Distributed Ledger Technology Redefines Modern Finance

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Adopting blockchain technology offers compliance cost and filing time savings for financial institutions serving high risk industries. Distributed ledger technology (DLT) helps to reduce friction while increasing the transparency of shared data in systems that rely on verifying identities to create trusted relationships when disseminating information between traditionally trust-less industries. 

There exists various uses for DLT in modern financial industries including pathways for providing banking services to traditionally restricted capital markets as we have seen with remittances. Another optimization based on current standards of modern financial services is the ability of distributed ledger technology to create a new universal business language around shared financial information which is the proposed solution for limiting costs associated with compliance.

A universal standard to communicate metadata associated with transactions between global financial institutions is one of the larger macroeconomic challenges facing rapidly globalizing data systems around the world. As we see more transactions move across borders at a faster rate, the speed as to which the information attached to those transactions must match or exceed the speed of the transaction.

Financial Industry Opportunities Utilizing Blockchain

Blockchain as a technological solution in high risk industries becomes more important as the relationship between money and attached information continue to grow more complex. This relationship will be explained further, but first let's briefly describe the concept of a blockchain. 

Blockchain technology is based on a cryptographically secure distributed ledger containing information stored in peer to peer network. Copies of interactions between each participant on the network is kept on the ledger in a near immutable way to limit any single point of failure. The proposed system relies on a validation protocol called a proof which guarantees individual transactions, and the information contained about them based on existing records on the ledger are correct and can be shared effectively.

Multiple areas of blockchain technology has seen exposure in the current financial system around the world. The economics of global remittances, Know Your Customer protocols (KYC), and Counter Terror Funding (CTF)  or Anti Money Laundering (AML) processes are seeing the impact of utilizing distributed ledgers to store information.

Let’s look at remittances over the last few years as an indicator of the kinds of problems banks are running into in regards to adequately tracking information associated with transactions in a modern globalized economy. Worldwide, an estimated $625 billion (USD) was sent by migrants to individuals in their home countries in 2017. Tracking remittance payments worldwide is difficult because many countries do not track funds that are sent or received.

There are many reasons why the process of tracking money is a complex problem for modern governments. In the scope of this research, the focus on the cost of compliance in tracking financial information and reporting it to each jurisdiction that requires regulatory reporting is the major friction mechanic of any transaction. The process of building a regulatory report is time consuming and expensive because it relies on traditional financial compliance solutions to track the movement of complex digital transactions which are becoming more popular across the globe. 

Human capital costs are a large portion of the expenses needed to accurately run compliance checks on money moving through international systems. Managing the flow of liquidity needed to facilitate these types of transfers offers a new set of challenges for financial institutions who attempt to do business overseas in developing markets through remittances and international wire transfers. This stems from the various forms of regulation that overlap and intersect when the process transferring funds begins. 

The wording of such regulation might be insufficiently clear or difficult for firms to understand. Sometimes this reflects the challenge of writing a set of instructions that can be understood and implemented by multiple types of public and private firms operating under separate jurisdictions and regulatory structures. This is where KYC and AML information become regulatory requirements so that financial institutions know who is involved in the process. Banks are required by law to process and record information associated with the identities handling the transactions so they can monitor the internal compliance teams to ensure that the information is validated before funds are settled.

The systems that currently act as the compliance layer for banks are built on the utilization of archaic human-capital rich resources and rely on transcribing information across non-standardized databases that can be changed and edited at will by financial institutions who must revisit certain transactions over time to ensure compliance information is maintained for regulators. 

Immediately one can see how the prototype blockchain systems being proposed today may offer significant efficiencies in sending information about transactions without centralizing complex processes that commercial firms currently carry out locally. One such feature is being able to understand and interpret regulatory instructions for digital identities and producing logic to generate regulatory reports and distribute information to all financial firms via a DLT platform.

For instance, blockchain can act as a distributed set of technical standards. These rules are agreed upon protocols in which the coded language of regulation will communicate with financial systems. Language standards will be required for how financial firms organize their data before providing it to any proposed blockchain system. The system must also provide an environment for data to be reused across multiple regulatory systems, built to differing standards based on regulatory requirements that they operate in as per existing obligations or limitations associated with existing practices. 

However, as previously noted, ensuring regulatory reporting is done correctly has major financial and legal implications for banking firms who must comply with Bank Secrecy Act regulations. Ensuring that correct regulatory reporting can be translated across borders with the money that is moving simultaneously is one of the processes that should be migrated to a DLT platform which may act as significant cost saving tool as these markets continue to scale.

Financial institutions currently have security standards built out to prevent data being accessed or used inappropriately by any one single entity that may have access to a distributed network. Similar universal business language standards can be applied to blockchain without the same costs in head-count and expertise when maintaining information on a distributed ledger can be simplified to a point of near automation if a universal language is used in mind with current financial messaging standards. 

One of these standards, ISO 20022 was develop-ed by SWIFT to ease the burden of sharing information around transactions, ISO 20022, “allows communities of users and message development organizations to define message sets according to an internationally agreed approach using internationally agreed business semantics and, whenever desirable, to migrate to the use of a common XML or ASN.1-based syntax.”

Developing modern financial compliance frameworks built on the concept of interoperability and transparency without increasing friction when sharing such information can save time and money when dealing with high risk industries. This concept of universal business language or (UBL) lays the foundation for distributed ledger technology to define new messaging standards in a decentralized way.