representation of real-world assets, such as real estate, commodities, stocks, bonds, etc.
This tokenization is the easy transfer, trading, and investing of these assets and would make brokers, custodians, and banks redundant.
As an example, a real estate asset can be tokenized and distributed into smaller units in which investors can buy fractional ownership of that property.
What’s more, this approach also creates new opportunities for investment: investors can buy exposure to a wider range of assets with less capital.
If tokenization succeeds, traditional investment firms and banks will be disrupted, which works as intermediaries in asset management and trading.
6. Financial Services for the Unbanked
Blockchain technology can enable financial services for those unbanked and under banked populations globally.
Financial systems used in blockchain can dispense with conventional banking infrastructure; thus, the people of the remote areas will be able to use the essential financial services.
Apps for peer-to-Peer payments, savings, and lending on a distributed ledger offer individuals a way to participate with a smartphone and an internet connection.
This could make financial inclusion and empower people in developing economies so much more.
Challenges and Limitations
Despite its promise, blockchain technology still faces several challenges that need to be addressed before it can fully disrupt the traditional banking system:
1. Uncertainty: There is much yet to be understood about cryptocurrencies and about regulation. The regulatory environment and financial regulators and governments around the world are working on frameworks to deal with blockchain financial systems, any of which may disrupt how they are used.
2. Scalability: Blockchain has come a long way but still cannot move fast. Bitcoin or Ethereum are in high demand; it stops with transactions.
Scalability and throughput, hindering the usage of blockchain and its high potential of handling large volumes of financial transactions in real time.
3. Risks: Blockchain itself is inherently secure; however, it is the containment, such as exchanges or wallets, that might be hacked or get defrauded.
4. Integration: Blockchain needs to be wide. Unfortunately, traditional banks and financial institutions are resistant to new technology.
Conclusion
The traditional banking system is already being disrupted by blockchain technology by offering the decentralized, transparent, and secure form of financial services to many others financial Services that a bank provides.
Within different domains—decentralized finance (DeFi), cross-border payments, payments, supply chain finance—or elsewhere, blockchain has the potential to reduce costs, improve efficiency, increase security, and so forth.
Nevertheless, regulatory uncertainty, scalability, and security remain as challenges. Having obviously encountered these obstacles, however, blockchain’s capacity for revolutionizing banking cannot be left unexamined.
Given that the technology is advancing, it seems traditional banks will begin to have to alter their practices and embed blockchain into their operations by creating their own blockchain-orientated solutions or even teaming up with DecentralPlatforms.
