Risks of implementing blockchain in fintech

Disruptive effects of blockchain will be in financial services

Sep 13, 2018
Financial services Blockchain Fintech

In the landscape of innovative disruption, the public’s attention is often focused on bitcoin’s impact on financing and investment options. However, it is important to understand that blockchain, the underlying technology that is often conflated with bitcoin, carries an even greater potential to disrupt many industries worldwide. 

The attraction of blockchain technology is its promise to provide an immutable digital ledger of transactions. As such, it is this underlying technology—an open, distributed ledger—that makes monetary and other transactions work. These transactions can include bitcoin, but they may also include records of ownership, marriage certificates and other instances where the order and permanence of the transaction are important. A blockchain is a secure permanent record of each transaction, one that cannot be reversed. 

Blockchain usage in financial technology

One of the most disruptive effects of blockchain will be in financial services. Between building cryptocurrency exchanges and writing digital assets to a blockchain, the innovation that is occurring today will have a lasting effect on the industry. 

One of the principles of blockchain technology is the removal of intermediaries. In financial technology (also known as Fintech), the primary intermediary is a bank or other financially regulated entity. This disintermediation has a dramatic effect on how fintech companies build their products and ultimately requires them to take on a greater regulatory burden. 

Key risk considerations

The first regulatory burden to consider concerns an often-forgotten practice that banks perform on a daily basis known as KYC, or Know Your Customer. Every bank follows anti-money laundering (AML) laws and regulations to help limit the risk of being used as conduits to launder money or fund terrorism. Remove the bank intermediary, however, and this important process now must occur before allowing customers to use the platform. While some companies may choose to outsource this to a third party, it is critical to remember that while a third party can perform the process, the institution still owns the risk. 

There are other regulations that should be considered as the technology is designed as well. The General Data Protection Regulation (GDPR), the European Union’s privacy law, is a good example of how regulations apply differently on a blockchain. One of the GDPR rules concerns the right to be forgotten. Since transactions are immutable and cannot be erased or edited, companies need to ensure that data they write to a blockchain doesn’t fall under these regulatory frameworks. 

Finally, while blockchains are sometimes considered “self-auditing,” that does not mean that the role of an auditor disappears. For example, revenue recorded on a blockchain can support a financial statement or balance sheet audit. While there is assurance that the number recorded has not been modified, auditors still need to understand and validate how revenue is recognized. 

Blockchain compliance by design

The use of blockchain technology has the potential to generate great disruption in the marketplace. Successful implementation will come to those who consider the risks upfront while embracing the existing regulatory framework. There has already been incredible innovation, and this is only the beginning of a massive journey of change.

RSM contributors