The announcement that Belgium-based financial services company, Euroclear, is to invest in Finality.org  is potentially very, very significant for the UK financial services sector. Firstly, we had the FPC announcement and then (the deputy governor at the Bank of England) Sam Wood's letter on 24th March. This was followed on 25th March when Finality.org revealed Euroclear as a new investor. Finality is to have a commercial relationship with the Bank of England, even though the Bank of England website claims it “only offers banking facilities to the government, other central banks and commercial banks.” The new synthetic CDBC that Finality is looking to issue would seem to suggest that the Bank of England is going to allow institutions to trial a sterling-backed digital currency which will need to operate outside the Bank of England’s long-established Gross Real Time Settlement (GRTS). The reason is because a cash-backed digital currency will be able to trade 24/7, unlike GRTS that operate 5 days, certainly not 24 hours.

Banks backing Finality

Source: LedgerInsights.com

It would appear though that London is striving to be on a par with Europe which had announced in November 2021 its “pilot regime for market infrastructure based on distributed ledger technology” enabling financial markets in the EU to use Blockchain technology to create digital stocks, bonds and UCITs (mutual funds). These new digital securities will also be able to be settled in digital commercial bank money and cash-backed stablecoins. Not to be left behind, ANZ mint (issued/created) the first Australian cash-backed Dollar A$DC  in March 2022, using the Ethereum blockchain. ANZ is one of Australia’s biggest banks. Meanwhile, it is worth remembering that cash-backed stablecoins generate no money for the issuer, especially when interest rates are so low. However, as interest rates rise it is possible for cash-backed stablecoins to pay out 80% of the interest they generate - so if we have interest rates of just 5%, that equates to 1% p.a. Of greater significance is that digital cash-backed currencies are like 'the oil in an engine', enabling financial markets to operate more efficiently and smoothly by allowing smart contracts to transfer value (cash) outside traditional banking rails - potentially faster, cheaper and with greater transparency. Trust evolves from transparency together with the promise of stronger compliance and risk controls.

Furthermore, there is also the promise that CBDCs and, indeed, stablecoins offer the ability to address a country’s shadow economy since a digital currency leaves a digital footprint - something that cash does not. Perhaps this explains why, for tax purposes, French residents are only allowed to make cash purchases of up to the value of €1,000 and in August 2021, Spanish residents had the maximum they were allowed to spend using cash reduced from €2,500 to €1,000. Meanwhile, if you take more than $10,000 in cash into the US you are required to notify customs and complete a Report of International Transportation of Currency and Monetary Instruments. So, this all begs the question - if you have cash-backed digital currencies that you can access anywhere, anytime, do you need to declare a digital wallet/your mobile phone that holds digital €, £, $ Yen etc?

Asset digitalisation, including CNDCs and stablecoins, will impact many aspects of the financial services sector. Bizarrely, we may well see compliance officers drive adoption as they appreciate the greater compliance and transparency which blockchain-powered tokenisation offers. This is not about crypto, but about a technology which has been tried and tested using BTC and Ethereum et al and which is now going to be used in conjunction with real assets, including cash.

In 2008, a developer (or group of developers) under the pseudonym Satoshi Nakamoto developed Bitcoin (although no one knows who Nakamoto really is) that would enable the transfer of value/unit of exchange employing a hash method used to timestamp blocks. To put this in more simplistic terms, it is useful to think of the hashes that link different blocks of data together as being a series of fingerprints so that, unless the correct fingerprint/hash is used, the different blocks of data cannot be linked/chained together.

Furthermore, blockchain is a record-keeping technology designed to make hacking information or forging the data stored on it extremely difficult, thereby making it secure and immutable. It is a decentralised, distributed and unchangeable ledger used to record transactions across many computers so that the record cannot be altered retroactively. It establishes trust, accountability and transparency. The use of blockchain-powered platforms results in removing intermediaries therefore helping to make transactions less expensive and more efficient. The technology has a broad range of applications that can be integrated into a variety of businesses giving investors an extensive range of options. The financial sector is one industry where Blockchain technology has obvious applications and many benefits. 

Use of Blockchain technology in the financial sector

Source: Research gate

Cross-border transactions

Transferring money internationally has always been slow and costly due to the fact that systems often go through many intermediaries and banks on their way to the payment's final destination. That could all change by using Blockchain technology to enable consumers to conduct digital transfers with mobile devices, whereby avoiding the necessity to use banks or many of the existing international payment transfer firms in order to send money to people and companies overseas.

Security

Blockchain technology uses advanced security compared to other platforms or record-keeping systems. Any transaction that is ever recorded needs to be agreed upon according to the consensus method. Since blockchain transactions are peer-to-peer and decentralised they are potentially more secure than traditional transactions. There is less time for hackers to access transaction data when the data is held in multiple locations, and this means disaster recovery plans become stronger and more resilient by using blockchain-powered platforms. 

Accountability

Blockchain technology offers the opportunity for an organisation to create decentralised networks where there is no need for a centralised authority, so improving the system’s transparency. Blockchains make transactions traceable as, in effect, the hashes leave a digital fingerprint so allowing banks to process and monitor transactions more effectively. A good example of this is the recent FBI success in seizing $3.6 billion of Bitcoin that had been stolen in 2016. The ability to track and trace digital transactions becomes easier compared to locating a suitcase of cash. As a result, Blockchain technology is an effective technique for tracking transactions and assuring accurate and secure data.

Improved efficiency

Cash, wire transfers and cashiers’ cheques are secure methods of payment, but cash is untraceable. Wire transfers are time-consuming and cashiers’ cheques can be faked. Blockchain-powered platforms help to address these challenges resulting in more trust and less risk, which is a key reason for increasing adoption of the technology for regulated organisations. Blockchains are paving the way for a wave of technologically-based modern finance that is already fundamentally changing the banking and financial industries.

Blockchain in the financial industry market

As more banks and financial institutions use Blockchain technology to transform significant parts of their businesses, the value of blockchain in this industry has steadily increased over the years. According to business information provider HIS Markit (Nasdaq: INFO), the value of blockchain in the financial sector reached $1.9 billion in 2017. A significant increase in the blockchain projects expected to be launched and become commercially deployed in the banking and finance industry in the coming years is very much anticipated. With such projection, the value of blockchain in the financial sector is expected to climb up to $462 billion by 2030.

Blockchain adoption being challenged in the financial sector 

Although blockchain is viewed as a revolutionary technology due to its ability to reduce transaction costs and increase the effectiveness of cross-border transactions, large banks are beginning to question its reliability and whether the technology is mature enough to warrant large-scale application. The Central Bank of Russia and the Central Bank of Netherlands have both raised their concerns. Despite the inevitable reluctance for change, especially for regulated companies, the financial services sector is beginning to understand the transformational potential of using Blockchain technology Equities, bonds, commodities and real estate are already dematerialised, but they are recorded on a plethora of internal databases often requiring constant reconciliation.  

The business value for blockchains in the financial sector

Source: HIS Markit