Blockchains came with a myriad of promises; both big and small. From structural re-engineering of the global economic order around egalitarian values to a simple functionality allowing us the ability to pay for local goods without need for intermediary financial institutes. In theory, this promise still holds its ground. However, despite the massive expansion (and correction) of the cryptocurrency market over the last two years, blockchain technology has still to fully reach its potential in terms of real world applicability.
One of the great potential uses of blockchains and offshoot distributed technologies is their viability as good solutions for a variety of a data settlement scenarios; none more critical then interbank settlement.
At their most basic, blockchains are semi-automated clearinghouses that function as per clearly defined algorithms to verify the authenticity of certain transactional claims. That might be a mouthful for those new to the technology, so let’s analyze the ways and means through which blockchains such as Bitcoin provide (potentially) a competent protocol for interbank settlement.
The Classic Problem of Interbank Settlement
For anyone who has had the (mis) fortune of transferring funds through international banks, it goes without saying that the process is long and arduous for all stakeholders.. The modern day Society for Worldwide Interbank Financial Telecommunication (SWIFT) protocol cut down on previous transfer times but has not adapted to meet modern day expectations of instant, secure international wiring. The basic reasons for this delay in wiring money revolves around the prevalent procedures for interbank settlement:
- End-of-Day Settlement. A good settlement procedure must run 365 days / 7 days / 24 hours. However, a majority of the current protocols employed for international transfers usually result in end-of-day processing and transfer of funds after working hours.
- Two transaction types. Traditional protocols for interbank settlement process high-value transactions separately from lesser-valued ones. This means that two separate procedures, individual and batch-processing, run simultaneously. This invariably leads to operational complications and delays.
- The Middle-man. Most international settlements are not just a simple case of bank-to-bank communication via SWIFT. Often, a ‘middle-man’ bank is employed as a facilitator between the sending and receiving banks in the absence of any formal banking relations between the two.
- Security. The threat of risk and fraud are always lurking around payments and transfers; the lengthy process of verification can lead to significant delays during interbank settlement procedures.
How Blockchains Fill in the Gap
Blockchains such as Bitcoin have shown to be strong potential candidates for viable, legal data (financial) settlement platforms. They may potentially replace banks as clearinghouses for financial and contractual settlements of all types. Here are some inherent benefits of the technology:
- Speed. Settlements on the blockchain are fairly quick. A single bitcoin transaction takes as little as 7 minutes before it is formally validated on the blockchain. This ensures quick and convenient settlement.
- Security. Blockchain transactions are secure; being distributed systems, they prevent government intervention and foul play by banking stakeholders. Impersonation, too, is hard due to the complex cryptography that protects each transaction. They do, however, come with their own set of risks.
- Cheaper. The median bitcoin transaction fee is .79 as of February 2018. This is exponentially less than the fees for a SWIFT transaction, although may actually be higher for national transactions (see RTGS below).
- Decentralized. This is the big one: blockchains get rid of formal clearing houses such as multinational banks and the SWIFT network, and place your transactional data on a distributed ledger. SWIFT transactions, in contrast, are subject to rigorous financial oversight and changing fiscal policies.
The Need for Decentralised Real-Time Gross Settlement Systems
Real-Time Gross Settlement Systems (RTGS) are already prevalent at the national level in most countries. These enable low-cost (often free), instant payment and settlement across nationally operated banks. However, changing exchange rates and the sheer breadth of banking stakeholders means that such a system is still very difficult to operate at the international level.
Another issue is that of security, which justifies the prospect of decentralised data settlement at the national level despite the presence of RTGS. Centralised RTGS can be taken down through a series of dedicated and focused cyber attacks, potentially decapitating an entire country’s financial transaction protocol.
This, of course, would be much harder on decentralised systems such as those using blockchain technology. BitTorrent, as an example, is extremely hard to take down due to it’s decentralised peer-to-peer operations across millions of computers. This makes the prospect of a decentralised, distributed RTGS an attractive solution at both the national and international level.
The banking sector at large has been exploring the possibilities of blockchain technology for half a decade; it is just a matter of time until we see significant real world applications of it’s true potential..