An awakening is taking place as blockchain technologies are being implemented across almost every industry, with the greatest impact and innovation taking place in the financial industry. Blockchain technology, originally developed as the underlying architecture for Bitcoin, has evolved beyond its cryptocurrency roots to become a revolutionary force in the financial industry. Before delving into its impact, it is essential to understand a variety of blockchain terms and technologies.
Blockchain: At its core, a blockchain is a decentralised, distributed ledger that records transactions across multiple computers so that the record cannot be altered retroactively without the alteration of all subsequent blocks and the consensus of the network. This technology has proven to be secure, reliable, scalable, transparent, and serves useful purposes where any form of ledger, transaction, tracking, or data management is needed.
Smart Contracts: These are coded agreements made possible on the blockchain that automatically execute when predefined conditions are met. In the real estate market, for instance, a smart contract can automate the transfer of property ownership once payment is confirmed, eliminating the need for lengthy legal processes and reducing transaction costs.
NFTs: ‘Non-fungible tokens’, originally known for their role in the digital art and collectibles space, are now being used in various industries. NFTs are unique digital assets that can prove ownership and authenticity of both digital and physical items. They are stored on the blockchain, providing a secure and immutable record that is verifiable by anyone. This has significant implications for creators and industries like gaming, music, and entertainment, offering new revenue streams and ways to engage with audiences.
Tokenisation: Tokenisation of Real World Assets (RWA) is enabling the linkage of a digital asset on the Blockchain, called a ‘token’, with real world assets. Similar to how a Deed is a document to show proof of ownership of a property, a Statement of Entitlements would show proof of the entitlements of a given token. The integration of smart contracts with tokenisation further enhances these capabilities by automating and enforcing agreements without intermediaries.
Tokenisation of securities, bonds, physical assets, gold, real estate, business profit sharing, gas/oil well working interest certificates, movie royalties, investment portfolios, a capital raise, etc, are all happening rapidly. It is estimated that there will be 10 to 20 trillion USD worth of real world assets tokenised in the next five years.
Increased Efficiency And Reduced Costs
Traditional financial systems and transactions often involve multiple intermediaries with varying systems, each adding their own layer of complexity, time delays, and fees. Blockchain can streamline these processes by enabling direct peer-to-peer transactions without the need for intermediaries and, in some cases, eliminate previously required resources for administration.
Fractionalisation is an innovation that allows for ownership by multiple investors of a high-value asset, like a piece of real estate or a valuable artwork, by purchasing shares represented as digital tokens.
With innovations such as OnChain IDs that are a digital form of identifying a person or entity while providing third party validation, it enables better Know Your Client (KYC) compliance and more efficient investor administration. This innovation is eliminating the need for fund investor administration resources.
Blockchain can enable less costly, more reliable and accurate implementation of distributions such as dividends, royalties, insurance payouts, and profit sharing done directly to the investor.
Enhanced Security And Fraud Reduction
Security is a critical concern in the financial industry. Blockchain technology offers robust security features that can help mitigate risk. The decentralised nature of blockchain means there is no single point of failure; transactions are recorded across multiple nodes, making it extremely difficult for hackers to alter or manipulate data without detection.
Blockchain’s transparent and secure ledger also reduces the risk of fraud, as every transaction is recorded and can be audited in real time. This makes security tokens an appealing option for investors seeking a more streamlined and secure investment process.
For example, in the case of securities trading, blockchain can provide an immutable record of trades, ensuring that all parties have an accurate and transparent view of the transaction history, thereby reducing the potential for fraudulent activities
Regulatory Compliance
For tokenisation to be successful, there must be an understanding of, respect for, and enforcement of the various jurisdictional regulatory and compliance, rules, restrictions and requirements, such as restricting the purchase of a security to Accredited Investors. Tokenisation also enables greater and more efficient compliance with anti-money laundering and other regulatory requirements.
Compliance with the USA SEC transfer restrictions for Restricted Securities of a Private Placement Offering, such as a Reg D / Reg S offering is required.
Alternative Trading Systems (ATS) which are specialised exchanges, ‘White Listing’ of wallets, transfer locks, and other technologies exist that enable compliance and enforcement of the transfer restrictions.
Permissioning standards, such as ERC-3643, and OnChain IDs combined with smart contract blockchain transfer rules engines can also enable permissioning of tokens and enforce the seasoning periods and transfer restrictions. This innovation allows for self-custody of tokens and less reliance on exchanges.
Greater Transparency And Trust
Transparency is another significant advantage of blockchain technology. In traditional financial systems, transaction records are often stored in centralised databases controlled by financial institutions, where trust is placed in these intermediaries. Blockchain allows for a decentralised and transparent ledger that is accessible to all participants, enhancing trust.
For example, in a supply chain, blockchain provides a transparent record of a product’s journey from manufacturer to consumer. All parties, including suppliers, manufacturers, distributors, and financial institutions, can access data in real-time, reducing disputes and building trust through a shared version of the truth.
Moreover, blockchain’s transparency can improve regulatory oversight and compliance. Regulators can access real-time data on transactions, making it easier to monitor activities, detect irregularities, and enforce compliance. This could potentially reduce the cost and complexity associated with regulatory reporting and audits, streamlining financial operations.
Revolutionising Trade Finance
Trade finance is a complex area of finance that involves numerous parties, documents, and processes. The traditional trade finance process is slow and paper-intensive, often leading to delays and increased costs. Blockchain technology has the potential to revolutionise trade finance by digitising the entire process and providing a single source of truth for all parties.
For example, letters of credit can be digitised and securely stored on a distributed ledger, accessible to all relevant parties in real-time. This eliminates the need for multiple copies of documents, reduces the risk of document fraud, and streamlines the approval process.
Innovating Capital Markets
Blockchain is making major changes in capital markets. Traditional processes to issue and trade securities are slow, costly, and involve several intermediaries. The digitisation of securities can be traded on blockchain platforms that are fast, efficient, and secure.
Furthermore, blockchain’s ability to provide a transparent and immutable record of ownership can enhance trust in capital markets, reduce the risk of fraud, and better ensure compliance with regulatory requirements.
‘DeFi’ And The Future Of Finance
Decentralised Finance, or DeFi, refers to a financial system that operates without traditional intermediaries, relying instead on blockchain-based protocols to facilitate financial transactions.
DeFi platforms offer a range of financial services, including lending, borrowing, trading, and insurance, all executed through smart contracts on a blockchain.
DeFi services are available to anyone with internet access, eliminating the need for traditional financial institutions. This can be particularly beneficial in regions with limited access to banking services, providing financial inclusion to the unbanked individuals around the world.
While DeFi is still in its early stages, it has the potential to transform the financial landscape by offering a more open, transparent, and efficient alternative to traditional finance.
Virtual Asset Service Providers (VASPs)
Across the globe, jurisdictions are implementing a regulatory framework to enable virtual asset service providers that offer services related to blockchain and digital assets. Each VASP brings a mix of different services to the blockchain and its related ecosystems.
Many of the efficiencies the blockchain and VASPs will bring are going to eliminate many traditional jobs and reduce resources required across the financial services industry. Examples include investor administration and distributions management for which VASPs can automate using blockchain.
Challenges And The Road Ahead
Despite its potential, the adoption of blockchain in the financial industry is not without challenges. Scalability remains a significant issue, as current blockchain networks struggle to handle the high transaction volumes typical of global financial markets. Additionally, the regulatory environment for blockchain and cryptocurrencies is still evolving, with different jurisdictions adopting varying approaches to oversight and compliance.
Moreover, the integration of blockchain technology into existing financial systems requires significant investment in infrastructure and a shift in mindset for many institutions. The need for technical expertise and the development of industry standards are also critical factors that will influence the pace of blockchain adoption in finance.
Another major challenge is general awareness of what blockchain can do amongst decision makers, executives, and the boardrooms of business. These groups need to embrace the transition to the blockchain. Investors need to better understand tokenisation. The regulators need to provide better clarity on regulations for the crypto industry and tokenisation to thrive.
Awakening
Blockchain technology is undeniably transforming the financial industry, offering numerous benefits such as increased efficiency, reduced costs, enhanced security, greater transparency, and better regulatory compliance. While there are challenges to overcome, the potential for blockchain to revolutionise finance is immense. As the technology continues to mature, awareness broadens, and regulatory frameworks evolve, we see this awakening happening with more innovative applications of blockchain impacting the global finance industry.
Douglas Spencer
Doug has 35 plus years of experience in technology, finance, investment and business management. Having traveled, lived, and worked abroad in areas of Asia, Middle East, North America, and now the Cayman Islands, he has a truly global perspective. His corporate experience and entrepreneurial successes have shaped his approach to business. Doug has an appreciation for the importance of regulatory compliance. With this background combined with a highly skilled team are enabling Monetaforge to become a leader and innovator in the area of Tokenization of Real World Assets.
Monetaforge is a Virtual Asset Service Provider (VASP) registered with and regulated by the Cayman Islands Monetary Authority providing design, mint, issue and administration of permissioned tokens enabling the Tokenization of Real World Assets.