McKinsey released a good piece on practical applications of blockchain in retail banking. Most all of them apply more to emerging markets than the rest of the world, so it’s a good idea to post here.
The three applications are 1) remittances, KYC, and credit scoring.
Remittances:
Cross-border payments total around $600 billion annually, and the market is set to maintain its recent growth of around 3 percent a year, driven by international trade. However, payments processing tends to be clunky, opaque, and highly mediated. As a result, costs are high. Fees are commonly 2 to 3 percent of transaction value and can be as much as 10 percent.
The emergence of numerous fintechs in payments (around one in four is focused on the segment) is increasing competition and leading to more efficiency in some parts of the value chain… Blockchain may be able to generate value by fixing certain inefficiencies. If counterparties were to exchange cryptocurrency assets (digital currencies that do not need a central regulating body) rather than fiat currencies, for example, payments could be made and settled in minutes via blockchain, rather than in days as with current systems. The distributed nature of blockchains would mean greater transparency and immutability (data recorded to blockchains cannot be altered). McKinsey estimates that blockchains applied to cross-border payments could save about $4 billion a year.
Despite the growth of blockchain-based payments solutions, there remain significant barriers to adoption at scale. One issue is that blockchain networks are transparent to their members, meaning that there are limitations to anonymity in some scenarios. In response, several companies are experimenting with “tokenization,” which disguises sensitive data by substituting it with a token that serves as a reference. However, this approach is still in the early stages of development. Another challenge is that real-time settlement is currently impossible due to lack of fungibility between crypto assets and fiat currencies. There is inevitable friction in converting back and forth, particularly given recent volatility (the value of bitcoin fell by 75 percent from December 2017 to November 2018). So-called “stablecoins” the value of which are pegged to real-world assets, are one solution, but they still require correspondent banks to make the eventual conversion.
KYC
Blockchain may be a potential solution. For onboarding or account opening, blockchain-based technology enables customers to use a digital fingerprint, which, like an actual fingerprint, can be used as a unique identifier. It can be stored on a distributed ledger and referenced by any bank in the network. The owner of the digital fingerprint can use it to submit new account applications and prove her or his identity universally. The decentralized blockchain structure eliminates overlapping KYC and AML compliance checks (banks share authenticating information), lightens the information burden, and allows banks to disseminate data as it is updated.
We estimate blockchain-based solutions for customer onboarding can create up to $1 billion of savings in operating costs for retail banks globally and reduce regulatory fines by $2 billion to $3 billion (exhibit). In addition, we expect blockchain solutions to reduce annual losses from fraud by $7 billion to $9 billion. Through individual management of private keys (a kind of digital signature used to approve transactions), blockchain technology also enables customers to control and share their personal data without the help of an intermediary. Several operating systems and browsers provide key stores to protect private keys, and private vendors offer wallets and similar alternatives that are resistant to cyberattacks.
Credit Scoring
Financial institutions are often required to make risk-management decisions based on limited data, obtainable from a few brokerages and agencies. In some cases, the data do not even exist. The unbanked (estimated to be 40 percent of the world’s population), the underbanked, and microenterprises may not have made enough noncash financial transactions for assessing their creditworthiness. As a result, banks tend to be conservative when making credit decisions.
Blockchain technology offers the potential for pooling large volumes of data that can be anonymized and protected by the ledger’s encryption protocols. Data carried on a distributed ledger could be accessed without explicit permission at the time (customer consent can be granted via preprogrammed smart contracts). Banks could theoretically view data that have been uploaded by any bank in the network. The result should be faster decisions, more efficient processes, and the potential for a more informed credit-allocation process.
However, there are technical and cultural challenges. For example, there is need for significant processing power to run scoring models using data that are distributed across thousands or millions of sources. In addition, customers may choose to restrict access to protect their own privacy and security. Financial institutions are likely to need to work hard to bring them on board.
Fintech companies have started to operate in this area, but most are relatively small initiatives; Spring Labs, for instance, launched a decentralized network for credit assessment, raising about $15 million in an initial coin offering in March 2018.
My Views
My views on this echo McKinsey’s views. Remittance fees have long been a problem in emerging markets, and will eventually fall, but not before the banks go down kicking and screaming. KYC is much better in the Asian emerging markets, but is a big barrier to doing business in Africa. If fintechs want to bring bank capital into their platforms or products the banks are going to require KYC. Blockchain would be a welcome addition there. Finally, emerging markets probably have made the most headway in alternative credit scoring methods and models. These models use huge amounts of data from telecommunication data or social media data to build algorithms that are bringing unbanked people into the financial sector like never before. I’m excited about what blockchain can bring to the space, but right now it’s more about improving the models. I’m not entirely convinced blockchain adds a lot of value in the scoring space yet.
All together though, it’s a step forward that McKinsey are thinking about blockchain applications in banking. There’s lots going on in the space, and more attention is always welcome.