The financial industry is experiencing a major disruption with the emergence of distributed ledger technologies (DLTs), which serve as the technology backbone for a wide range of products and services, such as digital currencies, real-time payments, and next-generation lending. Although blockchain is the best-known example, DLT refers to a wider family of protocols that represent a transformative way of recording, sharing, and synchronizing transactions and data among multiple participants. For a Fintech Software Development Company to remain relevant in the current climate and competitive beyond 2021, an understanding of the significant transformation of finance enabled by DLT is critical. This article breaks down the foundational components of DLT and highlights how it is unlocking opportunities across payments, trading, compliance, insurance, and more,
Defining Distributed Ledger Technology (DLT) and Blockchain
Distributed Ledger Technology (DLT) uses a digital system in which there is a distributed network of an agreed-upon database or ledger among participants, each having access to their own copy of it for data validation and change recording in a networked environment. Conversely to traditional databases managed by a central authority, DLT utilizes a consensus among all participants so that changes can be recorded and be respected in a timely and decentralized manner. This process leads to a flexible, immutable presentation of data across the distributed ledger.
The best-known example of a DLT structure is blockchain, in which data is stored in successive and linked blocks using cryptographic methods. Each blockchain block contains a synchronized batch of transactions that aim to have transaction history transparent and tamper-proof as each newly added block must achieve consensus with all network participants to secure the integrity of the added data. DLTs, such as blockchain, are mainly designed for transparent financial transactions, but by using other data structures and consensus mechanisms, they can be successfully introduced and used by a wider scope of industries, even outside blockchains themselves.
Why is DLT Critical for the Future of Fintech?
DLT resolves a number of ongoing pain points in financial services. Traditional financial infrastructures routinely feel the impacts of inefficiency, costly intermediaries, singular points of failure, and difficulty maintaining auditability in an intensive compliance environment. DLT features decentralized governance, cryptographic security, and automated consensus mechanisms that collectively build transparency, reduce effort associated with reconciliation, and limit reliance on centralized parties.
As fintech aims to modernize legacy operations, cope with ongoing regulatory pressures, and provide real-time experiences for an increasingly digital generation, DLT provides the critical underlying technology that supports secure collaboration across multiple parties, enhances complex integrations, and brings an additional layer of resilience and auditability. These features make DLT an essential aspect of the current landscape of digital finance and future opportunities in that space.
Core DLT Use Cases in Payments and Money Transfer
Cross-Border Payments and Remittances
Cross-border payments have become infamous for prolonged processing times, hidden fees, and elevated costs associated with numerous correspondent banks and intermediaries. Many of these frictions are removed in Distributed ledger tech (DLT) based platforms. Transactions are confirmed, recorded, and settled directly between the parties involved on the same shared ledger, decreasing the turnaround time from a matter of days to close to instantaneous settlement in many instances. DLT based remittance solutions such as Ripple, have been adopted by banks and payment providers alike to facilitate their processes, and deliver transparent, quicker, and more reliable cross-border solutions to consumers across the globe.
Real-Time Gross Settlement (RTGS) Systems
Traditional real-time gross settlement (RTGS) systems, as provided by central banks, settle payments with a high value in real time and reduce systemic risk. Nevertheless, traditional RTGS systems hosted on centralised infrastructure are vulnerable to outages and operational bottlenecks. Distributed ledger technology (DLT) based RTGS prototypes yield greater reliability, as the settlement is distributed to multiple parties. Reduced reliance on any one entity for settlement and a reduction in systemic risk should be understood. In addition, DLT offers continuous settlement capability, 24/7, eliminating the constraints of standard banking hours and offering the possibility of programmable settlement payments or executions for complex financial products.
Reconciliation and Clearing
Historically, reconciliation of payment and clearing, which requires multi-institutional exchange of payment information, verification and accounting of records has required an intensive manual reconciliation process that may include confirming the correctness of users across multiple versions of data and associated data versioning. The use of DLT transforms reconciliation of payments into nearly an automatic activity as all institutions are sharing and updating the same source of truth in real time with all other institutions. DLT removes discrepancies and errors, hastens settlement cycles, and reduces dispute resolution and other inefficiency.
Transforming Capital Markets and Trading
Asset Tokenization: Digitizing Real-World Assets (RWAs)
Distributed Ledger Technology (DLT) and blockchain technologies allow for the representation of real assets, e.g. company shares, bonds, real estate, or commodities, as digitally tokenized devices. You can program these tokens and divide them into smaller fractions to create additional liquidity and inclusiveness. Digitizing ownership records and automating compliance (e.g. allowing only certain verified investors to hold certain securities) can lead to broader and more efficient capital markets. Asset tokenization has the potential to democratize investment access and drive new business models around
Post-Trade Settlement and Clearing
Post-trade processes, which are usually managed by central clearinghouses, deal with the confirmation, clearing, and settlement of trades; this usually happens over several days. DLT automates post-trade workflows and allows for settlement in real-time, resulting in reduced counterparty risk, increased capital efficiency and less administrative burden. This results in greater market fluidity and can free up billions in capital that would have been held as collateral, while reducing operational and other types of risk and error.
Digital Securities and Issuance
Digital securities can be issued and traded using DLTs. Digital securities have compliance rules and regulations embedded into them and are also tracked on electronic records that cannot be altered or erased and have timestamps. The process of issuing and managing digital securities becomes more efficient, and regulators, issuers, and investors can get real-time granularity and assurance about where any security is in its lifecycle event, whether it is at the issuance stage, trading stage, or final redemption process. Trust is developed through transparency in the security lifecycle event, which
Identity, Compliance, and Lending
Digital Identity and Know Your Customer (KYC)
As per the top Software Development Services experts, Traditional onboarding and KYC processes involve repeated, redundant identity verification by each financial institution, resulting in friction, delays, and high compliance costs. DLT solutions transform this landscape by allowing for the sharing of once-verified, cryptographically secured digital identities among institutions (with customer consent). As a result, client onboarding is expedited, and the costs of compliance checks are distributed across all participating financial entities. KYC data stored via DLT remains tamper-evident and privacy-respecting, while access is finely permissioned and auditable.
Decentralized Lending and Borrowing (DeFi)
Decentralized finance (DeFi) has emerged as a principal advance within fintech, peer-to-peer and lending and borrowing systems directly enabled through DLT. By utilizing smart contracts hosted on blockchain platforms, DeFi eliminates the necessity of traditional intermediaries while offering borrowers and lenders the opportunity to connect globally through transparent algorithms and collateralized pools. Additionally, the programmable nature of these contracts automates payments of interest, management of collateral, and the handling of defaults. This democratizes access to loans, permits novel lending arrangements, and diminishes operational overhead when compared against established loan products.
Supply Chain Finance (SCF) and Trade Finance
Trade finance historically consists of multiple complex, paper-driven and siloed processes between buyers, sellers, banks and logistics providers. DLT employs shared ledgers to capture each stage of a transaction and the provenance, delivery and payment status of goods. The transparency provides assurance to reduce fraud, minimize disputes and advance payment cycles. In supply chain finance, DLT facilitates the verification of shipment data, confirmations of the amount and quality of receipt, and execution of the contract before payments or loans are disbursed. In all cases, this facilitates the management of working capital, unlocking value
Insurance (InsurTech) and Emerging Applications
Smart Contracts in Insurance
Smart contracts in DLT automatically handle insurance claims and payments. Terms of the policy are coded into a blockchain so that when oracles (external data sources) verify that the insured event occurred (e.g., delay of a flight or loss of shipment), it triggers the payment automatically. This automated process significantly reduces administrative costs, limits fraud, and settles their claims quickly and fairly. InsurTech companies are looking into new insurance products built on smart contracts for
Financial Inclusion and The Unbanked
Billions of people are unbanked or underbanked because of barriers such as lack of identification, affordability, or limited geography. DLT-based solutions can give these people a safe digital wallet, a verifiable financial history, and direct access to microfinance or cross-border remittance services, without a traditional bank’s legacy burden. DLT platforms also promote the digitization of credentials and financial ties, allowing a larger number of people to access the financial system and engage as economic participants and promote inclusive economic growth.
RegTech and DLT
RegTech refers to technologies that support the regulatory processes and requirements for financial institutions. DLT supports RegTech by providing the DLT’s immutability in real-time transaction records, compliance audits, and auditability standards. Automated regulatory reporting, identity verification, and data sharing simplifies the compliance burden for institutions and the oversight burden for regulators. Regulators are also looking at the development of supervisory nodes in DLT protocols, which would be a part of DLT systems, to monitor marketplace activities on a continuous basis, and fewer reporting burdens to the financial firms.
Final Take
Distributed ledger technology (DLT) has moved quickly from a theoretical innovation to a viable digital infrastructure that is reshaping and enabling global finance. Its decentralized, transparent and immutable properties promote efficiencies in whatever use-case one is addressing whether it be payments or capital markets or lending or insurance or compliance or financial inclusion and even onto a broader social agenda. There remain challenges to face including interoperability, regulatory harmonization, and operational scalability, but the acceleration was clear with DLT acting as the foundation for a next generation of fintech solutions, including by utilizing Cloud Computing Services – advance your financial services on a DLT distributed platform with Secure, inclusive and resilient financial systems leveraging comprehensive development services. Fintech is poised to create the financial systems for the next finance generations and for years to come.
