How can cryptocurrency drive innovation and efficiency within the financial industry?
Cryptocurrency is emerging as a new economic frontier — characterized by key traits such as transparency, accessibility, and security. Despite this, financial institutions are cautious to employ digital assets because they believe the inherent risks outweigh the potential advantages.
Sparrow discusses the real-world applications of cryptocurrency and its underlying blockchain technology, which may improve innovation and efficiency within the financial services business.
1. Seamless and secure payments
Digital payments offer a slew of advantages over cash-based transactions such as convenience, seamlessness, and the absence of contact. The transition of Singapore into a Smart Nation is slowly gaining momentum as cashless payment volumes are anticipated to grow by more than 80% in 2025. As such, financial institutions must address barriers that hinder customers from fully adopting digital payment methods. Here are some of the current challenges that financial institutions face:
- Firstly, digital payments are expensive and time-consuming due to the complexity of current systems, especially for international payments. According to a Credit Suisse report, cross-border wire transfers can take days to process and incur costs up to ten percent.
- Secondly, payment systems are susceptible to cyberattacks with hackers looking to exploit cybersecurity vulnerabilities. In 2021 itself, payment card fraud losses culminated in $28.58 billion affecting global brand, domestic market-only, private label and ATM credit, debit and prepaid cards worldwide.
- Lastly, sensitive data may be compromised during data transfer or while stored on a server.
Used as a viable payment mechanism to facilitate transactions between merchants and customers, cryptocurrency can address the above-mentioned drawbacks. It builds on customer experience while being a potentially disruptive force in the digital payment industry.
Following are some characteristics of cryptocurrency that financial institutions should explore when delivering groundbreaking payment solutions to their customers.
|Utilizes encrypted public ledgers||Eliminates the intervention of middlemen such as correspondent banks which expedites cross-border financial transactions and lowers processing costs.|
|Pseudonymous||Wallet address remains the sole identifier of customers. This maintains privacy by non-disclosure of any specific personal information.|
|Accessible||Globally available to a wide range of clientele, access to cryptocurrency payment gateways opens up a plethora of possibilities with just an internet connection.|
|Security||Enables transactions to be recorded in a more private and tamper-free manner on the blockchain.|
2. Enhance process efficiency with smart contracts
Contracts serve various purposes in the financial industry: formalize commitments between parties, mitigate risks, ensure compliance with regulatory requirements, provide legal protection, and more.
Despite dealing with contracts regularly, financial institutions still face challenges that affect business efficiency. Some examples: Contracts are at risk of being tampered with, they require manual keying and handling, and require third-party mediation during settlement. As such, financial institutions can turn to smart contracts to refine traditional contractual methods for smoother business operations.
So, what exactly are smart contracts? Smart contracts are computer-coded applications that run on the decentralized blockchain network. It automates the execution of an agreement between two or more parties when the pre-defined terms of the agreement (written into lines of code) are met. Parties can interact and respond in real-time to “if-when-then” conditions of the contract.
The benefits of smart contracts are as follows:
- Autonomy — Eliminates the need for intermediaries or lawyers to verify contracts thus reducing time and transaction costs.
- Accuracy — Records terms and conditions automatically which omits manual errors.
- Transparency — Fosters trust as the terms and conditions of the contract are visible to participants in the blockchain network removing any opportunities for manipulation and ensuring businesses are conducted fairly.
- Speed — Digitalize and automate processes to eliminate time-consuming paperwork and expedite verification.
- Security — Enterprise-level encryption that secures the system from unauthorized access.
- Record-keeping — Stores transactions in an unalterable manner driving convenient record management.
Offering a multitude of advantages, below are some real-world applications of smart contracts relevant to the financial industry:
|Trade clearing, execution, and settlement||Settle trades more swiftly by minimizing tedious processes to approve, audit, and reconcile asset ownership and payment|
|Know Your Client (KYC)||Verifies credit scores/identities of clientele during the onboarding process using Blockchain records that are immune to counterfeiting|
|Insurance claims||Utilize Blockchain records to assess risks when underwriting and assess predefined rules to verify claims more efficiently|
|Loans||Validate loan eligibility and lock in details of loan terms including repayment period and interest rates|
3. Cryptocurrency as an alternative investment
Financial institutions such as registered fund management companies manage the investment portfolios of high-net-worth individuals and family offices to help them achieve their growth objectives taking into account their goals, timeframe, and risk tolerance. Depending on the concept of portfolio diversification, they offer an array of financial products and solutions across various asset classes such as equity, fixed income, and real estate. The goal: Offset exposure to a specific asset class to reduce the impact of market volatility while leveraging on profit-making opportunities.
Due to the concerns over rising inflation and steeper interest rates coupled with geopolitical challenges, achieving portfolio diversification is an increasingly complex endeavor. A handful of asset classes have fallen in lockstep; increasing the correlation between them. As such, financial institutions see the need to explore alternatives for increased portfolio diversification in order to generate asset returns.
Cryptocurrency has been lauded as a competitive tool for portfolio diversification by investors by virtue of its low correlation to traditional asset classes. According to CoinTelegraph, Bitcoin and the S&P 500 performed in contrast to each other throughout 2018 and 2019, with their correlation coefficient at 0.01 — except for two occasions when the two markets behaved similarly. Likewise, Bitcoin has maintained a low correlation to other asset vehicles including gold (0.00), U.S real estate (0.01), and oil (0.03) from 2012 to 2020.
Even as cryptocurrency and other major asset classes are moving in tandem amid bigger Federal Reserve hikes, it is crucial to note that short-term correlations are not indicative of long-term time trends. Bitcoin has largely remained a non-correlated asset through the years. With that premise in mind, financial institutions can consider offering cryptocurrency products when building a well-diversified portfolio.
4. Global remittances to expedite transactions
Remittances are indispensable to the global economy; one in every seven people in the world is involved in remittances. Furthermore, over 70 countries rely on remittances that account for more than 4% of their gross domestic product (GDP), fueling the nation’s socio-economic progress.
During the COVID-19 pandemic which disrupted global economic activities, financial institutions providing global remittance services witnessed a sharp decline of 20 percent in remittance volume. They were also beset by higher overheads due to increased operational expenditures; a volatile exchange rate which complicated the balance of cash and digital accounts; and decreased personnel and working hours as a result of lockdowns.
As the economy continues on a path of recovery, financial institutions find themselves in a pre-emptive position to prepare for any unprecedented situations that threaten overall profitability. Digitization of cross-border remittance with cryptocurrency can be a boon in such times. The table below depicts important attributes of traditional remittance against its cryptocurrency counterpart and highlights the benefits of the latter:
|Traditional remittance||Cryptocurrency remittance|
|An intermediary bank is required when making international funds transfers between the originator bank and the beneficiary bank||Uses a peer-to-peer ecosystem of computers to verify and approve transactions removing the need for an intermediary bank|
|International remittance fees cost approximately $20||International remittance fees can cost between $1.78 and $62|
|International remittance can take between one and five business days||International remittance can take approximately 10 minutes|
|Mandatory for regulated entities to comply with anti-money laundering and combatting the financing of terrorism requirements including performing customer due diligence and transaction monitoring||Mandatory for regulated entities to comply with anti-money laundering and combatting the financing of terrorism requirements including performing customer due diligence and transaction monitoring|
Build customized cryptocurrency solutions with Sparrow
Sparrow can help you build bespoke products and solutions protected with layered-security measures and high compliance standards. From market insights to quality financial reporting, our financial professionals use a multi-faceted framework to help you allocate digital assets to your clients’ portfolios. Reach out to us today to find out how we can help build an alternative investment offering with Sparrow’s digital asset solutions.
Risk Warning on Digital Payment Token Services: