Jan Brzezek: How blockchains can bolster security in the financial system

After six months when a wave of bank failures in the US and Europe has shaken the financial system, how can we make it more robust? In my view, blockchain is part of the answer, cutting counterparty risk throughout banking.

It’s a new world for bank runs. In the old days, people used to learn about banks’ difficulties from newspapers and then queue outside physical branches between 9AM and 5PMm to remove their money. Today confidence is lost and money withdrawn far faster. Clients see the news online and instantly withdraw funds via their banking apps.

Blockchain technology by its nature has the power to improve resilience, even if it can’t entirely solve the problem of lightning-fast bank runs. Due to the nature of the blockchain ledger, all transactions are in real-time and can be viewed by all blockchain users. That virtually removes counterparty risk and bolsters confidence in banks through transparency.

We don’t have transparency in banking, even if some regulators think we do. Large international banks struggle with this because their trading operations are so complex. After all, when Lehman Brothers failed in 2008, it took other banks several months to work out their exposure.

What’s more, if settlement times are T+2 trade counterparties are exposed for two trading days. Blockchain mitigates that through instant settlement.

I’m not suggesting that blockchain can solve all of the financial system’s problems. Banks have to come up with a new solution such as liquidity tiers, where clients could have instant cash accounts for daily use and 30-day notice accounts with higher interest yields. That would limit their vulnerability to future runs.

It’s also true that the digital asset space has its own well-publicised difficulties. Yet increased regulation will accelerate the closure of smaller, offshore projects that will either shut down or be forced to merge with larger organisations that are regulatory compliant. Notably, the EU’s markets in crypto-assets regulation adopted in April is a game changer, setting a regulatory framework for the first time. Similarly, Switzerland has gradually put comprehensive, but sensible regulations in place over the last five years.

Above all, bringing together the best of traditional and digital finance would help to make the financial system more secure as a whole. Taken together, the regulatory probity of traditional finance and the innovation of blockchain would reduce the risk in the system, bringing many other benefits besides.

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