Blockchain is the key to reining in the financial system’s infrastructure costs

It’s time for financial institutions to start thinking about their IT costs in a different light. Legacy systems, built on decades-old technology, are outdated and tough to manage. Maintaining these systems is also costly, and these costs keep going up, yet financial institutions still find themselves locked into vendors using outdated technology. Unfortunately, there aren’t many people that know the complex computer programming languages that are needed to operate these systems effectively. The languages aren’t even being taught anymore, meaning that those who can understand them can charge a premium.

This has led business leaders in financial entities to believe that IT is extremely expensive. IT departments are seen as cost centers for complex private systems that drag on the bottom line, but this doesn’t have to be the case. Instead, financial institutions can modernize their existing IT infrastructures in a way that doesn’t increase costs.

Instead, IT can actually generate revenue. It seems counterintuitive, but the technology developed in the past decade has made this possible. It’s by no means an easy switch and would require the entire system to be turned on its head – the legacy systems would need to be removed, making way for new, modern infrastructure built on blockchain. After the initial cost of getting the new system running, long-term costs for maintenance would drastically decrease. At the same time, the new system would allow financial institutions to offset operational IT costs with revenue generated.

New revenue streams

With no end in sight to rising costs, banks are looking for new ways to keep costs down, while also seeking new sources of revenue – and there are limits to customer-driven revenue streams. Blockchain provides an obvious solution, though unconventional. First and foremost, using blockchain for transactions required for everyday operations means financial institutions can retire expensive, proprietary systems. While there is a transaction cost involved in using the chain, because it uses public infrastructure it’s much cheaper than legacy systems

Beyond the more obvious cost savings that comes with swapping out legacy IT, financial institutions also have the option to actually increase their revenue when using blockchain by becoming node operators. Operating public node infrastructure means financial institutions are able to participate in securing the chain that supports their business operations – and get paid to do so. While it does require an initial investment of resources, including purchasing equipment with substantial computing power and finding talent with the right technical knowledge, there’s also a payout for each transaction processed. 

The volume of transactions that would be generated on a blockchain at the scale needed to replace the current system would create revenue that outweighs the costs of operating the node, meaning financial institutions could actually make a profit. This would dramatically improve the existing cost structure that’s entrenched in financial leaders’ minds. And though it might seem far-fetched, the technology that can make it happen already exists.

Moving past perceived obstacles

When banking leaders hear the word “blockchain”, they might react with a mix of skepticism and fear of the unknown. Financial systems are traditionally built on private infrastructure, primarily for security reasons, so the notion that blockchain is on public infrastructure can mistakenly make it unattractive in many business leaders’ minds.

Though public, blockchain is extremely secure – arguably more secure than the current private systems. Blockchain is decentralized, meaning that the system does not rely on a single entity to operate. It’s comprised of nodes, which serve an essential role by helping to validate transactions and then batch groups of the validated transactions into a “chain of blocks” that becomes the blockchain. These node operators are the only ones who can actually add transactions to the blockchain, and a hacker would need to compromise every single node operator in order to change the record of the blockchain – making it virtually immutable. For added security, some blockchains even require permissioned operators who are known capital markets participants.

Looking towards the future

To move this revolution of financial services infrastructure from idea to reality, a few things need to happen first. One big one is that regulators need to lay the groundwork for blockchain to be able to operate. Without having similar regulations in place as the current banking system, it would be impossible and in some cases not legal for certain transactions to take place on the blockchain. 

One example is settlement, which doesn’t yet exist on a blockchain, but remains a process that can be improved. For instance, settling transactions between regulated participants throughout the day in regular intervals, is safer than an end-of-day process using centralized legacy systems that rely on lines of credit between the centralized entity and each regulated participant.

The high velocity of trading systems in the age of online retail investors means regulated participants can end up with large credit positions during the trading day. Thisthreatens the overall stability of the centralized system, as we saw during the US retail frenzy at the end of January this year. Regulated participants have no incentive to pay to transition from a centralized private network to a private peer-to-peer network. However, incentives do exist for entities and individuals operating a public peer-to-peer blockchain network that facilitates settlement for permissioned regulated participants to transact privately.

Regulators should also welcome such developments given the increased transparency they will have into the activities of the regulated participants. Using blockchain creates an automated monitoring environment, in which non-permitted activities and non-permissioned entities are automatically raised to regulatory agencies where enforcement can occur. 

Lastly, blockchain participants don’t take on centralized failure risk, and instead remain accountable to their own internal risk standards. The financial institutions that recognize this opportunity will reap the rewards in the form of lower operating expenses with better and cheaper services for customers, ultimately leading to increased market share.

Although the initial investment may seem steep, once the foundation for blockchain has been laid, the potential benefits are exponential. The inherent nature of blockchain’s infrastructure protects it from the same exorbitant costs incurred by the current ageing systems, and the potential for additional revenue streams is unmatched by any other technology on the market. Rather than a scary prospect, blockchain should really be a no-brainer for finance leaders around the globe. 

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