A blockchain is a growing list of records, called blocks, linked together by unbreakable cryptography. Among its many applications, this technology is used to underpin financial products and services including digital currencies such as Bitcoin and Litecoin.
The revolutionary potential of blockchain technology has been compared to that of the internet in the 90s. Like the internet, Blockchains have the power to drive dramatic institutional efficiency gains, save billions through reduced operational, financial, legal and governance costs, create widespread process redundancy, greatly reduce counterparty and market risk and reshape the architecture of the financial market.
Across the world, 200 banks and more than 40 central banks are testing blockchains to enhance financial efficiency, data management and information-sharing. This technology can also improve sovereign debt transparency - critical for ensuring effective risk assessment and management.
Growing debt requires more transparency
Financial risk management is becoming more relevant with the huge growth of public debt in recent years in both high and low-income countries alike. Furthermore, issues of debt transparency have come to the fore of discussions on debt sustainability.
The International Monetary Fund and World Bank, as the creators of the debt sustainability assessment, realise that creditors and investors may not have an accurate picture of a country's debt situation due to this lack of debt transparency. As poorly structured debt – in terms of maturity, currency or interest rate composition, and large and unfunded contingent liabilities – has a global financial impact, debt transparency is an important aspect of preventing fiscal crises.
The potential of blockchain-enabled debt solutions
Current reporting requirements for sovereign debtors can be administratively intensive and scattered across several databases. The blockchain, by contrast, could establish a much more efficient process in which reconciliation is an integral part of the transactional process. Loans issued on-chain, for example, can be tracked from the registration process through to completion or default. Each repayment can be traced from end-to-end and timestamped at each stage, all the while ensuring compliance with internal governance processes.
The use of blockchains in capital markets could reduce risk in securitised products through enhanced data reliability; the improved probability of debt recovery and the potential for automated enforcement; and automated recovery rates, reducing debt burdens and improving investor confidence. They can also improve data surveillance through the sighting of real-time balance sheets, end-to-end transactions and digitally signed loan documentation.
It adds up to an estimated 27 per cent cost-saving over the way we do things now. Other economic benefits include:
Commercial banks have typically employed fintech for cross-border payment efficiency. Central banks have used blockchains for a range of purposes including: retail and wholesale central bank digital currency; bond issue and management; trade finance; and know your customer and anti-money laundering processes.
There is a growing range of use cases for blockchains across a variety of financial services, including promising work in reducing the cost of remittances and improving financial inclusion. While this remains an emergent technology, prudent central banks are increasingly embracing it in their research and development programmes.