In this conversation, we delve into the intriguing world of blockchain technology and its potential application in the banking sector, together with our guest - Rashad Khalafov, the Chief Information Officer of one of Azerbaijan's leading banks. We discuss the benefits it can bring, the challenges it might pose, and the strategies needed to overcome these obstacles.
Before we dive into the world of blockchain, let's discuss one important thought. Today, blockchain technology and cryptocurrencies are often perceived by society as one and the same, and interest in them is primarily associated with the opportunity to make money. Unfortunately, such a perspective takes us away from the core essence of blockchain and its potential to improve our everyday experience and business development.
Blockchain is not just a tool for quick profit. Instead, it is a technology that can change the way we interact, transform business processes, and open doors for innovation. Unfortunately, in the public consciousness, blockchain/cryptocurrencies are too often associated with speculation, where people often risk and lose their money, like in a casino.
However, it's important to understand that blockchain is much more than just cryptocurrencies. It can help us create transparent data management systems, ensure transaction security, and increase efficiency and reliability of processes in various sectors. Instead of viewing blockchain as a playground where you can quickly make/lose money, let's look at it as a tool that can improve our daily lives and assist in the development of new products and services.
It's important to recognize the potential of blockchain and learn how to apply it to solve real problems, optimize business processes, and create new opportunities. Blockchain is not simply a casino game, but a powerful tool capable of changing our world if we learn to use it for the right purposes. Going forward, I will try to demonstrate the uniqueness and value of this technology, so readers can see how it can be useful and how its use can bring real benefits in different areas of our life, particularly in finance.
What are the main blockchain technologies currently being used in the modern banking sector, and what prospects for the development of blockchain applications in this sector can we expect in the future?
In the modern banking sector, blockchain technology has already found applications in several areas, and even greater expansion of its use is expected in the future.
Transactions registration and verification: Blockchain is used to create a transparent and secure system for registering and verifying financial transactions. For example, Ripple (XRP) allows banks to carry out international payments quickly and with minimal transaction fees.
Improving KYC (Know Your Customer) processes: Blockchain is used to create a distributed database containing information about a bank's customers, which helps verify clients' identities more efficiently and securely. An example of this is the platform for sharing KYC data between banks, a company called Verified.Me.
Securities Management and Trading: Blockchain simplifies and automates the processes of managing and trading securities. For example, NASDAQ has developed the Linq platform, which uses blockchain for issuing and trading shares of private companies.
Interbank Transactions and Settlements: Blockchain enhances the efficiency of interbank transactions and settlements, reducing the time and costs of processing. An example is the We.Trade platform developed by a group of European banks to simplify international trade.
Accounting and Auditing: Blockchain can be used to create a reliable and immutable accounting and auditing system, which makes it easier to verify financial reporting and audit transactions. This helps manage risks. An example is the Quorum platform developed by JPMorgan Chase.
As for the future prospects of blockchain applications in the banking sector, they could potentially revolve around several areas:
Integration with other technologies: Blockchain will integrate with artificial intelligence (AI), the Internet of Things (IoT), and other cutting-edge technologies, creating more sophisticated and innovative solutions for banks.
Imagine a bank that implements blockchain to create a transparent and reliable supply chain management system for its corporate clients. Blockchain will record each stage of the supply chain, from the manufacturer to the end consumer, while the Internet of Things will provide data about the location and condition of goods. Such a system would allow the bank and its clients to track deliveries in real time, improving the transparency and efficiency of the process.
Development of Smart Contracts: Smart contracts, an integral element of blockchain, will continue to evolve, automating and simplifying the fulfillment of contractual conditions between parties.
An example of the use of smart contracts could be a decentralized platform for buying real estate, such as Propy. Instead of the traditional approach, which requires trust in agents and intermediaries, blockchain and smart contracts allow property owners and buyers to enter into a contract directly and automatically fulfill the contract's terms. A bank can play the role of a financial intermediary that provides credit for the property purchase and participates in the smart contract process.
Decentralization of Financial Services: Blockchain can contribute to the decentralization of financial services, allowing users to interact directly with each other without the need for centralized intermediaries, and financial organizations can act as guarantors and validation nodes.
A bank can act as a guarantor in the blockchain network to ensure the reliability and security of financial operations or participate in the blockchain network as a validator node responsible for confirming and verifying transactions.
Digital Currencies and Stablecoins: Blockchain could form the basis for the issuance and use of digital currencies and stablecoins, simplifying cross-border payments and transfers. A financial institution can act as an intermediary in the exchange.
For example, if a user wishes to convert one digital
currency into another, a bank can provide exchange services with
the appropriate exchange rates and ensure the security and
reliability of the operation.
A good example of successful implementation of digital currencies
at the national level is the Digital Yuan (CBDC) in China. China's
national digital currency, officially known as the Digital Currency
Electronic Payment (DCEP), is used for everyday transactions within
the country's digital economy.
How can blockchain technology help increase efficiency and reduce costs in banking?
One of the main advantages of blockchain is the elimination of the need for centralized intermediaries. Instead, blockchain allows participants to interact directly with each other, simplifying and accelerating processes, and reducing costs associated with commissions and intermediate stages.
Blockchain also contributes to reducing bureaucracy and transaction processing time. The distributed ledger of the blockchain will enable banks and their clients to work together on transactions and other banking processes. This reduces the need for repeated verification and manual data processing, ultimately cutting down bureaucratic procedures and the time spent on processing operations.
Security and transparency are two more important aspects that blockchain brings to the banking sector. Due to its structure and immutable transaction history, blockchain provides a high level of data security. Blockchain transparency allows participants to track and verify transactions in real-time, which helps improve control and reduce fraud and falsification risks.
Another important aspect of blockchain application in banking is the possibility of using smart contracts. Smart contracts are program codes that automatically fulfill contract conditions without the need for intermediate stages or third-party involvement. This simplifies and automates processes, such as transaction registration, payment accounting, and contract condition fulfillment. Automation through smart contracts contributes to increased efficiency, error reduction, and cost-cutting.
Finally, blockchain can assist in improving KYC (Know Your Customer) processes and complying with regulatory requirements. The creation of distributed databases containing verified customer information allows banks to more efficiently fulfill customer identification processes and comply with regulatory requirements.
Taking all the above into consideration and assuming that the next generation of automatic banking system (ABS) will be developed based on blockchain technology, this provides the bank with significant opportunities to reduce CAPEX and OPEX for updating and maintaining the internal IT infrastructure.
Imagine every bank employee's computer, as well as the client's device running the bank's mobile application, will act as a node for storing and processing all financial transactions. This allows for more efficient resource use as data will be stored and processed decentrally, without the need for a centralized server. Also significantly increases the system's throughput and provides a higher level of security.
What aspects of security and privacy need to be considered when using blockchain technology in the banking sector?
One of the main aspects of security in the blockchain is data protection using powerful encryption algorithms such as AES and RSA. These algorithms ensure the confidentiality of information and protect data from unauthorized access.
Another important aspect is access management and identification. Banks can apply reliable authentication methods, such as two-factor authentication or biometric scanning, to ensure secure access to the blockchain network and prevent unauthorized access.
In addition, there are specialized blockchain platforms that offer data privacy. They allow banks to set flexible access rules and control who can see specific data in the blockchain.
Physical security of the blockchain infrastructure is also important to note. Banks must ensure the protection of servers and nodes where blockchain data is stored from unauthorized access and physical threats.
Ultimately, by using these technologies and approaches, blockchain helps banks ensure a high level of data security and confidentiality, which is a fundamental factor in modern banking.
What barriers can you tell about, as well as ways to overcome them, when implementing blockchain technology in the banking sector?
The implementation of blockchain technology in the banking sector can face several barriers, both in general world practice and in the context of Azerbaijan. One such barrier is regulatory and legal constraints. In many countries, existing legislation does not always take into account the specifics of the blockchain, which can create uncertainty and hinder its implementation. To overcome this barrier, active interaction with regulators and government bodies is necessary to develop and adopt appropriate regulations that support the use of blockchain in the banking sector.
Another barrier is the lack of standards and compatibility between different blockchain platforms. This can hinder data exchange and interaction between different blockchain systems. To overcome this barrier, the development of universally accepted standards and protocols is required that ensure interoperability between different blockchain platforms.
Technical limitations are also a significant barrier to the implementation of the blockchain. Some public blockchain networks may have limited bandwidth and require significant computational resources, which may be insufficient for large-scale banking operations. Developing new consensus protocols and optimizing the architecture of the blockchain can help overcome these technical limitations and ensure high performance and scalability.
A lack of education and awareness is also an important barrier to the successful implementation of blockchain in the banking sector. Blockchain is a relatively new technology, and many banking employees and regulators may not have sufficient knowledge and understanding of its advantages and capabilities. Educational programs, training, and active information sharing can help overcome this barrier and increase the level of awareness and staff preparedness.
I believe that to overcome these challenges and successfully implement this technology, active cooperation between banks, regulators, and the technology community within the country is necessary. It is important to exchange experiences with other countries, adapt international standards to local conditions, and develop innovative projects to ensure the successful implementation of blockchain in Azerbaijan's banking sector.
Despite the fact that many issues still require resolution in terms of applying and developing the technology, there are successful and innovative examples of blockchain implementation at the state level in our country. One such example, already available for public use, is the Digital Identification System (Rəqəmsal İdentifikasiya Sistemi). This system, created with the support of the Central Bank and IBM corporation, is based on blockchain technology.
Ultimately, regardless of the technology underlying the financial product, our goal is to create a high-quality and useful product for the client, the use of which does not necessitate understanding the technical details of its operation.