One of the most talked about & debated topics in the technology space today is Blockchain. Organizations are slowly beginning to understand the implications of using Blockchain technology and its potential for being a change agent across a variety of industries. While Blockchain may have usage across a broad set of verticals & functions, currently it is more prevalent in an industry which has been key to its genesis, Financial Services; and if you dig a little deeper, it becomes evident that Blockchain technology can be applied in context of negotiable financial instruments to make its eco-system more simplistic & secure.
A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, with the payer named on the document.
Negotiable financial instruments like Cheques, Drafts, and Bills of exchange have been around as early as the 8th century and are still a key supporting pillar for trade throughout the world. Until recently, most of these instruments were paper-based, physically exchanged, and endorsed to transfer value, leaving ample room for inefficiencies and fraud. People creating duplicates or forging signatures on a bill of exchange and then discounting it, is not unheard of. Banks have tried to address these issues using systems and processes but they are still prevalent.
With time, Negotiable instruments have moved to digital platforms which are often created by banks for their customers. Such centralized solutions have two main issues; first, they are not able to create a network which is required to provide universal acceptability & these instruments lose their benefit if they are not transferable or have restricted acceptance. Second problem is that it creates single points of trust, control and failure which is far from ideal. Financial institutions and customers realized that there were limitations with the centralized digitization model. As a result, many banks don’t issue digital cheques or BoE and endorsements/ settlements are still done using lengthy, risky processes.
Recent developments in Blockchain present a unique combination of key technologies to address the issues highlighted above. With decentralized, distributed, and immutable data management, Blockchain technology in banking can provide an ideal platform for issuance, endorsement, and settlement of negotiable instruments. This can be achieved with or without a traditional financial intermediary.
Reimagining Negotiable Instruments with Blockchain technology
As an example let’s see the current lifecycle of a cheque:
- A chequebook is issued by a bank
- The account holder physically writes a cheque and hands it over to a payee
- The cheque is submitted to a bank for clearing
- It goes to a clearing house, digital clearing happens
- The money gets credited
- Net settlement is done between banks.
Now imagine the same process with a Blockchain-based platform which provides facility to manage the whole lifecycle in a secure, digital way:
- All banks will be able to issue digital cheques to their customers on the Blockchain platform. The digital check will have a record of issuing bank and the current owner.
- Account holder can fill in details like the payee, amount, and date on the digital check and then sign that with his private key.
- A signed check will be transferred to the payee digitally, i.e. the payee will be able to see that check under his ownership.
- Smart contracts can be utilized here to present the cheque to payee’s bank automatically.
- Instead of utilizing a centralized clearing house, the settlement can be enabled by smart contracts that check the available balance in payer’s account and then initiate a fund transfer to payee’s account.
- The interbank settlement can be managed by smart contracts and can be done on a net or gross basis.
The Road Ahead
Currently a lot of time, effort, and cost goes into ensuring that the cheque is genuine, signatures are matching, and that there is enough balance in the account. All of this can be automated using smart contracts and made more secure while reducing the risks associated with current processes. Blockchain provides a clear advantage in such cases where there is handover of assets, authentication at various stages, chances of forgery, reconciliations etc. and assigns clear ownership of any asset, a cheque in this case.
You could ask why the banks haven’t embraced Blockchain banking yet. In my view, it could be because of two reasons 1) They’re waiting for the central banks to take the lead 2) It’s too expensive to setup. Like all Blockchain ideas, its success will depend upon getting a large number of stakeholders to understand & use the platform. Once there is significant traction in terms of customers & banks, Blockchain banking is bound to create a simplistic & secure alternative to the current system.
The ideas I’ve presented above are incremental in nature, building around what happens today. Maybe we don’t need something like cheques at all, a Blockchain-based asset/value transfer mechanism could replace it. If Blockchain continues to mature as everyone is expecting, it has the potential to change the core of all interactions whether its B2B, B2C or C2C.