Assessing the State of Blockchain Banking
The application of blockchain and distributed ledger technology (DLT) is rapidly expanding beyond cryptocurrencies and into core banking activities and offerings. With ongoing innovation and regulatory progress, the DLT landscape is constantly evolving, and the market growth presents vast opportunities for blockchain banking.
To understand the current state of DLT in the financial services sector, we have analyzed the top seven trends shaping the industry. These trends include the following:
1. Smart Contracts: Digital Implementations of Formal Agreements
2. Initial Coin Offerings: Alternative Methods for Raising Startup Funding
3. Asset-Backed Digital Tokens: Tradable Cryptocurrencies Linked to Other Sources of Value
4. Nonfungible Tokens (NFTs): Cryptocurrency Tokens with Their Own Inherent Value
5. Central Bank Digital Currencies (CBDCs): Proposals for New Nationally Backed Cryptocurrencies
6. Decentralized Finance: Blockchain-Based Banking and Financial Applications
7. Robo-advisory Services: Automated Guidance and Support for DLT Activity
Asia-Pacific Leads the Way in DLT Innovation
Innovation in DLT is thriving globally, with significant launches in Europe and the US, however, the Asia-Pacific region currently stands as the leading hub of DLT innovation, driven in large part by activity in China. Despite this dominance, we expect to see new DLT products and services emerge across the world in the coming years, with a strong potential fit between these fintech advances and conventional bank lines of business.
The Transformative Potential of DLT
DLT, or blockchain, represents one of several emerging digital technologies that have the potential to revolutionize the way we work and live. As the technology is based on peer-to-peer, cryptographically secured communication that records every change in a digital ledger stored redundantly across multiple computers, DLT-based applications become self-governing shared entities that ensure secure, transparent, and verifiable transactions.
How Banks Can Benefit from DLT
Banks have several opportunities to leverage the benefits of DLT, including offering their own cryptocurrencies, providing advisory services and acting as trusted brokers of new financial instruments, and playing a role in enhanced verification and trust-building mechanisms in the new field.
The Future of DLT in Banking
Although DLT may face controversy due to its roots in cryptocurrency, the digital ledger technology is so pragmatic and utilitarian in its own right that it may eventually be considered a cornerstone of the banking industry. Some experts argue that the digital ledger marks a third wave of internet-based technology, known as the “token economy”, which offers reliable execution of transactions without human oversight.
While some DLT-based banking trends may grow into billion-dollar lines of business, others may falter, but the field as a whole is poised to be transformational for the financial services industry over the next decade. The growth of DLT will continue to shape the future of banking and finance, and it is vital that banks stay ahead of the curve and remain informed of these emerging trends.
Latest Trends in Distributed Ledger Technology (DLT)
It is important to note that the regulatory landscape surrounding cryptocurrency and blockchain technology is constantly evolving and varies across different jurisdictions. With this in mind, we have analyzed seven of the most notable trends in the space, with the goal of providing financial services leaders with a better understanding of the opportunities and challenges that blockchain technology presents.
Trend 1: Smart Contracts
Smart contracts are digital implementations of legal agreements between multiple parties. Unlike traditional contracts, they use blockchain technology to track activity and changes, providing features not available with conventional contracts. For instance, when specific conditions outlined in a smart contract are met, it can automatically trigger a provision, such as the transfer of funds from a vendor to a customer when a project’s scope is expanded.
The transparency and accountability of smart contracts are ensured through automated oversight, making it impossible to alter or forge a signature without permission. Contracts are linked to each signer’s digital identity and are time-stamped, providing a secure and reliable means of agreement.
Smart contracts are typically comprised of if-then statements, which are coded on a blockchain ledger and reflect the conditions of a legal or contractual agreement between multiple parties. When conditions specified in the contract are met, the blockchain will automatically execute the predetermined outcome. The outcomes could include purchases, transfers of ownership, changes in legal status, or even changes to the contract itself. It is important to carefully consider all possible outcomes, as provisions will be executed exactly as coded.
One of the key benefits of smart contracts is their transparency and resistance to manipulation, as they are self-executing and self-verifying. Although they are still vulnerable to cyber attacks, the technology is continuously improving, and verification services are still needed to audit the code and underlying logic.
Another advantage of smart contracts is their efficiency and wider access to contract-based agreements. By eliminating the need for legal intermediaries, the cost of smart contracts can be significantly lower than traditional contract agreements. Many other technologies described in this report, including initial coin offerings (ICOs), rely on smart contracts in their operations and design. These contracts are being used for a growing number of legal and financial agreements, including fund distribution, vehicle registration, ticket issuance, and more.
Trend 2: Initial Coin Offerings (ICOs)
The use of cryptocurrency to raise capital is a well-established trend in the blockchain and investment community, and its scale and scope continue to grow. ICOs are similar to initial public offerings (IPOs), but they offer returns based on financial performance, rather than equity, and generally provide the issuing company with a higher degree of independence.
Startups create their own cryptocurrency offerings and sell coins directly to investors. The value of these coins is derived primarily from speculation and exchange, but the issuing company can also link their value to their success, as measured by criteria programmed into the offering. In addition to potentially benefiting from increases in their tokens‘ value, participants may also gain voting rights or protocol governance status, allowing them to make decisions about the company’s future.
Since the first ICO was conducted in 2013 by the team behind Mastercoin, the trend has grown into a global phenomenon. In 2017, more than $6.2 billion was raised through 360 ICOs, and this amount was surpassed in just the first quarter of 2018, with crypto ICOs raising a total of $7.
Trend 3: Asset-Backed Digital Tokens
he tokenization of financial instruments and physical assets has become a rapidly growing trend in the Distributed Ledger Technology (DLT) sector. This trend is driven by the recognition of the significance of asset-based digital tokens in financial portfolios, which has been previously overlooked by investors. Unlike Initial Coin Offerings (ICOs) tokens, the value of which is tied to the traded value of a cryptocurrency, asset-backed tokens are linked to a non-cryptocurrency source of value.
Four Main Types of Asset-Backed Tokens
Asset-backed tokens can be broadly classified into four groups: Security Tokens, Real Estate Tokens, Stablecoins, and Utility Tokens.
1. Security Tokens: These tokens represent shares of stock in a company or a similar financial asset, bought and sold through blockchain-based transactions. Security tokens are traded like an ordinary security, with a digital ledger tracking the transfer of the token from one owner to another for the life of the company. Some successful examples of security token programs include L’Osteria, Bitbond, and Lottery.com.
2. Real Estate Tokens: This type of asset-backed token is relatively new in the financial services sector and has emerged following the trend of online mortgage brokering and peer-to-peer lending. Property owners create real estate tokens to represent physical-world properties such as land or buildings, and the value of the tokens adds up to the total value of the assets. A digital ledger accounts for all the property included in the portfolio. Some countries, such as Sweden, are exploring the use of blockchain for their national land registry systems.
3. Stablecoins: Stablecoins are a form of digital currency that are backed by financial assets such as fiat currencies or investment instruments. The company offering the stablecoin holds the underlying asset, providing stability compared to other, more volatile cryptocurrencies that lack fiat currency backing. One example of a stablecoin is the US Dollar Coin (USDC) offered by Circle.
4. Utility Tokens: Utility tokens originated as a product of ICOs, but companies are now adapting them for other purposes, such as discounts or future benefits. For example, a sports team utility token can give the owner the right to attend games or make decisions about the players. By purchasing the token, the investor gains the option to participate in designated activities within the token ecosystem.
Benefits of Tokenization
Tokenization brings a new level of liquidity and transparency to domains such as real estate and portfolio management. Owners of asset-backed tokens can trade them on secondary markets and enjoy several benefits compared to non-blockchain-based programs, including less risk of personal information leaks, low transaction costs, and the ability to convert tokens into other forms of currency or trade them in real-time. The flexibility of the blockchain that tracks token activity also enables applications that would otherwise not be possible.
Some successful examples of blockchain-based token programs include Nebulous and its Siacoin platform for brokering data storage capacity on cloud computers, BrickMark and Fundament Group’s listed real estate tokens, and American Express and Boxed’s blockchain-based loyalty program.
Trend 4: Central Bank Digital Currencies (CBDCs)
Central banks around the world are exploring the potential of creating their own digital currencies, aimed at countering the decline of cash usage and the rise of private cryptocurrencies. A CBDC differs from fiat money, as it represents a liability backed by a country’s holdings and is verified through a blockchain-based technology system.
Exploring the Possibilities: Advancements in
Despite no central bank having publicly released a CBDC yet, several are testing various functionalities and advancing their concepts. The central bank of Sweden, Sveriges Riksbank, is developing a digital currency called the e-krona, with commercial banks set to participate in the next testing phase. The People’s Bank of China is exploring blockchain technology for its digital yuan pilots and has initiated a joint project with the Bank of Thailand and the Hong Kong Monetary Authority to simulate the use of CBDC for cross-border payments.
The European Central Bank (ECB) is devoting at least two more years to investigating the digital euro project, considering alternative designs that may include restrictions on privacy or limits on the type of services offered, along with specifications for low carbon emissions from associated data-mining processes. The ECB is also considering several business models, which could leverage blockchain technology as the underlying system.
The Benefits of CBDCs to Society
The release of CBDCs is poised to bring several benefits to society, such as supporting the digitization of economies and making digital transactions easier and more efficient to monitor. This will also increase trust in digital currencies and reinforce the role of central banks as independent market participants, free of commercial interests that might influence the use of individual data.
CBDCs also have the potential to minimize or eliminate counterparty risk, as central banks directly issue the digital currency, compared to companies like Google, which have commercial interests that make it harder for them to act as trusted participants.
Decentralized Finance (DeFi): Revolutionizing the
The trend towards decentralized finance (DeFi) encompasses a range of emerging cryptocurrency products, including lending, investing, staking, and creating mortgages. DeFi products are more adaptable and have a greater range of potential uses than smart contracts or tokens. They allow for peer-to-peer transactions, bypassing the need for intermediaries, and rely on smart contracts to monitor activity and establish transaction integrity.
The DeFi market is growing rapidly, with new innovations emerging continuously. The trend towards modular DeFi offerings combines decentralized applications and protocols, similarly to traditional IT systems using APIs, with smart contracts acting as connectors. Most DeFi projects have been built on Ethereum, making it the standard blockchain for decentralized applications.
Benefits of DeFi to Investors: Expanding Access to
DeFi offers investors numerous benefits, including potentially higher returns, expanded access to financial services, fast and efficient transactions, greater flexibility and innovation, open-source code for shared adaptation, general interoperability with other systems, and the automation of many business processes.
DeFi also facilitates innovative cross-chain offerings, such as digital tokens and crypto-backed coins, whose prices are pegged to other financial instruments, cryptocurrencies, or commodities, including gold. The DeFi ecosystem consists of multiple layers of activity, with numerous companies offering services, including Uniswap, Compound, and MakerDAO, among others.
Cryptocurrency Adoption Around the Globe: A Review
Cryptocurrency has seen an increase in adoption around the world, with the Asia-Pacific region leading the way in experimentation and activity. In this review, we will focus on six key countries in the Asia-Pacific region – China, Japan, South Korea, Singapore, India, and Australia – and examine the state of cryptocurrency adoption and regulation in each country.
China: A Vibrant Hub for Digital Ledger Technology
China is a hub for digital ledger technology and one of the most heavily regulated countries in the world. Binance, OKEx, and Huobi, all of which were founded in China, are the top three cryptocurrency exchanges globally by total volume, accounting for close to $100 billion in 24-hour spot and derivative volume. The Chinese government has recently sanctioned a blockchain-based service network that connects hundreds of blockchain software developers through 18 networks, with plans to add 30 more. Furthermore, the People’s Bank of China is conducting digital currency pilot tests.
The Chinese government has also taken decisive action to regulate Bitcoin and other privately issued currencies. As early as 2013, the central bank banned financial institutions from trading in Bitcoin or using it as a currency to prevent money laundering and protect ordinary investors from risk. Today, it is a criminal offense to offer blockchain-based investment opportunities, including initial coin offerings (ICOs), initial exchange offerings (IEOs), and security token offerings (STOs), without regulatory oversight. Despite these regulations, China’s cryptocurrency ecosystem continues to grow, attracting sustained interest from retail and institutional investors and the technical community.
Japan: An Enthusiastic but Turbulent Relationship with Cryptocurrency
Japan has a long history with cryptocurrency, starting with the pseudonym of the original blockchain algorithm creator, Satoshi Nakamoto. In the early days of the cryptocurrency markets, Japan’s Mt. Gox exchange accounted for 70% of Bitcoin trading. Today, many Japanese retail investors maintain cryptocurrency positions.
The Financial Services Agency (FSA) in Japan intensified its oversight of cryptocurrency exchanges after the Mt. Gox hack in 2014, requiring exchanges to obtain licenses and adhere to anti-money-laundering rules. The FSA stipulates that all cryptocurrencies must be held by a regulated bank or trust company, and has proposed a rule requiring exchanges to identify their participants to the government. In response, some exchanges in Japan have formed the Japan Virtual and Crypto Assets Exchange Association, a self-regulatory body.
Japan’s regulatory environment protects investors while favoring blockchain-based activity, resulting in a robust cryptocurrency system. Coincheck, one of Japan’s largest exchanges, operates a fully functional non-fungible token (NFT) marketplace, and the Japan Cryptocurrency Business Association has issued guidance on the proper treatment of NFTs. The Bank of Japan recently issued a review detailing the benefits and risks of decentralized finance (DeFi), indicating the regulator’s awareness and interest in the topic.
South Korea: High Concentration of Cryptocurrency Investors
South Korea has a large retail audience for cryptocurrency and one of the highest concentrations of cryptocurrency investors globally. Foreigners are not allowed to trade on South Korean cryptocurrency exchanges, which have historically had cryptocurrency prices significantly higher than the global average.
Recent regulatory changes include a proposed 20% tax increase on gains from cryptocurrency trading and new financial transaction reporting laws aimed at preventing scams and fraudulent initial coin offerings (ICOs). The Korean central bank has also announced the development of a central bank digital currency (CBDC) and a decentralized identification platform. Major payment applications in South Korea, such as Chai and Kakao, have integrated blockchain and tokens into their operations.
Singapore: Attractive Regulatory Environment for Investors
Singapore is a leading hub for cryptocurrencies and digital assets due to its favorable regulatory environment. The Monetary Authority of Singapore (MAS), the country’s primary financial oversight body, is responsible for most of the regulation of cryptocurrencies and digital assets. The MAS does not impose capital gains taxes on digital assets, but it does tax some cryptocurrency transactions and licensed Initial Coin Offerings (ICOs), as well as licensing cryptocurrency exchanges.
India: A Growing Market with Uncertain Regulations
India has an estimated 15 million crypto investors, with holdings totaling over $1.3 billion. The country is seen as a key market for global cryptocurrency exchanges, however, the regulatory environment remains uncertain. In 2018, the Reserve Bank of India banned banks from dealing with individuals or entities involved in virtual currencies, leading to the closure of several cryptocurrency-native companies. However, the ban was lifted by the Indian Supreme Court in 2020. In recent years, investment in Indian cryptocurrency and blockchain startups has grown significantly, reaching around $95 million in 2020.
Australia: Proactive Regulatory Approach
Australia has taken a proactive approach to regulation, with enforcement agencies providing clear guidance on Distributed Ledger Technologies (DLTs). The Australian Tax Office has classified cryptocurrency transactions as barter, exempting them from capital gains taxes and goods and services taxes under certain circumstances. The country has also established additional regulations for exchanges, cryptocurrency miners, and transaction processors.
Europe: Malta and Switzerland Lead the Way
Malta and Switzerland have established clear regulatory frameworks for cryptocurrencies and DLTs, making them leaders in the region. Other countries in Europe, including Italy, Spain, Austria, and the UK, have not yet enacted regulations for the industry. The European Union is in the process of creating a continental regulatory framework, known as the Regulation on Markets in Crypto Assets (MiCA). The European Central Bank has also expressed interest in creating a European Central Bank Digital Currency (CBDC).
The United States: A Varied Regulatory Landscape
The regulatory landscape for cryptocurrencies and digital assets in the United States is varied. While some states, such as New York, have established stringent regulatory requirements through the BitLicense, others, like Wyoming, have sought to attract cryptocurrency and blockchain companies with looser protocols. At the federal level, regulations remain uncertain, although regulators in the Biden administration have pledged to bring clarity to the space.
The Role of Banks in Facilitating the Commercialization of DLT
One of the key challenges in the commercialization of DLT is establishing trust. The decentralized nature of the technology provides security and verification, but there is still a need for a different form of oversight to ensure that user protections are in place. Banks have a clear opportunity to fill this role by acting as honest brokers and building relationships with clients and customers. This role is not fully automatable, as it requires a human touch and a focus on customer-centered solutions.
The Benefits of DLT for Banks
Banks can leverage DLT to develop a mix of blockchain-based products and services that align with their strategy and customer base. For instance, traditional banks can provide overall strategy, develop custody-related services, tokenization strategies, and platforms related to cryptocurrencies or DeFi. They can also offer tailored banking services to crypto companies and trading capabilities to capital markets. Additionally, DLT can be integrated into the banking back office to improve settlement systems, payment transfers, and central bank digital currencies (CBDCs). This integration can also help banks transform risk and compliance from a cost center to a strategic partner.
The Benefits of DLT for Challenger Banks and Fintech Companies
Challenger banks and fintech companies can also benefit from DLT by incorporating it into their risk and compliance operations. This technology can enable the development of new growth products, such as superapps that bring new forms of payment and trading into daily life. Payment companies can also partner with merchants to onboard crypto-related systems and use DLT for risk and compliance purposes. However, these companies may also face a potential existential threat if other services use crypto as a way to bypass their conventional payment methods.
The Benefits of DLT for Asset Managers and Institutional Investors
Asset managers, sovereign wealth funds, and institutional investors can use DLT to manage partnerships, custodianships, and vendor relationships with greater flexibility and lower costs through decentralized finance. Moreover, corporations in other industries are increasingly using blockchain to manage their financial operations, setting up tokens and non-fungible tokens (NFTs) that are closely aligned with their respective industries.
The adoption of DLT presents numerous opportunities for companies in the financial services industry. Banks, challenger banks, fintech companies, asset managers, and institutional investors can all benefit from DLT by leveraging its capabilities to improve their operations, enhance their product and service offerings, and drive growth. We have already seen this trend among the companies we work with and observe. The time is now for companies to get involved with DLT and build the necessary capabilities to become leaders in this field as it continues to evolve and become standard operating practice.