How Distributed Ledger can be Applied into Finance Industry?

February 13, 2019

Much has been said about the revolutionary power of Distributed Ledger Technology, or DLT, and recent trends show that it is currently the go-to technology in the financial sector. With this in mind, we take a look at the influence of the technology in the finance industry and the different sectors that will enjoy its disruptive force.

What Is Distributed Ledger Technology?

Distributed Ledger Technology allows for the consensual distribution of a database across the nodes of the networks, thereby promoting a public witness-oriented ecosystem. In its simplest form, it involves the real-time update of a ledger held by each participant of a network.

What Are The Features Of Distributed Ledger Technology?

Distributed Ledger Technology has innovative features that set it apart as a revolutionary technology suited to the financial sector. These features include:

👉 Decentralization: A distributed ledger, such as blockchain, relies solely on decentralization for its operations. As a result, blockchain-powered networks side-step the disadvantages of centralized infrastructures, which depend on inputs from central authorities. Unlike centralized systems, a distributed ledger facilitates a consensual network, where all the participants are involved in the verification of transactions and new inputs on the ledger.

👉 Nodes Of The Network: As earlier mentioned, a distributed ledger involves the consensual distribution of a database across the nodes of the network, rather than the conventional centralized single server model. This protects the database from attacks to which the latter is susceptible, since the attacker must simultaneously alter the contents of the database at each node of the network.

👉 Immutability: Another feature that gives DLT an edge over traditional systems is content immutability, which is a result of consensus mechanisms that tag each data entry into the ledger and link it to the previous entry. Therefore, for an attacker to tamper with the ledger, he or she must alter other entries that carry the signature of the content he is trying to isolate. This is almost impossible, since the ledger is available to participants in real-time, and as such, changes as significant as this will not go unnoticed.

👉 Cryptography: DLTs also employ a state-of-the-art cryptographic system that ensures the encryption of the contents of the ledger. This results in a network that only allows individuals with decryption keys access to its database. Cryptographic systems include Secret Key Cryptography (SKC), Public Key Cryptography (PKC), and Hash Functions.

Secret Key Cryptography, which is also known as symmetric encryption, uses a single key for both encryption and decryption. SKCs are primarily used for privacy and confidentiality. Public Key Cryptography, or asymmetric encryption, uses one key for encryption and another for decryption. Its primary use is for authentication, non-repudiation, and key exchange. Hash functions use a mathematical transformation to irreversibly encrypt information, creating a digital fingerprint. Hash functions are often used to safeguard message integrity.

👉 Smart Contracts: Smart contracts, which were introduced by the Ethereum blockchain, has become one of the most important features of the distributed ledger in recent years. They are “self-executing contracts,” which autonomously enforce the binding agreements that govern the success of a transaction.

The above-listed features have contributed to the implementation of DLT in various sectors of the finance industry. These sectors include:

  •  Banking

The banking sector is perhaps the biggest financial sector that has felt the full force of the disruptive nature of the technology. Major players in this sector have introduced various initiatives that look to capitalize on the innovative features of the distributed ledger technology. The technology has the potential to effectively reduce the paperwork and transaction costs involved in banking. Hence, the explosion of blockchain-powered banking products will increase the profitability of banks.

Over the years, we have seen an influx of DLT consortiums endorsed by major banks, which are working on resolving major issues plaguing the banking sector.

  • Stock Market

Big names in the stock market, like the Nasdaq, have not shied away from exploring the benefits of DLT in the sector. The features of the distributed ledger have proven beneficial in resolving the dependence of the market on intermediaries. It is also becoming evident that DLTs are capable of speeding up the processes involved in the settlement of trades. This is possible when we factor in the capability of smart contracts to enforce the regulatory framework for transferring the ownership of securities without the need for human supervision, thereby eliminating the need for middlemen.

The possibility of reducing the cost and running time of these processes is major factor in the explosion of DLT-related projects in the stock market sector.

  • Real Estate

Influencers in this sector have identified the potential of the distributed ledger in improving existing rental property payment systems. A distributed network can serve as a melting pot for stakeholders of a property, where they can transparently agree on tenancy payment plans, the transfer of ownership, and the provision of services.

As expected, this will also capitalize on smart contracts and enforce agreed terms involving the establishment of ownership and ensuring that payments are prompt. The ability of DLT to streamline these processes will bring order to the chaotic nature of the real estate sector.

  • Insurance Industry

The insurance industry is a regulatory playground, and the introduction of DLT will go a long way to ensuring that these regulations come to full effect. Firstly, the immutability of the ledger makes it impossible for fraudsters to falsify claims. Also, smart contracts can ensure that the policies governing an insurance plan are met at all times. Lastly, the distributed nature of the ledger can help insurance firms better liaise with health providers when it comes to health insurance.

  • Cross-Border Payments

The majority of distributed ledger products tackle issues plaguing cross-border payments. Currently, the technology offers payment systems that sidestep middlemen-related issues and regulatory hurdles that exponentially increase transaction costs and time.

Conclusion

There remain uncertainties surrounding the effectiveness and practicality of distributed ledger technologies in many of the above-listed sectors. This, coupled with the fact that regulations remains a grey area, threaten to slow down the adoption of blockchain. However, these limitations do not  diminish the potentials of the distributed ledger technology in the finance industry.

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