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Blockchain And Finance - Everything You Need To Know

Bitcoin was developed by Satoshi Nakamoto an unknown developer in the year 2018. It came to be known as the world’s first digital and peer-to-peer cryptocurrency. The best and the most amazing thing about bitcoin is the blockchain technology that powers through it.

As an ever-increasing number of businesses and industries are finding the sheer utility and advantages of building blockchain technology within their framework. One of those industries is the Finance industry. Blockchain technology can potentially change the finance industry.

What’s the proof? Let’s take a look at the numbers.

blockchain and finance funds raised

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Source: InWara’s Market Intelligence Platform

This is a breakdown of Funds Raised by tech startups (only considering tech startups that leverage that leverage Blockchain technology) according to the industry sector they belong to. Unsurprisingly, core Blockchain technology startups (tech startups that are building core blockchain infrastructure) attracted the most funds, having raised a whopping $7.5 billion so far.

Now comes the interesting part, following Blockchain the next three industry sectors - Trading and Investing, Financial Services and Fintech, all come under the umbrella term Financial Ecosystem. And have collectively raised funds to the tune of $14 billlion, easily making Financial Ecosystem one of the most competitive industries there is.

So why are startups lining up to offer services to the Financial system? It’s because Blockchain technology, if implemented correctly, has the potential to revolutionize the Financial ecosystem, the same way the internet revolutionized how we access information.

Blockchain Technology 101

A blockchain is, in the least difficult of terms, a time-stamped series of an immutable record of data that is overseen and managed by a bunch of computers which not owned by any single entity. Each and every block that consists of data is secured and is bound to each other using a principle called cryptography.

The reason behind why blockchain has gained so much administration is that:
· It is decentralized is not owned by a single entity
· The data stored inside the block is in the form of cryptography
· No one can tamper or hack the data inside the blockchain as it is unchangeable
· The data can be tracked by an individual if needed as blockchain technology is completely transparent.

Pillars of Blockchain Technology

There are three main pillars and properties of blockchain technology which has helped blockchain gain widespread and get so far and they are as follows:

· Decentralization
· Transparency
· Immutability

Pillar 1: Decentralization

We were more used to centralized services before Bitcoin and BitTorrent came into the picture. In a centralized platform, there is one single entity which stores all the data and to get any information you need you will have to interact solely with this entity. Some of the examples of centralized system are:

· Centralized banks: It is the same with the centralized banks they store all the money and the only way you can get the money and pay someone else by going through the bank.
· Client-Server Model: In the traditional client-server model, when u search for something on google you send a query to the server, the server then gets back with relevant information.

The centralized system has been very useful to us for a very long time, even then they have a few vulnerabilities.
· Right off the bat, since they are centralized, every one of the information is put away in one spot. This makes them obvious target spots for potential hackers.
· In the event that the centralized framework was to experience a software update, it would stop the whole framework.
· Imagine a scenario in which the centralized system in one way or another shut down for unknown reasons. That way no one will likely be able to access the data in it.
· Worst case scenario, consider the possibility that this entity gets ruined and malicious. On the off chance that that occurs, at that point, every one of the information that is inside the blockchain will be compromised.

So once for all what if we just remove this centralized entity?

In a decentralized system, everyone in the network owns the data and is not stored by one single entity. In this decentralized network if u want to interact with one party then you go interact with that person directly without the interference of a third party. That was the fundamental philosophy behind Bitcoins. You and just only you are responsible for your money. You can send your money to anybody you need without going through a bank.

Pillar 2: Transparency

Transparency is the most interesting as well as misunderstood concept in the blockchain technology. It is said that blockchain gives you privacy and it also says that it gives you transparency what is the right answer?

Well, an individual’s identity is hidden by means of complex cryptography and is only represented only by their public address. If you somehow happened to look into an individual's transaction history, you won’t see “Adam sent 1 BTC” rather you will see “1MF1bhsFLkBzzz9vpFYEmvwT2TbyCt7NZJ sent 1 BTC”. So, in simple words, we can say that the person’s identity is hidden and you can still see all the transactions that take place done by their public address. The transparency of this level has never existed before in a financial system. It includes that extra, and genuinely necessary, level of accountability which is required by these biggest institutions.

In the cryptocurrency point of view, knowing the public address of any big companies will allow you to search the address and explore into and look at all the transactions that they have done. This makes the companies be honest with their transactions, and this is something that they have never foregone before. Even then, we are pretty sure that most of the companies won’t do their transactions using cryptocurrencies. Even if they do then they won’t do all their transactions using cryptocurrencies. This shows how blockchain can be useful and can change the finance industry.

Pillar 3: Immutability

Immutability is nothing but unchangeable, in blockchain context, it means that once something has been entered into blockchain it cannot be tampered or messed with. This will be the most valuable thing for the financial institutes and it can completely cut out the embezzlement cases when people know that they can’t work around the books and make changes in the company accounts. This blockchain property is that of a cryptographic hash function.

In basic terms, hashing means taking an information string of any length and giving out an output of a fixed length. With regards to cryptocurrencies like bitcoin, the exchanges are taken as input and go through a hashing algorithm (bitcoin utilizes SHA-256) which gives an output of a fixed length.

Let’s look into how the hashing process works. Here we are going to use the Secure Hashing Algorithm 256 (SHA-256).

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We can see that in SHA-256 no matter how short or long your input is, the output always has a fixed 256-bits length. So, this becomes critical when you work with a huge amount of data. In order, to make it efficient it is better to just remember the hash instead of the huge input data. A cryptographic hash function has various properties which makes ideal for cryptography. There are several properties required to consider cryptographic hash function secure and one such property is called “Avalanche Effect.”

Avalanche Effect

This property means that even if there is a small change in input there is a huge change that occurs on the hash.

Let’s look at an example where. We make a small change.

INPUT - InWara is the most trusted blockchain market intelligence platform
OUTPUT (Hash) - EBCA753293DF1ABE49ED631979E35E9E8224725FC2D4193B8911A18EEB7066BF

INPUT - InWara is the most trusted blockchain market intelligence platform.
OUTPUT (Hash) - 9A410B2F7604EAC80B990E7AF116F53ADE8FAE7A8D9D8FCF018F9E58AF9DF7E8

Can u see the change? Just a full stop is added at the end of the sentence in the input, and look at how much of a change has occurred in the hash.

Blockchain and Banking

Banking is one of the major sectors that can be improved by blockchain technology. What are the areas that blockchain can improve in the finance industry? There are various areas that blockchain 3 such areas are identified as follows:
· Faster cross-border payments
· Cheaper KYC
· Trade Finances

Faster Cross-Border Payments

In today’s world, the major issue faced by the banking sector is the problem in cross-border payments. An internet bank-to-bank money transfer takes an average of up to 2-5 days. Looking at the number of people employed in remote areas this has become a major problem in today’s world. You would know how long SWIFT transfer can in bank-to-bank transfer if u have ever worked as a freelancer or even bad if u get paid through PayPal. If the payment is made on Friday by your company then you will have to wait till Tuesday to receive the payments as these financial institutions are closed on weekends.

The reason behind this long settlement days is that there are a lot of middlemen involved when the transaction takes place and it is dealt in batches. The settlements will become user-optimized and will save much more time and money for both the parties with blockchain technology being involved. If the blockchain technology comes into the picture there is complete removal of middle-men as the transactions will be settled instantly.

For example, Ripple is one of the most famous companies tackling this problem. The company has its own cryptocurrency dubbed XRP and it is a core part of the cross-border payments solution Ripple is offering. Interestingly, XRP is the third most valuable cryptocurrency by market capitalization at a whopping $13 billion, only behind Bitcoin and Ethereum.

blockchain and finance

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Source: InWara’s Market Intelligence Platform

An analysis of the Ripple’s trading volume and spot price from 2018 reveals that the XRP has observed a significant jump in both metrics during May 2019. So why the sudden jump? It could be a variety of reasons like maybe it's because Bitcoin’s unpredictable price fluctuations which affects other altcoins due to correlation effect or it maybe because of bullish news surrounding Ripple like signing a partnership with a major bank.

Ripple has raised $93 million so far, in various funding rounds but interestingly, the company has not launched a token offering so far and has always raised funding through traditional Venture Capital. According to InWara’s Market Intelligence Platform.

Truth be told, that is not mere speculation, there is now a working PoC of how blockchain innovation can exponentially lessen transaction times in these areas. SAP recently worked together with ATB Financial and fin-tech startup Ripple to send the first international blockchain payment from Alberta, Canada to ReiseBank in Germany. The bank utilized the SAP HANA Cloud Platform and the SAP Payment Engine application to exploit Ripple's pioneering blockchain network.

The $1000 CAD (€667 EUR) blockchain payment, which would regularly have taken from two to six business days to process was finished in around 20 seconds. The proof of idea has since been upgraded, and we can finish the exchanges in only 10 seconds. From 2-6 business days to 10 seconds. that is a major change to this industry.

Cheaper KYC

Know Your Customer (KYC) regulations are the area where banks lose a major chunk of money. Some shocking statistics are as follows:
· A normal bank goes through £40m every year on KYC Compliance. A few banks may spend up to £300m.
· JP Morgan has purportedly spent up to a stunning £1.6 billion on its compliance department and employed more than 13,000 individuals to monitor regulatory changes.
· 70% of the 722 corporate correspondents, who took part in the study by Reuters, said that customer on-boarding can take up to 2 months while 10% guaranteed it can even surpass four months.

The two chief guilty parties are:
· Consistently changing regulation policies.
· Draconian strategies which are still followed by specific banks. A few banks still do their consistence procedure utilizing papers.

There are two ways that blockchain technology can work on to change this space.
· Firstly, we can look at the concept of self-sovereign identity. Self-sovereignty is a concept that says that it is the individual’s right to have ownership of their own body and life. As each and every company today has an online presence the Self-Sovereign Identity is very critical. With the increase in the number of siloed identities, it is drastically increasing the chances of online fraud or identity mismanagement. When u upload your identity on the blockchain it means that you have full and complete control over yourself. How is this going to help with blockchain? Let’s take an example, if you walk into a bank and open an account there, you can give access to your identity directly to the bank, instead of a centralized third party.
· Secondly, the banks can have their own private blockchain network. For example, Edward wants to open a bank account in let’s say in Bank A and has already completed his KYC regulations, then Bank A can simply upload these details on blockchain. As it is privately owned blockchain anyone who is a part of this blockchain network can upload and share information with everyone else.
Now if Edward wants to open an account in Bank B instead of going through the whole procedure again, Bank B can simply access data from blockchain get the required KYC information.

The blockchain’s KYC protocol will play a major role in intra-bank and inter-bank functions:
· Intra-bank: The KYC information collected from a bank can be uploaded on the blockchain and the data can be accessed by the banks of the same branch which leads to a smooth and faster transaction.
· Inter-Banks: The KYC data collected by a bank and uploaded to the blockchain can easily be used and accessed by another bank.

A report that is co-authored by Santander, estimated that using of blockchain technology can reduce costs of infrastructure of banks up to $20 billion a year.

Trade Finance

Trade Finance is an ideal sector where blockchain can disrupt drastically. There are various parties who are involved in trade finance who are slowing down the process. They don’t really trust each other, so in order to move ahead, they involve third parties like banks and clearing house which makes the process really slow.

Smart contracts are the way here through which blockchain can help. Smart contracts are nothing but automated contracts which are self-executing with particular instructions written on its code. Which then gets executed when a certain condition is made. Smart contracts are the means by which things get done in the Ethereum system. When somebody needs to complete a specific task in Ethereum they start a smart contract with one or more individuals.

Shrewd contracts are a series of directions, composed utilizing the programming language "solidity", which deals with the basis of the IFTTT logic otherwise known as the IF-THIS-THEN-THAT logic. Fundamentally, on the off chance that the first set of instructions is done, at that point execute the following function and after that the following and continue repeating until you achieve the end of the contract.

The most ideal approach to understand that is by imagining a candy machine. Every single step that you take acts like a trigger for the following stage to execute itself. It is kind of similar to the domino impact. Thus, let’s look at the steps that you will take while interacting with the candy machine:

· Step 1: You give the candy machine some cash.
· Step 2: You punch in the button relating to the candy that you need.
· Step 3: The candy turns out and you collect it.

Now take a look at every one of those steps and consider it. Will any of the means work if the past one wasn't executed? Each and every one of those steps identified is directly related to the previous step. There is one more factor to consider, and it is an essential part of smart contracts. In your whole interaction with the candy machine, you (the requestor) were exclusively working with the machine (the supplier). There were definitely no third parties involved.

Smart contracts on a blockchain, which execute automatically, will move the title to products and money, evacuate the requirement for banks to give reports, for example, letters of credit. What this does is it totally removes all the middlemen and their charges. It likewise helps in making a system that doesn't require any trust in any particular party.

A worldwide trade finance platform named Batavia was propelled by IBM alongside a consortium of five banks, UBS, Bank of Montreal (BMO), Caixa Bank, Commerzbank, and Erste Group. The consortium means to help the formation of multi-party, cross-border trading networks by building up Batavia as an open system that can be accessed by companies big and small around the world.

Obstacles Ahead

In order to gain adoption by financial institutions blockchain technology must overcome a lot of obstacles. Firstly, the current blockchain system is not ready to take up millions of transactions per second as per the demand, which means there is a scalability issue. Secondly, the whole blockchain technology completely depends on public-key cryptography through which one can unlock the assets sent to them. It is observed that there is a potential for that key to be lost or misplaced which allows the owners to change the ownership of the assets recorded on the blockchain network.

It seems that blockchain and finance are like two peas in a pod. There are some obstacles that blockchain needs to overcome before they widely get adopted by financial institutes. But, when it’s all done blockchain technology will disrupt the industry in a positive way.

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