Can Banks Capitalize on Web3 Technologies?

The power and possibilities of Web3 represent a compelling opportunity for banks and financial services firms to consider. These emerging technologies are here to stay, and potentially transformational.

 So, what exactly is Web3 and what can it deliver?

 Web3 is a new iteration of the Web, and it is a work in progress. While there’s plenty of information about Web3 – a quick Google search yields 117 million hits – there’s also substantial confusion about what it means. Definitions are evolving, but it is generally agreed that Web3 is largely about decentralization (supporting decentralized finance, DeFi), distributed ledger technologies (such as blockchain), and tokens (which can generate smart contracts). All of these have enormous potential within financial services.    

 In theory, Web3 reimagines the Web as a collection of digital products and services enabled by a decentralized infrastructure (in contrast to previous iterations of Web that are highly centralized). Under this new architecture, privacy and trust are assured as the decentralized infrastructure gives participants ownership of their data, and the data is immutable – it cannot be altered or erased. With Web3, all transactions­ – such as payments – are recorded and irreversible, and everyone shares the same real-time market picture of events.

 Trends to Watch

Recent survey findings confirm that banks are starting to adopt Web3 to boost efficiency and innovation, and 60% of executives believe Web3 will disrupt traditional banking models.[1] The survey also notes that banks are well placed to capture the opportunities because of their history of complying with regulations, strong risk management, KYC abilities, and the trust they’ve earned with customers.

 A Closer Look at Web3 Opportunities for Banks

Web3 and decentralized finance (DeFi) are almost synonymous, and with the right approach a bank can drive innovation using both. A cloud-based digitally enabled bank can transact and work with a plethora of digital currencies and deliver bespoke banking services at pace. Even banks that aren’t as technologically advanced can quickly realize some benefits.

Blockchains are designed to authenticate users, validate transactions and maintain a record of digital information in a manner that cannot be altered. This has significant implications for bolstering identity and transaction authentication across a broad range of financial services. Benefits include streamlining banking and lending services, reducing fraud in payments, and decreasing issuance and settlement times in trading.

• Faster settlement. Finance has struggled to keep up with the 24/7 “always on” world. Although real-time transactions are becoming mainstream, many payments still take days to settle. With Web3, settlement can happen in near real time – for domestic payments and foreign currency remittances – and transaction and settlement fees can be reduced.  

• Fast, accurate credit reporting. With Web3, immutable credit histories can be built quickly using blockchain. While this is useful for banks, it is enormously beneficial for the bank’s customers whose financial wellbeing is often impeded by a lack of credit history. Blockchain also offers a strategic gateway to automate credit lending and borrowing and reduce costs for lenders and borrowers.

• Lower cost compliance. By offering total transparency and immutability, blockchain can offer a “golden source of truth” for regulatory compliance. All documents that must be disclosed to regulators are always available on the blockchain, streamlining and automating compliance to a level that was previously impossible.   

• Liquidity management. Complexity is a universal banking challenge. All liquidity managers must understand and manage a multitude of accounts in real time to assess risk and manage liquidity. With distributed ledgers, banks can obtain a real-time view of all bank accounts to manage intraday liquidity with unprecedented precision. With an accurate real-time view of funding requirements, banks can reduce their liquidity exposure and liquidity buffer requirements. Distributed ledgers also facilitate real-time settlement, which improves efficiency and allows money market transactions to be completed with greater certainty. 

• New bond issuance. Many banks are already harnessing blockchain technology to issue bonds. Historically, new bond issuance was cumbersome and bureaucratic, with long settlement delays and unclear ownership post-issuance. Smart contracts can transform bond issuance by removing manual processes and effecting same-day settlement, rather than the current 3-day settlement period. In addition to reducing cost and risks, blockchain makes bond issuance more democratic and affordable to smaller companies.

• Digital assets are a building block in the DeFi world. Blockchain allows for the creation of a multitude of digital assets, such as fungible cryptocurrencies, stablecoins, and non-fungible tokens (NFTs). For example, digital art NFTs are a perfect example of free-market economics: Ownership is unambiguous, value is determined by the members of the blockchain they’re on, and they can be freely transferred using smart contracts. 

Over time, Web3 will help to deliver a new and improved banking ecosystem, one that is powered by dramatic innovations that are likely to transform the nature of finance in many meaningful ways.

Keys to Success

Web3 is essentially about collaborative technologies, and no bank can build success on its own. Successfully harnessing these technologies requires hard thinking and a strategy that is aligned with business goals. To make the most of the opportunities, banks should speak with their trusted technical partners to better understand how to think big and start small with these transformational technologies.

[1] Bain & Company, Web3 Experiments Start to Take Hold in Banking, December 2022