Securing Blockchain in Banking: TradFi’s Journey from Bitcoin to DeFi

Bitcoin wasn’t created to integrate into TradFi; it was an alternative that criticized TradFi. The first Bitcoin block makes this evident by including a headline from The Times, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks." 

This headline had two purposes. One was to prove that Satoshi Nakamoto didn’t premine a number of Bitcoin blocks to build up his holdings of the currency. Since he couldn’t have known this headline before it was published, its inclusion in the first block sets a hard limit on how early the first block was created.

However, any headline from any newspaper from that time could have served the same purpose. In fact, another headline might have made more sense, since the second Bitcoin block wasn’t mined until 5 days later, not the ten minutes that usually separate blocks.

The other purpose of the message in Block 0 was to highlight the fact that Bitcoin was explicitly designed to address perceived failings in the TradFi industry. By creating a decentralized currency, Satoshi eliminated the centralized power that made the 2007-2008 financial crisis possible and inspired the bank bailouts that the cited headline referenced.

This decentralization and anti-establishment ethos didn’t make Bitcoin — or more generally blockchain — popular in the early days. The cryptocurrency was commonly cited as a scam, a tool only for criminals to use, and something that was doomed to failure.

Fast-forwarding over a decade, blockchain’s image has changed significantly within the TradFi space. As the technology has endured, matured, and grown more popular, TradFi institutions are increasingly exploring it as a new element of their own service offerings.

In the early days of TradFi’s adoption of blockchain, the focus has been on addressing some of the biggest challenges that the industry faces. For this reason, cross-border payments are the top application of blockchain technology in banking, accounting for over a third of market share in 2024.

With TradFi infrastructure and processes, these types of transfers are time-consuming and expensive. A simple wire transfer can take multiple days and cost $25 or more to perform. Financial institutions also need ways to perform cross-border settlement, which can be complex as well.

In contrast, blockchain transactions can be completed and trusted in minutes for a nominal fee. These transactions are fast, transparent, and backed by cryptographic and algorithmic security guarantees. Additionally, the infrastructure required to perform these transactions on-chain is minimal, which can be useful for financial institutions that operate using different platforms and infrastructure that would otherwise need to be securely integrated to support these transfers.

In the short term, it makes sense for TradFi institutions to focus on piloting projects that offer simple solutions with significant ROI. Bitcoin and blockchain are designed to offer fast, cheap, and secure financial transfers, making them ideally suited to addressing this pain point.

While cross-border settlements and payments are a valuable application of blockchain technology, they’re far from the only one. In fact, they’re one of the simplest uses of the technology, not even requiring the capabilities of a smart contract platform.

As TradFi institutions increasingly adopt blockchain technology, one of the key building blocks is decentralized identity management. Bitcoin and other blockchains implement identity via pseudonymous addresses and public keys. Anyone can generate a public/private key pair and associated address and perform on-chain transactions. Additionally, since these addresses are randomly generated, it can be difficult to tie on-chain accounts to real-world identities, especially with single-use addresses and mixing services like Tornado Cash.

However, while this is a boon to on-chain privacy, it’s also a major stumbling block for TradFi adoption of the technology. These institutions operate under regulatory constraints, including the requirement for Know Your Customer (KYC) and Anti-Money Laundering (AML) controls. Blockchain pseudonymity limits the effectiveness of these controls and is a major limitation on TradFi adoption of the technology.

For this reason, KYC and digital identity are anticipated to be the blockchain applications with the greatest compound annual growth rate (CAGR) in the foreseeable future. Digital identity solutions with widespread adoption not only provide TradFi organizations with a feasible way to meet KYC/AML requirements but also can help to eliminate the current friction created by digital systems reliant on physical identity documents (passports, etc.) that are increasingly prone to falsification via AI deepfakes.

Blockchain technology has the potential to reshape the TradFi industry. Cross-border payments are a major pain point for customers that blockchain solves trivially. Decentralized Finance (DeFi) also offers a wealth of potential applications and use cases for TradFi institutions, as well as a larger, more global customer base.

However, any use of blockchain technology comes with its risks, and these can differ significantly from those of the Web2 era. On-chain cross-border payments are convenient but require strong custody solutions and controls to protect funds from theft. Other applications of DeFi for banking face various risks associated with smart contract and infrastructure security, private key security, and more.

Halborn has deep expertise in both the Web2 and Web3 spaces and knowledge of both TradFi regulatory security requirements and the capabilities of blockchain technology. Our advisory services offer support throughout every stage of an organization’s adoption of blockchain technology, from initial planning through smart contract deployment. To learn more about how your organization can ensure that it’s considering all of the potential risks and implementing security best practices in its on-chain endeavors, get in touch.