Will banks soon be replaced by super-efficient computers?
In an increasingly networked world, the financial industry faces the prospect of banks becoming superfluous.
“Blockchain” technology — which facilitates financial interactions without central intermediaries — is the benchmark here. No other financial technology has ignited such a heated discussion about the possible end of banks.
The innovation actually consists of two independent inventions that are most often referred to jointly — the “blockchain” database and “distributed ledgers.”
On the one hand, current transactions are linked to a chain of all former transactions in a so-called “blockchain,” allowing all participants in the network to reconstruct a seamless history of transactions.
It is likely that blockchain will significantly influence where in the banking sector what sort of value creation occurs.
On the other, “distributed ledgers” make it possible for transactions in this blockchain to simultaneously be documented and compared in a decentralized network of computers. So it is the consensus that matters.
This means financial transactions, at least in theory, can be documented beyond recall and with no danger of manipulation. And participating parties no longer have to wait a day or longer until transactions are processed. Instead, they happen immediately.
The new technology could revolutionize not only IT infrastructures, but also market-trading and financial contracts. Expenses for administration and verification would decline enormously. Some predict the banking sector could save to the tune of double-digit billions with blockchain technology.
Of course, it would compete with existing systems of loan institutions and market infrastructures. At the moment, trust in impeccably processed transactions and in the correct administration of contractual relationships is still assured by a multiplicity of authorities inside and outside credit institutions.
But is this necessary? Already today, many visionaries question whether credit institutions are necessary when trust can also be assured by technological processes.
This issue is also interesting for banking monitors. The fact is, the blockchain prototype arose in the digital payment system for “bitcoins,” the digital currency that requires neither intermediaries nor a central bank.
This sort of decentralized bookkeeping still depends on once-defined rules and consensus in the network, but detaches itself from individual institutions and is even independent of existing social frameworks: The user community itself watches over the integrity of the system. Self-administration replaces supervisory agencies and state interventions.
But such a system isn’t “free.” This is the beginning of “domination by code,” where programers have decisive impact on the network.
Legal difficulties already arise over how faults and errors in the blockchain can be subsequently removed. And up to now, self-administered networks have failed to assure legal security of transactions.
Which future applications can be achieved with blockchain technology, and which remain pipe-dreams?
Consider: For its computer-intensive form of bookkeeping, the bitcoin supposedly requires as much electricity as all of Ireland.
And in its current construction, the bitcoin system is already threatened with bottlenecks – even though in comparison with international cash flows, the transactional share of bitcoins is negligible. Every day in the world there are some 200,000 bitcoin transactions, while Germany alone has more than 60 million remittances and debits.
But the fundamental question doesn’t concern technical feasibility but social desirability. The impression that loan institutions and other financial intermediaries can be dispensed with is an illusion, because it doesn’t take into account their underlying function.
It is true that banks and savings institutions need a dependable and trustworthy system for processing transactions or trading on the markets. But their essential contribution lies elsewhere.
Credit institutions play a fundamental role in managing the everyday risks of our society. This makes them a fixed part of our financial system. And market infrastructures not only conduct bookkeeping, but also sometimes assume responsibility for guaranteeing a smooth procedure.
Because of these risks – and not in order to protect long-established institutions – there is justification for a special status, as well as a special supervision of financial institutions and market infrastructures.
Since banks and savings institutions are subject to financial monitoring, they are accountable for their systems. Similarly, a decentralized network must be able to clearly identify who is ultimately responsible for the consequences of a programing error, for example.
So the blockchain can’t operate in autonomous detachment, but must be an integral part of the financial system.
Admittedly, this doesn’t rule out big structural changes ahead for the financial sector. And the number of institutions or market infrastructures is not set in stone. It is likely that blockchain – like other important financial technologies – will significantly influence what sort of value creation occurs and where in the banking sector.
So the practical questions are: At what point does the technology actually lower costs, offer increased reliability and avoid expensive delays — all while meeting regulatory requirements?
Because new applications can be fundamentally superior to old systems, individual financial institutions are compelled to realize new potential early on, in order to avoid chasing after new standards. This is perhaps why credit institutions are currently examining blockchain technology so intensively.
One thing must be clear here: The thinking behind blockchain and distributed-ledger technologies is only a preliminary sketch.
Ultimately blockchain can transfer almost all conceivable processes, access rights and similar into programing code. Regulators accordingly cannot and should not issue an across-the-board evaluation regarding any of the applications. The crux of the matter might very well lie in individual lines of programing.
Thus an application must continue to conform to privacy-protection regulations and meet all security standards. It is also important that the decentralized character of applications should not be an obstruction for rendering individual institutions and system operators accountable.
At the same time, monitors in the financial sector could acquire promising possibilities. For example, cyber security could be enhanced with decentralized network solutions. And certain supervisory functions could perhaps be technologically implemented and increasingly comprehensive. Time-sensitive analyses might be handled more simply.
This gives monitors and regulators every reason to explore the new possibilities, rather than waiting to examine these developments only when they are ready for the market.
Financial intermediaries define themselves not with technical resources but through their services. Like the blockchain, computers, networks and algorithms ultimately remain first and foremost tools.
There is reason to believe that in a few years such applications will be implemented in areas where significant cost advantages and increased performance can be expected.
But our financial system will continue to require that banks and savings institutions be called to account when mistakes are made – even while being open to innovation. All of this cannot be replaced by a computer program.
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