Other parts of this series:
Can blockchain play a role in a financial firm’s Finance & Risk function?
Blockchain is making a name for itself in financial services. Its potential to shift paradigms can profoundly affect finance and risk functions. With blockchain, financial institutions can build leaner, more streamlined finance and risk organizations by leveraging the “trust” element of transactions, and other recorded content, thus reducing reconciliations and reporting efforts among different entities, systems and industry participants.
What do financial firm risk managers need to know, or do, to prepare for blockchain?
This blog series will introduce blockchain and smart contracts, consider the potential cost savings, and review use cases that illustrate finance and risk benefits including reference data, Know Your Customer (KYC), trade finance and insurance risk transfer.
Blockchain: Transferring trust in a trustless world
Let’s begin with the basics: What is blockchain? This new technology is a secure transaction ledger database, shared by all parties participating in an established, distributed network of computers. It records and stores every transaction that occurs in the network, reducing the need for reconciliations.
Blockchain proponents often describe the innovation as a “transfer of trust in a trustless world” because, with blockchain, entities participating in a transaction are not necessarily known to each other, yet they can exchange information with surety and without needing third-party validation.
Most blockchain platforms provide an extended capability known as smart contracts, supporting automatic negotiation or performance of contracts.
A smart contract is essentially self-executing and self-governing code embedded within the blockchain that implements terms of a contract between parties. This allows any blockchain platform (e.g., Ethereum*) to act beyond its original purpose as a carrier of agreed information. Because all covenants and business rules are hard-coded as logic within the blockchain, smart contracts should execute without interference and make the process secure and efficient, cutting operations costs and improving the bottom line.
In cases where frequent transactions happen between parties based on clear and pre-defined terms and conditions, smart contracts support automated transfer of agreed funds. Financial services institutions are looking to introduce smart contracts in areas such as:
- Trade settlement: By automating the contract between buyer and seller, or any market maker, and performing funds transfer on defined events
- Syndicated financing: By automating the process of enforcing loan terms between various stakeholders
- Mortgage loans: By automating the property validation process and funds transfer based on updated information from the builder or buyer
Smart contracts offer great potential. Accenture has already applied this technology to use cases like smart energy consumption and insurance. But some details need to be ironed out before smart contracts are ready for broad use and adoption. In particular, adequate fail-safe measures are needed to eliminate vulnerability in contracts that can be exploited.
We’ve looked at what blockchain is, and the key features it offers. In our next post we’ll examine blockchain’s suitability for finance and risk applications.
* The Ethereum decentralized platform was developed by the Ethereum Foundation