Experts: Banks should embrace blockchain to remain relevant

When people think of “blockchain” they often associate it with cryptocurrency. But in fact, crypto is just one facet of blockchain, which is designed to provide trustworthy and speedy financial and other transactions. As such, blockchain is increasingly important to banks, according to some knowledgeable professionals.

Blockchain is already affecting the banking industry, according to Sam Newbold, a member of CSG Law. “It has the potential to disrupt consumer, commercial and investment banking, and banks are still coming to grips with the scope of blockchain,” he noted.

To their credit, banks are not burying their heads in the sand, he added. “Instead, financial institutions are investing in R&D around blockchain,” Newbold noted. “One of our clients is a leading blockchain and cryptocurrency services provider, and the company is experiencing heavy demand for its expertise.”

While blockchain, which underpins cryptocurrency, has been around since the 1980s “it did not catch on until recently,” he added. “But within the next few years, it’ll have a profound effect on banking and on institutions like the FDIC and other state actors, because blockchain’s transparency will promote decentralized yet relatively secure financial activity. Consider the controversy of the banking crisis of 2008, when some institutions were classified as ‘too big to fail.’ But once blockchain and decentralized cryptocurrency become widely affected, no one will be ‘too big to fail.’ It’ll be like telephone booths in New York City—the streets used to be packed with them, until mobile phones made them obsolete, and instead the streets are packed with bank ATMs. But Web 3 and blockchain-enabled cryptocurrency will render ATMs obsolete once everyone stores their currency in a digital wallet.”

Jason Juliano is a director with EisnerAmper Digital and serves as technology leader of the firm’s digital assets committee. He’s had hands-on experience building B2B AI-enabled blockchain networks for banks and other organizations, and noted that, “Blockchain networks enable customers to execute transactions faster and cheaper across banking platforms. But the changes it’s driving, and will continue to drive, are not just operational. Historically, for example, when banks looked for new hires, they focused on candidates who had a background in banking and financial services—but now banks are increasingly looking for digital asset and blockchain talent.”

Juliano warned, though, that governance and compliance standards have not caught up with technological advances. “Federal and other agencies are encouraging banks to adopt blockchain and crypto initiatives, but regulators also want tighter controls and strong governance. Regulations are still evolving, although I’d say that right now, the New York State Department of Financial Services is probably ahead of most agencies.”

Juliano and his team worked with a national bank to set up controls and process improvement around blockchain networks. “Previously, we constructed a blockchain for a community bank, and helped the institution to review partner-vendor practices and rules of engagement,” he said. “There are still a lot of regulatory and other changes coming down the road – including, likely, federal Know Your Customer and Anti-Money Laundering guidance – but overall, blockchain can provide a lot of benefits, including speed and trust, to financial institutions and their customers.”

Blockchain technology offers many benefits to “the banking ecosystem,” observed Spencer Savings Bank Senior Vice President and Treasurer Dushyant Abhyankar. He noted that banks traditionally store valued assets, provide the infrastructure to facilitate payments and remittances, and provide capital and credit services to clients—and “Blockchain technology has the potential to offer a faster way of providing these services, along with a few other benefits. It verifies and transfers store of value in a banking ecosystem, has the potential to cut costs, provide faster processing of financial flows as well as regulatory/compliance transparency.”

Building a Moat

Still, “Government and regulators have the challenging task of balancing blockchain innovation with consumer and market protection,” cautioned Abhyankar. “Over the past two years we are seeing government and regulatory bodies starting to really take a closer look at the flourishing crypto market and technology behind its exponential growth across the world. Due to the secure and anonymous feature of blockchain technology, governments and regulators want to ensure that bad actors around the world do not take advantage of its use case to execute any illicit activities.”

The banking industry is still at an early stage of adopting blockchain, he added. “There are regulatory roadblocks. Regulation is required to ensure participants have certainty around the status of crypto assets, rules of engagement and investor protection. For this reason and at this time, Spencer Savings Bank has joined many other financial institutions in choosing to cautiously wait and not adopt the use case of blockchain technology. But looking ahead, as mainstream demand for this technology increases, and some of the roadblocks can be overcome, all banks will have no choice but to slowly adopt to this modern technology—using it to enhance their current products and services, compete with other financial institutions and be on par with the rest of the banking industry.”

In the long run, blockchain and other financial innovations will have a large, positive impact on banking, according to Steve Yang, an associate professor in the School of Business at Stevens Institute of Technology. “Cryptocurrency represents the earliest use of blockchain technology, but now an increasing number of startups are looking for new ways to process payments, and many banks are working on blockchain behind the scenes,” he said.

In 2021, to address the need for research in blockchain and related areas, Stevens Institute of Technology and Rensselaer Polytechnic Institute – with co-sponsorship from National Science Foundation – established the Center for Research toward Advancing Financial Technologies (CRAFT). In addition to his other responsibilities, Yang is director of CRAFT.

“Blockchain is one of the key technologies being researched at CRAFT,” he explained. “It is a promising technology because it offers privacy, efficiency and transparency in a decentralized environment. Beyond payment capabilities, blockchain also enables developments like NFTs [non-fungible tokens, which represent fractional ownership of artwork, digital content and other assets], which open up new, non-traditional investment opportunities.”

In addition to its decentralized finance research, CRAFT is examining innovations like AI-enabled finance and quantum finance, which Yang said will “help to secure our financial data, create and test more equitable trading platforms, inform financial regulations, and support improved market simulation and stress-testing tools that ensure financial system stability for all.”

Despite making inroads in U.S. banking, and in applications like Apple Pay and Google Pay, “Asia, Europe and Africa are leading in adoption of Blockchain,” noted Yang. “But I think the U.S. will catch up. The Boston Fed, for example, is working with MIT to develop research about central bank digital currencies (CBDCs).”

In February, Boston Fed Executive Vice President Jim Cunha announced that “This collaboration between MIT and our technologists has created a scalable CBDC research model that allows us to learn more about these technologies and the choices that should be considered when designing a CBDC.”

Still, solving trust issues will be important to securing widespread adoption of blockchain-related technology, Yang noted. “The blockchain platform is anonymous and involves multiple parties, so developing checks and balances, and ensuring trust is central to the continued acceptance and growth of blockchain. That means regulatory agencies will have to get involved, but they need to be careful and take a balanced position, refraining from overregulating the technology, since that could suffocate development. Instead, regulators need to give the tech space room to grow.

Much like cloud computing, blockchain offers speed, efficiency, and the ability to transact across different systems. “But it’s not infallible,” according to CSG’s Newbold. “Coding errors in constructing blockchain infrastructure can create cyber security weaknesses; and users who misplace their private key or email it someone – which could make the information vulnerable to hacking and other threats – can result in vulnerabilities.”

Regulation may help, “but it should be geared to the way blockchain and cryptocurrency are used; instead of regulating the infrastructure itself,” he says. “It’s like a greenfield, or undeveloped property. Greenfields themselves are generally not regulated—instead, regulations focus on what gets built on them.”