Blockchain technology is one of the leading innovations in the finance industry, holding promise to reduce fraud, ensure quick and secure transactions and trades, and ultimately help manage risk within the interconnected global financial system.
Blockchain accomplishes this through advanced cryptography that is designed to be resistant to hacking, adding trust to the transaction ecosystem.
There are many financial uses provided by blockchain, not limited to keeping track of transactions and trades. As our global financial system becomes more connected in our age of digital transformation, investors would be well advised to learn about how blockchain is changing the system and how to gain and regulate exposure to this development.
Here’s what investors should know about blockchain’s growing role in financial services and the earning potential and risk factors it poses, from tech-oriented startups to traditional banks:
— What is blockchain?
— Benefits of blockchain in financial services
— Risks that blockchain and financial institutions face
— Blockchain investments to buy
What is Blockchain?
Blockchain is a digital collection of transactions that are tracked and recorded in a decentralized network. It is a distributed ledger, which means there is no central authority of the network, or no one person or entity in control with the ability to corrupt the network. The blockchain comprises individual blocks of data, each containing a record of information, that are linked together in chronological order. These links cannot be changed, which is what instills confidence in the network.
This revolutionary technology manages transactions of information by securing them as they occur. The purpose of blockchain is to lower the cost of transactions and make them more efficient and faster.
The technology has many applications that can be integrated into different industries, providing investors with many opportunities. For starters, it’s one of the technological underpinnings of cryptocurrencies like Bitcoin.
One industry with clear applications for the blockchain is financial services, where companies are in a perpetual race to reduce the costs and friction of transactions.
[Sign up for stock news with our Invested newsletter.]Benefits of Blockchain in Financial Services
Blockchain has the potential to make the financial services industry more transparent, less susceptible to fraud and cheaper for consumers.
Improving transparency. Blockchain can make the financial industry more transparent since users are performing activities on a public ledger. This transparency can expose inefficiencies like fraud, leading to problem-solving that could reduce risk for financial institutions.
Adding security. As consumers become increasingly active online, the digital universe is a breeding ground for scammers. With blockchain technology, this concern could be reduced. Payments and money transfers made on the blockchain are faster and more traceable than in traditional banking.
When information flows through different financial intermediaries, there is a risk of interception of that information, raising the possibility of fraud. This hole in oversight can be filled with blockchain’s cryptographic algorithms that bring security in the exchange of information between parties.
“In traditional finance, clean audit trails can be difficult to procure at times, which have led to severe economic losses in the past due to negligent behavior or malicious actors,” says Ben Samaroo, co-founder and CEO at WonderFi, a decentralized finance platform. “This risk can be significantly reduced with a combination of blockchain technology and machine learning to monitor and manage risks with a high degree of precision.”
Financial technology companies other businesses that use large amounts of data need blockchain to build data integrity.
“Since the blockchain network is distributed, it doesn’t have a single source of failure,” says Marie Tatibouet, chief marketing officer at Gate Technology, a cryptocurrency exchange based in China.
This characteristic, Tatibouet says, increases the network’s resilience, protecting it from compromise.
Lowering costs. As investors move away from financial advisors to avoid higher fees, blockchain provides an opportunity for consumers to benefit from lower costs associated with traditional financial services.
Financial technology companies have become a huge part of the financial services industry, allowing investors to open accounts with digital advisors and make independent financial decisions. As fintech plays a stronger role in global finance, its relationship with blockchain will inevitably become stronger.
This innovation can be good for consumers because investors are getting more for their money and they’re getting a balance between automation of financial services and a lower cost.
“The institutions that adopt this new technology first will be able to streamline internal processes and provide their customers with lower-cost financial services, effectively beating their competitors on cost to capture a larger portion of the market,” Samaroo says.
This ultimately benefits the everyday investor who’s looking to cut expenses while accessing this new financial services environment.
[READ: How to Invest in Art.]Risks that Blockchain and Financial Institutions Face
Weighing against the promise blockchain holds for financial institutions is one major risk affecting the bottom line: Traditional financial institutions make money on transaction fees that could be lowered or eliminated with blockchain technology.
When it comes to transferring money, consumers have to rely on banks or third parties to process transactions.
But adoption of blockchain could bypass third parties such as banks, which would eliminate fees and other costs associated with these services. As a result, banks may face challenges in volume and transaction-based revenue.
Blockchain makes the infrastructure that’s proprietary to financial institutions less important because it serves as a verification mechanism that’s “not concentrated in the power of one institution,” says Thomas Shohfi, assistant professor in the Lally School of Management at Rensselaer Polytechnic Institute in Troy, New York.
In addition, blockchain innovation is moving so fast that regulation hasn’t caught up yet. So the potential policies impacting blockchain can be seen as another obstacle in incorporating blockchain in financial services.
“Existing regulation does present a significant obstacle for blockchain adoption since regulators will prioritize existing incumbents over disruptors,” Tatibouet says.
Regulators are working through determining the pros and cons of blockchain technology to see if it’s suitable for financial institutions and what the consequences are for companies and consumers.
“This rigidity has stifled innovation so far,” Tatibouet says. “However, this view is changing as governments and other public organizations are seeing the benefits of this technology.”
[See: 7 Bank Stocks Investing in Cryptocurrency.]Blockchain Investments to Buy
For investors who want exposure to blockchain as it changes the financial services industry, there are a few ways to approach this investment. One way is to buy into companies whose businesses are tapped into blockchain technology.
“Financial companies or technology companies that see blockchain as a disruptive technology and want to be experts in it can sell their services to customers,” Shohfi says.
A company that falls in this category is International Business Machines Corp. (ticker: IBM), which is focused on the development of blockchain technologies. IBM also provides services for businesses to integrate blockchain for efficiency, scalability and growth.
Another approach investors can take is investing in cryptocurrency-oriented stocks that serve as a pure play for blockchain investments. MicroStrategy Inc. ( MSTR) fits the bill here. The software solutions company holds more than 105,000 bitcoins, a portfolio valued at more than $5 billion.
Square Inc. ( SQ) is another company that’s heavily invested in Bitcoin and strongly believes in the blockchain network. The payment services company recently announced that it will launch a decentralized finance platform with a focus on Bitcoin applications.
Investors are taking notice of these stocks and their potential. MicroStrategy is up about 80% year to date, and Square has seen a year-to-date rise of 23%. That’s compared with the S&P 500’s year-to-date return of about 20%. Investing in these publicly traded companies allows you to broadly invest in the blockchain without having direct exposure to the volatility and speculation associated with some cryptocurrencies.
For investors looking to further hedge their risk against Bitcoin speculation and volatility, exchange-traded funds may be a better option. Amplify Transformational Data Sharing ETF ( BLOK) offers investors exposure to companies that are positioned to profit from the development of blockchain technology. Since the fund’s inception in 2018, it has returned 150%, making it a profitable investment option.
