More than a decade ago, anonymous writers using the name Satoshi Nakamoto published a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” The whitepaper explained a system through which electronic transactions could be carried out without relying on one-on-one contact.
Also known as blockchain technology, this system formed a foundation for cryptocurrency transactions.
Blockchain technology has the potential to dramatically impact the society almost as much as the internet has.
Will Moneylenders Start to Use Blockchain in the Future?
Simply put, blockchain refers to a series of data record or ledger which is managed by a network of computers which are not owned by an entity. Each of these ledgers or data blocks is secured and bound to other data blocks through cryptographic principles, that is, chains.
The blockchain technology is decentralized. This means it is not centrally controlled by a corporation, bank, or government. Since the ledger is shared, the information is open for all those in the network to see. This makes blockchain technology very transparent as everyone can see and certify all that has happened throughout the chain.
How Blockchain Technology Works
Bitcoin is the most known and widely discussed blockchain technology. Therefore, we will use it to give you an idea of how blockchain technology works.
Just like monetary exchange mediums such as dollars, pounds, euros, and so on, a bitcoin is a means of exchange. The only difference is that the latter is a digital currency. The digital currency has no value unless in itself unless we use it to buy goods and services. Unlike conventional currencies whose source is the central bank, bitcoin is decentralized. Rather, a network of people called miners or nodes run the network. These nodes or miners compete to solve intricate problems to complete a transaction.
For example, figure a scenario where several people are carrying out bitcoin transactions. Every person initiates the transaction through a “private key.” A private key is a digital signature that acts as proof that the transaction came from a specific wallet owner. All these transactions form a block with strict cryptographic rules. The private wallets of those transacting are either credited or debited according to the transaction instructions. Each node on the network receives a message and automatically updates the account balances on the ledgers.
According to Marc Lowell Andreessen, an American software engineer, “Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.”
Advantages of Blockchain Technology
Some of the advantages attributed to the use of blockchain technology include:
Blockchain technology has a reliable member identification process. This can significantly reduce time wasted manually verifying information submitted by loan applicants. For instance, you can create a digital account that has your information which is stored in a central repository. This includes data such as your credit score, income, mortgage history, outstanding debts, and so on. When applying for a loan from different lenders, all of them can access this data.
2.Improved Efficiency When Servicing Loans
Financial institutions often face challenges when it comes to loan transfer processes and collection. Through blockchain technology, it is possible to make such processes streamlined and more efficient.
We think block-chain technology is the way of the future. Voting, property registry, micro-lending… endless possibilities. https://t.co/g7aOGqOsdz
— JustPeace Labs (@justpeacelabs) September 22, 2017
Transactions carried out through blockchain technology cannot be canceled, erased, or reversed. Each transaction is not only attributed to a specific person or corporate but is also time-stamped. It is also validated by every copy distributed throughout the blockchain network.
The processes and rules used in blockchain technology are handled by algorithms. The companies no longer need to reconcile their records as the data provided is authentic. Security is no longer a cause of concern as changes and facts are transparent. Lenders can also track the process right from when they submit their loan application up to the actual fulfillment.
Risks of Blockchain Technology in Lending
Blockchain technology allows for relative anonymity when carrying out transactions. For instance, a buyer only needs to know a seller’s address to initiate a cryptocurrency transaction. But can a lender guarantee that a borrower will pay?
Even though digital currencies and blockchain technology have proved their usefulness, new uses, and the implementation of public policies make them volatile. This makes the use of cryptocurrency as collateral expensive. Should you borrow before there is a drop in the value of cryptocurrency, you benefit from cheaper repayment terms. However, if your repayment coincides with the rise of a cryptocurrency’s value, repayment becomes quite expensive.
Applications of Blockchain Technology in the Finance Industry
The initial purpose of blockchain technology was to facilitate the transfer of cryptocurrencies. Today, technology has gone on to become one of the most secure technologies in multiple industries, including banking, medicine, government sectors, and so on. As the main focus of this post is the financial sector, we will explore some of the blockchain technology applications in banking.
Share Trading and Stock Exchange
Normally, share trading and stock exchange markets involve time-consuming processes, complex processes, and high costs. Besides, they are extremely risky. The application of this technology lowers the risks and challenges traders face.
For starters, traders can use blockchain technology to transfer shares from one participant to another as opposed to carrying out transactions through a centralized hub. This will have a huge impact in this sector as it promises faster exchanges, better security, and reduced risks due to enhanced transparency.
Due to the presence of intermediaries and third parties in the stock exchange process, traders have to wait for as long as three days to complete transactions. Blockchain technology simplifies stock exchange processes due to automation and decentralization. It also eliminates the need for third parties such as brokers and regulators as transactions and regulations are carried out through smart contracts. This not only ensures faster transaction settlements but also reduces operational risks.
Although global trade has become commonplace, cross-border payment systems and processes have barely changed. Sending international payments existing banking channels is a complicated and multifaceted process that involves several intermediaries.
For example, if you have a company based in the USA, and you want to buy goods from Africa, you initiate the process by asking your banker to send the payment. Your banker collaborates with a correspondent bank for the transfer to be carried out successfully. A respondent bank in Africa receives the payment and transfers it to your dealer’s account. In most cases, you incur costs on each step as well as waste time. According to the World Bank, the average cost of sending payments worldwide is 7%.
Blockchain technology solves all these obstacles by storing and updating each transaction on a secure sharable ledger. It also streamlines the process by getting rid of middlemen and unnecessary fees. Once you initiate the transaction, the receiving party accesses the payment immediately. A transaction cannot be altered or reversed on the ledger. This fosters better security and accountability.
Digital Identity Verification
A key element of the advanced digital economy is the capacity to gather, check, and verify the identities of the parties involved in online transactions. The existing approaches used in sharing sensitive information often lead to poor data management or privacy vulnerabilities.
Blockchain technology enables people or organizations to have more control over what they consider sensitive information. Also, processes involved in identity collection, management, and verification are streamlined through direct data sharing and consistent verification processes.
Trade finance should not be confused with stock exchange trading. It refers to financial activities related to international and domestic trade and commerce. In spite of the widespread use of technology and innovations, trade finance processes still involve a lot of paperwork. All the parties involve such as the importer, exporter, and shipper maintain a database of their invoices, bills of lading, inspection documents, letters of credit, and so on. Although order management systems enable you to carry out and verify such paperwork online, the process still takes a lot of time.
Blockchain technology reduces processing times when it comes to trade finance activities. It also saves you money and eliminates the use of papers while ensuring security, trust, and transparency. It also rids the process of unscrupulous middlemen, thus eliminating the risk of manipulation.
This refers to loans awarded to individuals by several financial institutions. Due to the unusual number of participants involved, the process of awarding syndicate loans can take as long as two weeks or even longer. Also, financial institutions that provide such loans face challenges when it comes to client data verification. They also fall prey to money laundering activities.
Through blockchain technology, if one of the banks involved in syndicate lending has completed the compliance processes, all the others do not have to do it. This saves time and makes it easier to meet all the requirements needed in syndicated lending.
Peer-to-peer (P2P) Transfers
Blockchain technology has a huge impact on P2P transfers. While there are hordes of P2P transfer applications in the market, all of them have limitations. For instance, some allow you to only transfer money within a certain geographical region. P2P service providers also charge huge commissions, not to mention that the data you submit is not secure.
Blockchain technology enables P2P transfers across the world. Besides, blockchain transactions happen in real-time. This means that the recipient does not have to wait for days or weeks to receive their money.
Raising money through venture capital is more often than not a strenuous process. As an entrepreneur, you have to sit through numerous meetings with stakeholders, negotiate over business equity, and go through numerous valuations.
Blockchain technology has enabled different organizations to raise money through initial coin offerings (ICOs). This is carried out through public cryptocurrencies such as Ethereum and Bitcoin. In an ICO, entrepreneurs sell coins or tokens in exchange for money. The raising of over $4 billion in a year-long ICO by Filecoin is evidence that blockchain technology has revolutionized fundraising.
Auditing, Bookkeeping, and Accounting
Recording transactions by using blockchain technology eradicates dispenses with human errors and also protects this information from interference. Remember that records are checked, verified, and updated each time they are transferred from one blockchain node to another. Apart from guaranteeing high levels of accuracy, this process leaves behind a traceable audit trail.
The whole bookkeeping process likewise turns out to be increasingly efficient. As opposed to keeping isolated data records, a financial organization only need to maintain a single, joint register.
Implications of Blockchain Technology on Consumer Lending
Blockchain technology has dramatically altered the finance industry. It has effectively reworked the rulebook, especially when it comes to around ways to data management, ownership, and transparency. The use of digital currencies is reducing the costs associated with transaction costs, thus bringing about financial inclusion. This is particularly helpful to those who are left out of mainstream financial service providers.
Within the lending sector, blockchain technology will have a huge impact on the way credit bureaus operate. This is because it has successfully solved challenges associated with identity verification, data security, and information ownership.
Data Breach in Credit Bureaus
While banks and other lenders use several factors to determine your eligibility to a loan, the largest determinant is your credit history and your corresponding FICO score. This information is collected from such credit bureaus as Experian, Equifax, and TransUnion.
Despite there being protocols through which data from such credit bureaus can be accessed, the bureaus are not immune to data breaches. This is evidenced by the recent data breach on Equifax where information to around 143 million Americans was compromised. Another huge data breach took place in 2012 on Experian, where personal information belonging to around 200 million Experian customers was compromised.
Some of the ways through which blockchain technologies can address the challenges and inefficiencies associated with a centralized credit system include:
Individuals have Better Data Control
The use of blockchain technology puts back data ownership and control in the hands of the owners of the data. This is because there’s no longer a need to have a central data repository. As a borrower, you have free and constant access to your financial information. You can use it to borrow without the risk of identity theft or data leakage to unscrupulous individuals.
It will Boost Value Lending
Blockchain technology involves the use of a tamper-proof ledger where data integrity is achieved by technological design. On the other hand, data integrity in credit bureaus is quite arbitrary. Therefore, blockchain technology has the potential to successfully address outdated data practices employed by credit bureaus.
Decentralized ledger technology that has been made possible through blockchain technology will impact consumer loaning in various ways. For instance, blockchain records reduce the chances or out-of-sync data and redundancies. All information is shareable, and those who need to access it can do so using a cryptographic key. This implies that all parties involved in the loaning and lending process work using similar data sets. This reduces the possibility of miscommunication and errors.
Blockchain technology will make Know Your Customer (KYC) protocols faster and more secure. Financial firms often incur huge expenses in their quest to become KYC compliant. This is because KYC standards are more often than not broad and unclear. In their Cost of Compliance 2017, Thomson Reuters reported that 53% of the participating firms expected inflation of their compliance budgets.
Blockchain technology could greatly improve credit reporting, which is a fundamental part of consumer lending. FICO scores and credit reports are used in the approval of loans. They also affect the loan approval amounts as well as the loan interest rates. As discussed, the credit reporting system is plagued with challenges, which include data inefficiency and insecurity.
Storing data across multiple nodes in the blockchain network eliminates the errors and risks associated with a centralized system. The automatic updates also take care of such inaccuracies as double entries. In the absence of data administrators, the cost of data also drops significantly.
After the economic recession, which took place in 2008 in the U.S, financial institutions and big banks have worked hard to ear the borrowers’ trust. However, consumers are on the lookout for more trust and security when it comes to their lending needs.
Through the adoption of blockchain lending, conventional banks will become obsolete. The reliance on third-parties, such as credit bureaus will also be eliminated. The use of an automated and decentralized system will speed up the loan process and minimize operational risks. In short, the use of blockchain technology will improve the reliability and trust in an otherwise complex lending process.
Some of the features that characterize the blockchain lending community include:
- Nature of the debt market – the market has a peer-to-peer network of borrowers and lenders. This diversifies risks and makes it possible to carry out cross-border transactions
- Collateral – as these are digital transactions, borrowers pledge crypto assets as security for their loans. They trade this for a more acceptable currency such as Euros or dollars
- Creditworthiness – most lenders have come up with their methodologies of assessing the borrower’s creditworthiness. What is provided as collateral is also valued. In most cases, the borrower’s creditworthiness assessment involves the use of FICO scores
- Smart contracts – as agreements take place online, decentralized lenders make use of digital signatures to sign deals on loan agreements. Such agreements involve such info as maturity terms, the parties involved, the borrower’s creditworthiness, capital, and consequences in case of a breach.
Top Considerations in the Blockchain Lending
Blockchain technology is already being used to offer personal loans. Here’s where to get a blockchain loan:
Bitcoin is one of the most popular cryptocurrency loan places. A bitcoin loan works like a conventional loan. You borrow money and place your bitcoins as collateral. You pay back the loan along with interest over some time or as a one-time payment. This is as far as the similarities with conventional loans go.
As bitcoins are not associated with central authorities or banks, your bitcoin loan comes from other bitcoin users. Bitcoin loans are normally awarded through a peer-to-peer platform. To apply for a loan, you need to first create an account on your preferred lending platform as is the case with a bank.
A bank has to either underwrite the loan or sell the debt to another party as is the case with mortgages or a large commercial loan. On the other hand, no one banker holds a lot of BTC to loan out, therefore, your loan is published to a large audience of investors. This makes bitcoin loans rather appealing as you can get funding from multiple investors.
This allows you to obtain P2P loans if you are on Ethereum Network. As a borrower, you have to post Ethereum Name Service (ENS) domains or ERC-20 compatible tokens as collateral against your Ethereum Loans. You will also be required to set loan data such as the interest premium, the loan’s duration, and the number of tokens you will place as collateral. Should a lender agree to the terms, they will credit your account with the loan amount.
A secure automated lending platform (SALT) is a platform through which you can get Bitcoin, Litecoin, Ether, and Doge loans. SALT acts as an intermediary that connects borrowers to lenders. The platform is easy to join, and the interest rates are as low as 5.99%. The repayment terms range from one month to three years.
Challenges Facing Blockchain Adoption
Despite its revolutionary advantages, the adoption of blockchain technology is facing some challenges which include:-
Although the expenses charged on loan transfers are reduced, and processes are streamlined, blockchain technology is still relatively new. Lending firms have to customize the software on which lending and borrowing processes will run. A staff that is conversant with the blockchain technology has to be recruited. Where this is not possible, firms providing these services have to outsource. Adopting this technology means getting rid of existing systems. This is especially hard for organizations that take a stance of “better the devil you know than the angel you don’t.”
2.Lack of Skilled Blockchain Programmers
With the rise of blockchain technology to stardom, there is a low supply of software engineers, developers, architects, and programmers. Although in the end, this could change, the initial lack of talent is delaying the migration from conventional processes to blockchain technology.
Blockchain technology is quite vulnerable to exploitation, particularly in a situation if a small group of cryptocurrency miners controls the majority of the mining power. In this case, the miners may control transactions to maximize their profits. This challenge can be successfully solved if more people become cryptocurrency miners.
All transactions in blockchains are visible. While it promotes transparency and openness, it is a challenge when it comes to corporations and governments who need to limit access to sensitive information. A permissible blockchain technology, where people can only access transactions related to them, takes time and money to create.
Blockchain technology is governed by no legal framework. Cryptocurrency dealers fear that regulation will halt the adoption of this innovation. On the other hand, legal experts argue that regulation is the factor that will ease uncertainties and encourage blockchain adoption.
Governments around the world are still trying to figure out what blockchain technology is and how to regulate it. Likewise, stakeholders face the challenge of how they will shape regulations so that whatever rules implemented will bring about a win-win situation.
6.Association with Criminal Activities
Cryptographic forms of money, for example, bitcoins have been associated with criminal activities such as the dark web. Digital currencies make it easy for criminals to access restricted items on the internet. The security features of blockchain technology are not immune to cybercrimes. Case in point is Coincheck’s recent security breach where a total of $530 million was stolen.
What does the Future Hold for Blockchain Technology in Lending?
The stakes that blockchain technology holds are certainly too important for financial service providers to ignore. It will not only streamline operations and minimize expenses but also open up new ways of revenue creation. However, a larger percentage of consumer lenders are still in the planning phase. Numerous lending companies have initiated migrations to AI-powered consumer lending platforms as a way of gearing up towards blockchain technology.
Until lenders start using blockchain technology, you can always shop for a loan online. It is easy and won’t take you much time the whole procedure. Here at Loanry, we can connect you with reputable lenders who may give you a loan.
Blockchain technology’s instability and volatility are one of the key reasons why moneylenders have been reluctant to consider crypto-assets as security for loans. Borrowers are also hesitant to cash out cryptocurrencies for fear of missing out on massive profits. With the emergence of middlemen such as SALT, the parties involved in a transaction have guarantees in the form of smart contracts. These contracts enforce the terms of the loan, such as interest, loan duration, and repayment amount regardless of the asset fluctuations.
Cole is a personal finance research analyst and writer with extensive experience in building and maintaining a corporate brand utilizing both qualitative and quantitative methods. Cole has written on a diverse range of topics including financial planning, cryptocurrency, commercial real estate, and tax strategy. A graduate from Drexel University, Cole seeks to demystify financial borrowing and help individuals achieve financial freedom.