Rob Behnke
April 13th, 2023
In a rapidly-evolving digital world, it's more important than ever for banks to stay ahead of the curve when it comes to protecting their digital assets. This is where digital ledger technology comes into play. Digital ledger technology offers banks an efficient and secure way to manage and protect their digital assets, and in this blog article, we'll look at how banks can use this cutting-edge technology to stay one step ahead of the competition.
Before diving into the details of how digital ledger technology can help protect a bank’s digital assets, it’s important to have a clear understanding of what a digital asset is, especially as definitions of digital assets can vary.
For example, some definitions label digital assets as things of value tracked on a distributed ledger platform, such as cryptocurrencies or NFTs. However, in this discussion, we’ll use it more generally to mean assets that can be stored digitally or virtually, whether on or off of the blockchain.
(For a comparison of digital assets, virtual assets, and crypto assets, you can check out this blog post.)
Blockchains and other distributed ledger technologies are designed to maintain a shared digital ledger via a decentralized network of servers. This enables the creation of cryptocurrencies and other digital assets where proof of ownership is not tracked by any one organization.
For financial institutions, like banks, blockchain technology may be seen as the competition. However, distributed ledger technology can provide various benefits to an organization wishing to track ownership of its digital assets. Read on below for some of the biggest benefits of blockchain technology for financial institutions.
One of the core functions of blockchain technology is to track proof of ownership of digital assets. Originally, Bitcoin was developed to track ownership of the Bitcoin cryptocurrency. Since then, numerous blockchains have been created, and a wide variety of assets are now tracked on them via non-fungible tokens (NFTs).
With a blockchain, it is easy to track — and securely transfer — ownership of digital assets. Transactions can only be generated with knowledge of the private key of the account that owns the asset.
Financial institutions are accustomed to managing and securing private keys for various purposes. With distributed ledger technology, they can easily extend this to tracking ownership of their digital assets.
Financial institutions commonly need to send and receive assets from financial institutions. When their clients send money to one another, these organizations need to securely transfer funds and settle accounts.
Often, these transfers are performed over legacy systems that take a significant period to securely complete a transfer. For example, it is not uncommon for an ACH or wire transfer to take 3-5 business days to complete from the initial request to the funds being available in the recipient’s account.
With digital ledger technology, financial institutions can perform more rapid, large-scale transfers of value amongst themselves. For example, Bitcoin — which is commonly regarded as one of the blockchains with the slowest block rates — can complete a transaction in about ten minutes and have the block approving it be financially and statistically infeasible to rewrite in as little as half an hour.
Accurate record-keeping is essential to banking and financial institutions. At any point in time, a bank should be able to determine the exact amount of value held in any user’s account. Also, the financial institution may be asked to produce records for compliance, investigative, or legal purposes.
Blockchain technology differs from traditional databases because it creates an immutable record of the history of the blockchain network. Once a block is added to the blockchain, it rapidly becomes infeasible for an attacker to rewrite history and destroy these digital records.
This immutability can be invaluable for financial institutions wishing to accurately and securely track the transactions that they process and the assets that they hold for themselves and their customers. Immutable records provide a clear, trustworthy account of the history of the ledger and make it difficult to conceal fraudulent activities, errors, and other issues.
Financial institutions commonly need to walk a tightrope between privacy and transparency. On the one hand, a bank’s customers commonly want to maintain their privacy and conceal information about the contents of their accounts from prying eyes.
On the other, financial institutions need to maintain a certain level of transparency to maintain regulatory compliance and avoid bank failures. For example, the collapse of the Silicon Valley Bank (SVB) and Signature Bank was enabled by a lack of regulatory oversight of the financial institutions’ activities. SVB was able to conceal the fact that many of its investments were underwater, hiding its issues until it was nearly too late.
Most blockchain platforms are designed to offer a high degree of transparency. Every node in the network has visibility into the digital ledger; this enables them to review and validate transactions before including them in their copies of the ledger. For transactions performed on a blockchain network, a regulator with access to a blockchain node can achieve a certain level of visibility into a financial institution’s operations and more quickly identify potential issues.
Banks provide vital services to their customers. When a bank is unable to do so — even for a short period — it makes waves and looks bad for the organization.
Numerous examples of this have occurred over the past few years. A 2019 outage of Wells Fargo services was caused by a fire in a single, vital data center. In 2022, multiple Canadian banks experienced outages due to technical issues.
Often, these issues have been caused by single points of failure within an organization’s infrastructure and processes. These core dependencies — whether internal or external — can cause outages if they go down.
One of the core strengths of blockchain technology is its resiliency. Blockchains are maintained by a distributed and decentralized network of nodes, and no node in this network is essential to the operations of the blockchain.
Moving certain operations onto blockchain-based platforms can help financial institutions ensure the availability and resiliency of these services. Even if the organization’s own infrastructure goes down, blockchain-based solutions can continue providing services to the organization’s customers.
Blockchain and cryptocurrency have been derided as a passing fad since their creation and entry into the public consciousness. However, these technologies are still around and doing well, and new and novel solutions continue to be developed on them.
Expanding their service offerings to include the blockchain can expand a financial institution’s access to markets. By being the first to provide certain services on the blockchain, a bank can stay ahead of the competition and capture valuable market share.
Smart contract platforms dramatically expand the capabilities of blockchain technology. All of the benefits of the blockchain — decentralization, immutability, asset tracking, etc. — can also be applied to programs that run on top of the blockchain.
The emergence of Decentralized Finance (DeFi) in recent years has demonstrated that many services that were traditionally provided by financial institutions can also be implemented effectively on the blockchain. By embracing blockchain technology and digital assets, financial institutions can update and modernize their service offerings, creating new opportunities for themselves and their customers.
Financial sectors commonly experience periods of boom and bust. Recent events have clearly demonstrated the effects of public perception and shareholders’ fears on the health of financial organizations and other companies.
Bitcoin and other cryptocurrencies are globalized and often loosely tied to the health of markets and other currencies. This enables them to act as a counterweight and alternative store of value to help protect the health of financial institutions’ portfolios during times of financial turbulence.
Blockchain technology can be beneficial to financial institutions; however, it also comes with potential risks. When planning to move assets or services onto the blockchain, it’s important to consider the following:
Blockchain technologies come in a few different forms, and different ones are better suited for different use cases. A financial organization may choose public, private, or hybrid blockchains depending on their use case.
For example, a solution designed to track sensitive financial data may need to be hosted on a private blockchain for privacy, regulatory, and security reasons. In contrast, an organization looking to provide new services to its customers may wish to host them on a public blockchain to maximize access.
Massive hacks of DeFi and other blockchain projects are a regular occurrence. For a risk-conscious industry like the financial sector, this can be interpreted as a major warning sign.
However, one of the most common threads of DeFi hacks is that the attackers exploited vulnerabilities and business logic flaws in unaudited code. By undergoing a comprehensive security audit before release, financial institutions can ensure that blockchain-based service offerings are secure and resilient against potential attacks.
Distributed ledger technology can provide various benefits to financial institutions. By adopting digital assets, banks can stay ahead of the competition, improve their service offerings, and even reap benefits for their own security and compliance.
However, blockchain-based solutions must be designed and implemented carefully to ensure that they don’t become a costly mistake. For more information on securely making the move to the blockchain, reach out to our blockchain security experts here.