Deutsche Bundes bank has been smoothing out the waves since the outbreak of the corona crisis: Payment transactions and settlement systems are stable. Not in the sense of “rigid”; rather, the industry is (crisis) safe. After all, international payment traffic in particular is by no means deadlocked. It wasn`t before Corona and it will not be afterwards. Distributed ledger technology (DLT) has been noticeably turning the financial sector upside down for some years now, even though the potential for global financial transactions has remained largely untapped to date. According to Accenture, around 25 trillion US dollars are transacted across borders every year. These sums of money would benefit from increased security and integrity – also and especially in times of crisis. But can blockchain technology solve these problems and be the key to greater transparency and efficiency? Or do completely different challenges arise here?
Over the years, distributed ledger technology (DLT) has increasingly developed into an important field of experimentation for financial market players and central banks, among others. Distributed ledgers are basically distributed account management systems in which data is shared, replicated and synchronized across several locations. The cryptographic procedure enables a nearly forgery-proof mapping of transactions. If these are represented in interconnected blocks with the help of a proof of work procedure, one speaks of a blockchain. This technology offers various potential advantages through shared data storage, which can facilitate coordination processes in complex value chains based on the division of labor.
Handle complex processes automatically
Many users evaluate the DLT as useful for triggering changes in the applied industries. A pioneering role is played here by the financial sector, which envisages the substitution of intermediaries or the creation of new, more efficient processes in areas such as payment transactions and securities settlement. In theory, distributed ledger technology could eliminate the need for special systems operated by intermediaries. Intermediaries, which classically perform the validation of financial transactions, would no longer be necessary from a purely technical perspective. The P2P network structure is seen as the key to an efficient, globally accessible means of transmitting value. This includes, above all, the advantages of one-time verification of customer master data as well as a reduction of manual – and thus error-prone – processes. However, a differentiated consideration shows that the special structural characteristics of DLT do not mean a break through revolution for payment transactions per se. Even SWIFT’s extensive network is not yet sufficient to create truly global transparency in payment transactions.
Encrypted storage: process transactions confidentially
Through the distributed ledger technology, each participant is basically given the opportunity to gain insight into the transaction history. Consequently, the confidentiality of financial transactions without encryption cannot be maintained. Even an encrypted storage of data by all network participants does not provide sufficient security. If the data were to be decrypted by future improvements of the hardware or software components, the transaction history would again be visible to all network participants where it was stored. However, this limitation of confidentiality in the future could now be solved by not storing all data at all participants, but by exchanging and storing it in a subnetwork. Nevertheless, this protection mechanism led to a significant deviation from the basic principles of complete transparency and traceability of a distributed database and reduced the DLT’s tamper resistance.
Uncertainty about efficiency in high-volume applications
Scalability and performance are crucial criteria for using infrastructures with high transaction throughput or high transaction peaks at certain times, for example as measured by the latency of the system. The scalability of DLT solutions depends on the technical specifications that are made. In particular, it depends on the consensus mechanism. Depending on the procedure, DLT solutions require far more data storage, data instructions and time to process a single transaction than a central financial market infrastructure. If DLT systems do not achieve the transaction throughput provided by today’s financial market infrastructures, their useful applicability would be limited to systems with high complexity but relatively low transaction volumes.
Especially in global and cross-country payment transactions, a standardization of requirements is almost impossible. Correspondent banking is less standardized than centralized payment systems and often requires complex coordination processes between the parties involved. Processing takes a long time and causes relatively high transaction costs. The DLT applied in highly technological countries could simplify or even make some process steps in correspondent banking business dispensable and enable end users a faster and cheaper processing.
DLT continues to be the subject of intensive research and development in the expectation that its use can reduce transaction costs. The transfer from its original role as the technology behind the virtual currency Bitcoin to applications in payment transactions and securities settlement is proving to be a veritable challenge, but one that also offers opportunities for greater transparency. It has become apparent that a variety of adaptations of the original Bitcoin process are necessary. A pure P2P transmission without intermediaries is unlikely to be feasible in the financial sector. But one thing is certain: Thanks to its network structure and parallel access to a common database, DLT guarantees a high degree of transparency, data consistency, operational efficiency, security and resilience as well as independence from intermediaries and automation in processing – from which the financial sector can only benefit, especially in times of crisis.