Thursday, 13th August 2020

How the financial industry can connect securely to blockchain

With traders executing thousands of transactions a day, financial firms are investing large amounts of money in building systems and processes to manage key risks. Furthermore, firms are dealing with increased requirements for reporting and transparency. They are subsequently incurring significant costs to maintain the infrastructure and manage the underlying risks, while also being exposed to day-to-day risks due to market restraints. Blockchain technology is still in the relatively early stages of development, yet analyst firm IDC has predicted that worldwide spending on blockchain is set to reach as much as $11.7 billion in 2022. By Rob Coole, director product management at IPC.

At a very high level, blockchain is a distributed ledger technology, a communal database that is validated by a network of participants, rather than a single central owner. It is an enabling technology that can securely and irrefutably share data between counterparties. Transactional records are represented as individual “blocks” and the “chain” is used to link all relevant “blocks”.

The potential uses for blockchain are promising. Organisations in a variety of sectors are turning to blockchain to revolutionise multiple aspects of business, beyond just its use for cryptocurrencies. For example, blockchain in the financial services is redefining the way businesses trade, are regulated and interact. Below are just a few of the better-known use cases and those areas causing particular excitement throughout the industry:

1.Cryptocurrencies – The most commonly known use of blockchain, financial services can exchange money for a digital token that has been ‘mined’ by computers. Examples include, Bitcoin, Ethereum, Dogecoin and Ripple.

2.Cross-border payments – Blockchain is touted to greatly improve cross-border payments, a field that is currently slow and expensive. Using blockchain provides faster automated agreements at a lower cost and with total transparency. In October of last year, IBM launched a solution to help universal cross boarder payments.

3.Regulatory compliance – Maintaining compliance with regulations is crucial for financial firms. Blockchain technology can greatly ease the onus of compliance on both the regulators and the organisations due to its transparency and security. In September 2017, the Royal Bank of Scotland (RBS) and the Financial Conduct Authority (FCA) partnered with R3, the open source enterprise blockchain network, to automate mortgage delivery receipts for the bank and send the data to the FCA.

4.Smart contracts – Blockchain is facilitating smart contracts in the financial services sector whereby agreement terms between the contracting parties are directly written into lines
of code; the code and thus the agreement terms contained within exist across a distributed decentralised blockchain network. These smart contracts can be used to oversee agreements of varying complexity automatically while being very secure, more so than traditional contract law.

5.KYC and AML – Know your customer (KYC) and anti-money laundering (AML) are other areas that can be costly to financial organisations and where blockchain’s transparent and untamperable ledger could save the need for identification and reporting as it is all on display.

One of the key advantages to blockchain, as shown in the examples above, is its ability to make entire networks’ interactions transparent. Transparency is very important in the financial community, particularly since the financial crash when disguise permeated into the very fabric of the system. Total network visibility can eliminate or diminish many of the uglier parts of finance, such as money laundering, fraud and many types of corruption. It also has other benefits to trades, such as including irrefutable timestamping for trades, as well as reducing arduous audit or compliance process to free up time for business-critical activities.

While it potentially offers may benefits, there are still many challenges facing firms wanting to utilise blockchain technology. While network transparency is vital to forging a new and open banking industry, it is also to some extent a security risk. Many firms, particularly financial organisations responsible for receiving, processing and storing sensitive data, are still wary of internet connectivity, which is required to connect to many blockchain exchanges and applications. In part, this is due to the inherent risks of internet – such as malware and other attacks, data loss and policy violations – but also mistrust derived from the lack of service level agreements (SLAs) when internet connectivity is used.

As more blockchain applications and cryptocurrencies are created, companies are increasingly finding that there is limited private network access to this technology. Many firms are cautious about storing transactional data and wallets locally or in the cloud. Even companies who rely on encryption key solutions to protect their data can find these solutions are exposed on the internet when connecting to blockchain exchanges via the internet.

Secure connections to public and private blockchains

By using private networks, financial firms can negate the risk of the internet and access public blockchain on a built-for-purpose network. Deploying blockchain proxies on the edge of a private network enables financial market participants to have low-latency, private – and thereby secure – network connectivity to public blockchain. The primary objective of these private networks is to overcome traditional risks associated with internet links, as well as providing tailored SLAs and guaranteed quality of service (QoS).

Increasingly, companies are looking to connect to private blockchains on a private network, using ‘blockchain-as-a-service’ capabilities. The rise of such solutions is enabling financial organisations to maintain secure segmentation from the internet by containing all transactions within a known community of users on a private cloud transaction. Moreover, blocks and wallets storing critical transaction data will be securely stored in a private vault.

Having private network connectivity can also minimise if not eliminate some of the concerns with transparency, since the customer can choose the information they wish to make available. While blockchain transparency is end-to-end, governance policies can be tailored to each network participant, so that if network providers don’t want to disclose IP address ranges or other sensitive statistics within the blockchain, a private network can facilitate that.

Connecting new blockchain offerings to financial market participants

Best of breed private networks also have the ability to connect to blockchain providers and new blockchain offerings that have been developed in any environment – public, private or hybrid cloud – to diverse financial organisations around the globe. This enables blockchain providers to manage the lifecycle for a blockchain deployment from development through to user acceptance testing (UAT), quality assurance (QA) and production, providing the fastest possible time to market. Moreover, financial market participants within the network have direct access to state-of-the-art blockchain offerings.

Ultimately, blockchain is set to revolutionise the way financial market participants operate and interact with each other. Yet, many operating in the finance industry are still cautious to embrace the new blockchain technology and applications when internet connectivity has so many inherent security risks. Turning to private network ecosystems to connect to public or private blockchains can provide quality, low latency connectivity for fast and efficient trading, as well as mitigating internet security risks and providing custom built SLAs for greater peace of mind.

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