Nowadays, blockchain and cryptocurrencies slowly creep into daily our lives. Most industries are experimenting with blockchain technology in some way or another. But many people still can’t tell the difference between blockchain and cryptocurrency. Blockchain is a technology, and cryptocurrency is an example of how you can use blockchain technology. Unfortunately, blockchain technology is synonymous with cryptocurrency, so the highs and lows of the cryptocurrency market continue to dictate the level of attention blockchain technology receives. Blockchain technology is yet to rise to its true potential.
There are some problems with current processes within the financial sector that blockchain technology can potentially resolve. The primary one is lots of paperwork. Even though many banks are partly digitized, lots of processes are still done on paper. The second is long-term trade and payment settlement. Typical international trade finance and sanctions can take as long as 90 days to finish because of the cumbersome paper-heavy process. Sending money to a different country is not as easy and quick as it sounds, even though the majority of people think that it is. It takes 2-3 days, sometimes 5 days, before one receives this money from another country. The third problem is money laundering. It's very important to say that it is a crucial process in all financial industries. Making money isn't always easy and can lead to black money as a result. Due to that, it is vital for all businesses to be careful about money and to prevent money laundering. It’s a regulatory requirement too. Single databases are very interesting in international payment industries.
Within the financial sector, one particular example of the successful implementation of blockchain technology is digital biometric identification. This technology enables banks and other financial institutions to identify individuals using a secured blockchain-enabled identification system.
In the blockchain, data is frequently encrypted, and banks can increase public trust while protecting against fraud and speeding up the verification process. Cross-border payment can be expensive since it typically involves multiple banks in different jurisdictions before the payment reaches its destination. Blockchain can make the process faster, safer, and less expensive. Smart contracts and, therefore, trade finance platforms are a very interesting case since many banks are using blockchain in their financial platforms to create more contact between participants and increase efficiency and, therefore, transparency, which opens up new avenues of opportunity. A smart contract may be a computer program or construction protocol that is intended to execute, control, or document regularly relevant events and actions according to the contractor or agreement.
Once a block is built into the blockchain, the data is irreversible. In some companies or financial institutions, a common shared blockchain network is used, or some parts of the method. Multiple banks and financial institutions are often part of a single blockchain or network, which has combined KYC data from all parties. The blockchain protocol allows everyone to trust the data because it was confirmed in previous blocks by other institutions, which can significantly accelerate many processes in banks. They will do it faster and easier because they can use some information from these databases and check all the institutions' guarantees.
The Evolution of P2P Payments
Everything started with Bitcoin in 2008. Bitcoin was the first cryptocurrency and is now the biggest one. Bitcoin was created with an idea of "A PEER-TO-PEER Electronic Cash System" but now the narrative of digital gold is prevailing. Bitcoin proved that payments can be done globally, with low cost, in real-time, with greater traceability and transparency, and without intermediaries, hence the P2P. Bitcoin brought us something that we have never had before. The problem with bitcoin was its price volatility. When somebody sends money in Bitcoin to a friend, the price might have changed in between and the recipient might get less than what was intended.
For those reasons, Stablecoins appeared, and they took all the good things that we saw in Bitcoin and removed the price volatility. So, Stablecoins are a class of cryptocurrency backed by a reserve asset (most likely a fiat currency like the US dollar).
One of the projects was the Libra currency and the underlying financial structure, created by Meta Platforms (formerly known as Facebook Inc.) and backed by a basket of different currencies. Now, there are many more Stablecoins but most of them are pegged to USD. The emergence of Libra was a wake-up call to central banks. Stablecoins could endanger their monetary sovereignty. So they came up with their own digital currency. Central Bank Digital Currencies (CBDCs) are digital forms of a country’s fiat currency issued by a central bank. There are two different types, which are wholesale and retail CBDCs. Not all of them use or will use blockchain technology. Retail CBDC is open to retail clients. They relate to the evolution of payment based on blockchain, but it might also happen that they will not be based on blockchain.
Vid Hribar from Raiffeisen Bank International comments that there is a case not just the maturity of Blockchain. The time frame will be 5–10 years or even sooner, and when it comes to Central Bank Digital Currency (CBDC), this is a hot topic for central banks, and more than 80% of Central Banks worldwide are working on CBDC, not just discussing but also experimenting. There are also many open topics like privacy, that is how anonymous this will be, and whether this will be for retail clients or wholesale CBDC.
There are still many questions about the design of CBDC, but there are already some countries that have rolled out CBDC, for example, China. Many countries will be working on this, and this will play a big role in how this payment system will look like.
Using Cryptocurrency as a Payment Method
Mastercard conducted research last year, asking over 15,000 customers worldwide what they would use cryptocurrency for, and the results revealed that 40% plan to pay with cryptocurrency in the next year (67% of millennials). The younger generation had a higher percentage. There are still some barriers to widespread cryptocurrency payment acceptance. To begin with, its high volatility and disincentive to spending cryptocurrency mean that many users or retail clients see cryptocurrency rather as an investment instrument, and expect the price to appreciate in the long run than using cryptocurrency as a means of payment.
Nonetheless, Mastercard allows merchants to accept cryptocurrency payments. However, other entities and countries are beginning to accept crypto payments in addition to Mastercard. El Salvador, for example, made Bitcoin a legal tender in 2021. Customers in that country had the option and the right to pay with Bitcoin.
Despite their popularity, Stablecoins are still primarily used for cryptocurrency-related applications. Stablecoins have a current market capitalization of around $180 billion (a 250% increase year on year). The most important Stablecoins are USD-pegged (there are no comparable EUR stablecoins in Europe for now). Primarily, Stablecoins are used in Decentralized Finance (DeFi) - trading, staking, and collateral. Meaning that it is still a very specific usage. The majority of the major stablecoins (USDT, USDC, BUSD) are issued by private companies with their own fiat reserves (allegedly 1:1).
Banks are exploring existing Stablecoins but are also experimenting with issuing new Stablecoins. They started experimenting years ago, but there are not many live projects. They are not just focused on USDT and USDC, but they also want to issue new Stablecoins in a more regulated environment. Different use cases are being explored: wholesale payments and settlement, remittances, micropayments, and programmable money. Some banks decide to issue their own Stablecoin (JPM coin), whereas others decide to join a consortium (e.g., Fnality). Stablecoins here are used for cross-border payment, and we are still in the experimental phase.
Blockchain Adoption in the CEE
Luka Milinković, from NLB Bank Belgrade, elaborates on Blockchain in the financial sector. Referring to the Hype Cycle for Blockchain Technologies 2020 from Gartner, he states that the population has a lot of information about blockchain as well as cryptocurrencies. People think about blockchain and cryptocurrency as ways to earn money, whereas companies think about how they can improve their processes. Nowadays, the banking sector views Blockchain as a real-time payment solution but not as a means to change the existing payment system as a whole. Blockchain can be used as an alternative payment method, or maybe for other solutions like storing data, protecting data, or creating transparency of data for some currency situations and regulations.
Companies, managing directors, CEOs, and other top management are wary of using Blockchain to create new value, but they are also wary of other new technologies such as Artificial Intelligence, Machine Learning, and others. Furthermore, they can consider how to use blockchain in specific areas of their business, such as loyalty programs. The banking industry needs to find a better way and needs to think about how to use new technologies to be ready for better use of Blockchain in 2–5 years.
In 2015, the Hype Cycle was Cryptocurrencies, in 2016-2017, Blockchain was going through the Hype Cycle, and asset tokenization will be getting through the complete cycle in the next 2–5 years. Asset tokenization, which is making assets easily exchangeable by creating a token form where people can exchange them in a frictionless way, will be the use case that will be gaining a lot of adoption in the coming years, which we saw in the last year with the rising popularity of NFTs.
Vid Hribar predicts that the topic that will come up in the next couple of years is asset tokenization, and here banks play an important role as they need to have custody of the assets, that is, store the assets somewhere. Bankers are storing the money now and the assets in the future. An outlook on the future where Blockchain can go, and there are also some new opportunities and some new business models like micropayments, machine-to-machine payments, and open new business cases.
Luka explains that another use case is the supply chain, which can be used in every type of company. When we talk about transportation or any other industry that requires guarantees from the banks and lots of paperwork, one needs to think about moving some processes to Blockchain as it creates new value, and in this way, this information is shared with other stakeholders or clients. Blockchain in this case can simplify a lot of processes.
For example, if a client changes his phone number and address, one just needs to look at the Blockchain and take the latest update of this information and use this information if needed. After that, the information is deleted from the banking system.
Regulations are very important for the date-to-date application of Blockchain technology. The payment system is a crucial part of every company, like banks and all other industries, therefore, having regulation in the blockchain is very important. Many companies don’t know what to expect and need to be very careful.
Resources:
Exploring new Revenue Opportunities through Blockchain Innovation, a presentation by Luka Milinković, Advisor in IT Audit Consulting at NLB DigIT at the Payments CEE Summit on 17-18 June 2021
P2P Payments: Will We Pay with Cryptocurrencies, Stable Coins or CBDCs in the future?, a presentation by Vid Hribar, Blockchain Hub at Raiffeisen Bank International AG at the Payments CEE Summit on 17-18 June 2021
Successfully Blending Real-Time Payment Systems Into Payments Landscape, a presentation by Chrisitan Cengher, Product Owner Cross-Border Payments at Erste Group at the Payments CEE Summit on 17-18 June 2021