Blockchain technology is not just for financial services

24 July 2017

If global supply chains are to gain the full benefit of blockchain technology for managing payments and related data, all parties that play a role in global trade must be involved, according to Alexander van Tuyll van Serooskerken, a Senior Management Consultant at the Business Consulting arm of Synechron. In an article originally published in SQC magazine, he briefly explains what blockchain is, and discusses why it is important for all parties involved in global trade transactions to adopt it. 

The blockchain concept originally was developed as an efficient and secure way to manage and register transactions made with cryptocurrencies (for example, Bitcoin). Until now, it has mostly been of interest to individuals and financial institutions. But with its distributed-ledger technology (DLT) and smart contracts, blockchain has great potential to benefit all companies across the global supply chain – not just banks. 

DLT, smart contracts, and digital payments

Blockchain is a new computing infrastructure that emerged to power the Bitcoin digital currency application. In essence, blockchain provides the opportunity to have a connected, secure world with a distributed ledger that centralises data for the involved parties and the ability to run automated checks and processes (called "smart code" or "smart contracts," depending on the legal implications of the code) that trigger all kinds of events (for example, payments).

The distributed-ledger technology component of blockchain allows each counterparty to have its own copy of the same ledger, similar to the way a Google doc allows multiple parties to view the same information at the same time. The database is built to be immutable, which means there is inherent security. Blockchain also allows for smart contracts to be coded and connected in such a way that the contract automatically executes an event if certain preconditions are met. An example would be a (near) real-time payment when goods are delivered. 

Blockchain technology is not just for financial services

Blockchain beyond banks

Banks that deal in trade finance – those that would, for example, give importers or exporters a loan to finance their global trading activities – are viewing blockchain as a technology that can provide these entities with a single view of the trade finance transactions in real time. But what about the other parties involved in trade finance? In addition to traditional banks, non-banking participants (for example, shipping companies, insurers of the goods, and credit-rating agencies, among others) and entities that fulfill the role of importers and/or exporters are all part of the trade finance chain. They already play a role in traditional payment methods, such as the commonly used letter of credit (L/C) described below. 

For a trade finance blockchain to be successful, it requires more than just banks coming together. Instead, it requires a critical mass of organisations to adopt "straight-through processing" (STP), an automated workflow from the point when the loan is requested through to when the goods are received and the payment for the shipment is processed. Participation by non-banking participants is critical to its success. However, each will need an incentive to become part of a blockchain. Let's consider just a few of the potential participants and how they could benefit from involvement in blockchain. 

Benefits for importers and exporters

Blockchain enables faster processing of transactions between and within parties. Consider the example of an international letter of credit (other trade finance products can benefit from blockchain technology, but this article will focus on the example of L/Cs.) In very simple terms, a letter of credit is a written guarantee by the buyer's or importer's bank (the "issuing bank") to the seller's or exporter's bank (the "advising bank") to pay an agreed amount for the goods when specified conditions, including time limits and the presentation of documents, have been met.

When the importer applies to its bank for a letter of credit, all kinds of checks (for example risk, compliance, and credit) are required before the L/C can be initiated. Once it has been initiated, the importer must then wait for the exporter's bank and, subsequently, the exporter to be informed. When the goods have been shipped, it could take up to five days for both the advising and issuing banks to complete their parts of the transaction; only then can the importer retrieve the documents required for picking up the shipment.

With blockchain, however, smart contracts perform the automated execution of the L/C application steps and checks, issuance and advising processes, document checking, execution of payments, and the registration of all these transactions on the blockchain. All of this can occur outside of business hours. The time required from initiation to payment can therefore be dramatically reduced. For example, because blockchain automates the document checking steps (paperless trade is a prerequisite), the time required from sending the documents to the exporter's bank until document retrieval by the importer – including all settlements and payments, if they are not deferred – can be reduced from as many as 10 days to only one hour. 

Blockchain enables faster processing of transactions between and within parties

This, of course, assumes no discrepancies that could still occur, depending on the setup of the blockchain. If there are discrepancies, they will be detected right after the documents are created – much sooner than in traditional processes – and all applicable participants will immediately be aware of them. In addition to the reduced transaction time, other benefits for importers and exporters include reduced bank fees (due to less manual activity on the part of the banks), reduced time for loan approval, and reduced risk of fraud.

Why others should join the blockchain

Blockchain initiatives hold great promise for non-banking participants and other organisations involved in international trade, including supply chain and logistics players. Let us highlight some of those benefits, what the impact on their existing activities would be, and the possible role they could play in the future. 

Starting with the insurers of transported goods: data is key for them; they use it, for example, to determine the risk involved in a transaction and the associated pricing of insurance premiums. As a consequence of the blockchain's distributed ledger, all participants involved have insight into all validated trade finance data. This would make a wealth of information available to insurers, allowing them to conduct a deeper analysis and make better decisions around the type of insurance product to be offered and at what premium. In addition, the information would be available in near real time – even while the transaction is still ongoing. 

So with blockchain technology, insurers could obtain information much faster and the data would be more accurate, thus helping them to enhance their offerings to clients and reduce their own risk. Furthermore, blockchain technology enables faster processing between and within parties (for example, document checking), which reduces the duration of an insurance policy. 

Some of the benefits for insurers are also applicable to credit-rating agencies. For example, if blockchain makes data about importers and exporters more accurate as well as more widely available in near real time, then credit-rating agencies will be able to create more accurate models, thereby enhancing their ability to operate in the trade finance chain. However, because data is stored on the blockchain in a distributed ledger, the method of retrieving data and making it available to clients without conversion would no longer be a unique selling point for the credit-rating agencies. Instead, they will have to focus on their ability not just to retrieve data but also to enrich or convert it to useful information for their clients. In other words, they'll need to rethink their commercial models and consider where they can add value with the new data that becomes available through blockchain. 

Non-banks and other companies can also benefits from blockchain technologyCurrently, credit-rating agencies measure the creditworthiness of individuals and corporations based on historical records related to transactions, financial behaviour, and other factors. With blockchain, they could combine proprietary data on the financial history of the individual or entity with the aggregated import/export data now made available on the blockchain. This would create the opportunity to draw insights related to the type and concentration of deals, which customers are seeking what types of deals, what buyers are looking for from their suppliers, and related analytics. Right now this data is not always or not completely available; with blockchain, it would be available to all intermediaries (on a private, permissioned blockchain if the parties prefer). In short, combining private credit-rating data with the blockchain data could create a powerful revenue stream for credit-rating agencies. This could also take some of the pressure off of shipping and logistics companies to provide this data.

Get ready for the future

This article highlights how importers and exporters, insurers, and credit-rating agencies could benefit from blockchain technology. They are not the only ones, of course. Blockchain would allow any participant in the value chain – not just those mentioned above, but also shipping companies and related logistics service providers, among others – to share a single view of the financing around a shipment. 

In fact, many parties that are interested in exploring the benefits of blockchain have moved in the past year from the "thinking and learning about it" phase to the "experimenting with it" phase. All kinds of questions have come up, such as (to name just a few examples): Who should be involved? What will their role be? How are we going to make money? Not all questions have been answered yet; a lot depends on the role existing parties want to play in the future trade finance chain of activities as well as on the incentives they have to participate in blockchain. 

There are challenges to be dealt with, too, such as the need to implement paperless trade, issues of data privacy, and how to get all members of a supply chain to participate. Most of the trade finance-related blockchain pilots today are being run by banks, with limited outside participants. The problem with that approach is that banks will only get their own networks to join, limiting the value when other participants are needed for the redesign and adoption of an existing process and product. 

All in all, though, huge opportunities and benefits can be achieved if all parties get involved. So for banks, non-banking participants, and other companies that are considering blockchain, the benefits are clear. Luckily it's not too late to start thinking about their future and how they can join the blockchain revolution.

Related: Blockchain Technology: How it works, main advantages and challenges.


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.