How might blockchain technology transform financial services

How might blockchain technology transform financial services?

As the digital future unfolds, we remain committed to helping our customers and colleagues unlock this potential, ultimately contributing to our overall ambition of helping Britain Prosper.

Today, the financial services industry use digital databases, also known as ledgers, to store customer records. We trust these record keepers to act as custodians of our money and assets. And in return this allows us to conveniently pay for goods and services, with a simple click or tap of a button from an app.

Behind the scenes, however, even standard transactions require multiple systems, messaging layers and third parties to connect, communicate and interact with other participant's ledgers. It gets more complicated when connecting to different ledgers across borders, or transferring assets.

As digitisation continues to shape our daily lives, improving these existing systems is essential - but there's only so many more incremental upgrades we can make. Afterall, many of these databases were built decades ago, when no one could have predicted just how pivotal the internet would become to our everyday lives.

But imagine a host of modern interconnected databases - where buying a home could involve your bank seamlessly interacting with property databases, other financial institutions and legal professionals who meet regulatory standards.

The question is, if everyone used such a single database or system, who would own and maintain it? Enter blockchain technology - a potential solution to these challenges.

What is blockchain technology?

In recent years, digital currency has emerged as the antithesis to traditional banking. Bitcoin, considered the first digital currency, surfaced as a peer-to-peer payment network leveraging blockchain technology - also called Distributed Ledger Technology (DLT). To make a payment on the network, users simply send money from wallet to wallet - there's no third party involved in the transfer of ownership. And we now see concepts with the technology began to develop even further as we now see various digital assets and currencies co-existing inside single platforms.

With blockchain, things can be programmed to automatically happen based on conditions. For example, you and I could try and guess tomorrow's weather. The winner would receive an agreed-upon amount in the form of a digital token. If it rains, I win. If it doesn't, you win. We can pre-programme these conditions into the contract, without the need for an intermediary. The network would instead act as the notary.

It's no surprise then that the concept of blockchain technology has sparked the imagination of the financial services industry, and caused many institutions to consider the benefit and increased efficiencies it could bring.

How does Blockchain technology work?

Blockchain is a distributed database or "shared" ledger, which involves numerous interconnected participants who host and store copies of records on the network. Unlike traditional centralised databases, no single entity holds control.

When a transaction is submitted to the network, a participant is chosen to validate it. These participants collectively determine the network's state, and one is designated to write the 'block'. Decisions are reached without a central intermediary.

Once validated, all participants store copies of the transactions within a block. Each block links to the previous one, forming a chain - the blockchain. Importantly, once a block is added, previous blocks cannot be altered. This means records cannot be deleted and are irreversible, which strengthens the reliability of data, transparency, and provenance.

Since each participant maintains a full copy of the chain, records are distributed across the network. This minimises the risk of hacks, enhances security, and ensures tamper-proof resilience.

How might blockchain transform the financial services industry?

The financial services industry relies on global networks, intermediaries and their own systems. These intermediaries and third parties operate within specific jurisdictions. For instance, Lloyds Banking Group participates in UK and EU domestic payment schemes (such as CHAPS and Target2) to support clients. We provide access to our markets, and reciprocally access other markets for our customers.

However, reliance on third parties and their systems can lead to friction, time zone challenges and delays - even though checks like sanctions and anti-money laundering are absolutely necessary.

Blockchain technology offers an alternative. Think of it like a social messaging group, where members interact in real time, rather than communicating individually. Each message could represent a transaction, the members as the nodes and the chat history being the financial events. This means every message is transparent and shared by all members, but could also be made private using encryption.

There would be no group admin to confirm events, instead members would have equal roles in verifying and recording messages. They would see and respond to events in real time with any attempt to alter a message immediately apparent to the group.

Now imagine siloed financial databases being inside group chats like this. Participants could bring specific currencies; others might bring assets to the group. So rather than eliminate the role of an intermediary, it creates potential for a new role, a "message composer", that can programme ownership, rules and logic inside transactions. This role would reduce counterparty risks and the dependency on clearing and settlement.

Unsurprisingly, financial institutions are actively exploring blockchain to address some of today's challenges. Take our work with Fnality International, for instance.

Lloyds Banking Group forge partnership with Fnality International

Fnality International is a payments company building in Financial Markets Infrastructure (FMI). Their infrastructure combines traditional and digital finance to improve wholesale settlements.

To achieve this, Fnality leverages blockchain technology to a closed network of regulated financial institutions and operates an account at the central bank, which allows settlement in a digital representation of central bank funds.

Just last year, we - alongside shareholders Santander and UBS - used the Sterling Fnality Payment System, underpinned by an Omnibus Account at the Bank of England, to complete the world's first payment on a fully regulated DLT-based wholesale payment system, settling in a digital representation of central bank funds.

Participants use their pre-funded balance to make near-instant transfers to other participants on a 24/7 basis. This combines the safety and credit risk of central bank funds in a systemic wholesale payment system with the functionality and resilience of blockchain technology.

Going forward, Fnality will expand into multiple currencies that will coalesce inside a network of networks. This will allow members instant, atomic exchange of currencies or payment for an asset that settles safely and in risk free central bank money.

"Unsurprisingly, financial institutions are actively exploring blockchain to address some of today's challenges."

What's next? It's not just money that could evolve

There are many instances that could be recorded digitally using blockchain. For example, it might be a digital identity, bank deposits or even a corporate customer issuing a bond.

We refer to this opportunity as tokenisation - the representation of real-world assets stored on a blockchain. Tokenisation holds enormous potential. In fact, experts estimate that by 2030, approximately $16 trillion worth of assets could be tokenised.¹

Imagine tokens as standardised containers on a ship. Each container has fixed dimensions, accommodating anything that fits within those bounds. We could put an array of financial products inside of these "digital" containers. This could bring greater liquidity to markets through tokenising assets that are traditionally more illiquid like insurance, funds or pensions. It would be bolstered by fractional ownership of assets (smaller segments in the form of tokens), to support issuance and ownership transfer with speed, efficiency and transparency.

Tokenisation would also allow us to pair digital money and assets within a single ecosystem, significantly reducing clearing and settlement times. We could also embed rules into tokens such as local compliance or programme automatic voting or dividend payouts to simplify asset ownership and transfer. This would improve reconciliation with single records of truth agreed by all participants.

However, it's unlikely there will be one ledger to rule them all. Instead we're likely to see the introduction of multiple financial ecosystems across jurisdictions that can be orchestrated and/or connect for specific use cases. Indeed, thinking here has commenced via the Bank of International Settlements, under the banner of the "Finternet."²

Looking ahead

Transferring tokens and assets across a network has the potential to unlock new capabilities, efficiencies and automate financial services. By representing real-world assets on a shared infrastructure such as blockchain, we can enhance the lifecycle management of these assets.

We've already achieved this with Enigio, a strategic partner that leverages their self-built hybrid blockchain to streamline the creation, management and transfer of asset ownership in international trade across supply chains, digitising the full documentation associated with actual shipping containers, and all trade flows.

In 2022, we completed the UK's first digital promissory note transaction using Enigio's trace: original solution. We continue to build on this and completed the first digital trade transaction under the new UK Electronic Trade Documents Act last year.

As the digital future unfolds, we remain committed to helping our customers and colleagues unlock this potential, ultimately contributing to our overall ambition of helping Britain Prosper.

About the authorDan Maggs Dan's background Read Less

• External links expandable section

  1. Wholesale and retail CBDCs - what exactly is the difference? | World Economic Forum (weforum.org)