How traditional finance is becoming ‘sufficiently’ decentralized

The rapid evolution of the digital economy has brought new possibilities and risks that could revolutionize banking. The choice is simple: adapt or get left behind.

There has been considerable discussion about the impact of cryptocurrency. Certainly, in banking circles, the word crypto itself is treated with disdain, as if it were the stronghold of degenerates, criminals and money launderers. It doesn’t help that hardcore crypto believers, including both authors, affectionately refer to themselves as “degens.”

But this is not an article about meme coins and altcoins, trends and signals and making 100x returns over arbitrage. There is enough gossip and discussion about those topics in secret Telegram groups, Twitter spaces and invite-only Discord servers. This is a discussion about blockchain technology, which, contrary to colloquially held beliefs, is not synonymous with and constrained by exchanges dealing in crypto.

Crypto is one — highly visible and reported — use case of blockchain technology, but it is not the only use case and, by far, the least interesting one.

Blockchain and other advances in emerging sectors, such as artificial intelligence (AI), present a unique opportunity for the banking sector to be forced into the 21st century.

The revolution is already underway as the steady rise in fintech companies, payment services providers and innovative solutions is already prevalent in the startup world. This revolution will not be televised, but it will be narrated in real-time in late-night Twitter spaces, GitHub discussions or Reddit threads for those who know where to look.

Virtual Assets: Opportunities for financial institutions

Challenges for the banking sector will continue throughout 2024 due to a declining global economy and a diverse economic landscape. New strategies will need to be implemented to increase the capacity of banks to earn revenue, manage risk and control expenses. Financial institutions and capital markets are undergoing fundamental structural changes because of several disruptive pressures. Factors driving this trend include rising interest rates, shrinking money supply, stricter laws, sustainability requirements and geopolitical conflicts.

The widespread adoption of virtual assets is also causing a sea of change in the world of finance. Take remittances, for example. By utilizing blockchain technology, a single remittance from a bank in one country to the destination bank in another can be achieved instantly, seamlessly and frictionlessly without the need — or expenses — or multiple intermediary banks.

The customer journey can be made more transparent, secure and efficient. Banks may meet the changing needs of their customers for digital financial services and access new sources of revenue by forming partnerships with virtual asset companies that supplement the existing banking rails with blockchain technology and infrastructure.

Banks are actively collaborating with Web3 companies to improve revenue and operations. For one, real estate, stocks and bonds are just a few examples of traditional assets that banks might tokenize using blockchain. Through asset tokenization, banks may improve liquidity, shorten transaction times and simplify asset management by creating and issuing digital tokens representing ownership rights.

Consumers can access novel forms of borrowing, lending and trading services when banks integrate hybrid decentralized finance (DeFi) protocols. Banks can broaden their product lines, reach a wider audience and increase their income from transaction fees thanks to DeFi.

Banks can automate several financial activities through smart contracts, such as contract validation, settlement and compliance. Smart contracts are self-executing programs that automate a set of predefined actions required in an agreement or contract. Once the actions are complete, these transactions are trackable and irreversible, removing the need for intermediaries.

Institutions can also tap into the technology for user information protection. By utilizing blockchain-based identification solutions, businesses can create digital identities that are both safe and verifiable. This integration improves client onboarding processes and helps fight against fraud and identity theft. Zero-knowledge proof (ZKP) protocols are a perfect example of this, allowing customers and institutions to verify whether something is true without disclosing any further information apart from the fact that a specific statement is true.

Lastly, banks can take part in decentralized lending and asset management protocols by using blockchain to provide investment possibilities and collateralized loans, either against real-world assets (RWAs) or directly against virtual assets including nonfungible tokens (NFTs).

Virtual Asset challenges, regulatory environment

Despite virtual assets’ enormous promise, the intricate regulatory environment presents several obstacles for banks. While they seek to find a middle ground between fostering innovation and protecting customers and investors, regulatory regimes differ greatly between jurisdictions. Banks must follow strict compliance regulations to reduce the likelihood of financial crimes, fraud and money laundering. Considering that banks are already one of the most highly regulated financial services institutions, a new set of regulations to address a new asset class should be neither surprising nor especially onerous as banks are uniquely placed to build such requirements within their compliance teams.

Virtual asset framework in the UAE

Commercial and licensed banks in the United Arab Emirates are leading the way in using blockchain technology and virtual assets. Virtual asset companies can function and innovate in a trustworthy and secure environment supplemented by rigorous regulatory frameworks.

As UAE banks work with the various regulators to identify the best path forward, it is clear that the UAE’s unique selling point is its presence of active, invested and highly competent regulators who are taking Web3 seriously and have identified it as the future of the economy. This foresight, in our view, will pay huge dividends in the years to come.

The UAE government has claimed a global leadership role in defining what the future will look like, pairing visionary aspiration with a relentless focus on execution.

As a bank, CBI is fully committed to supporting the government in achieving its vision. We strongly believe that the best way to predict the future is to help shape it and to help shape it, you first need to understand it. This is why it adopted an approach of continuous experimentation, working closely with our network of expert partners like TLP Advisors on proof of concepts (PoC) and pilot studies to identify and develop meaningful use cases to integrate new technologies, while simultaneously ensuring full regulatory compliance and the right security and control standards to safeguard customer interests.

Future of banking in the Web3 era

There are plenty of exciting new opportunities to explore. Yet, it is imperative that we do so in a manner that reflects the trust, safety and credibility of a regulated bank.

One thing is for certain — banks have to face the rising reality of the disruptive impact of virtual assets and the digital economy on a century-old model of doing business. The financial institutions that mould themselves within this rapidly changing landscape will be the ones to win the revolution and emerge stronger, better and leaner as a result.

The revolution is not something to be expected in the future or off in the distance. It is already here and thriving. With the advent of a new bull run, there has never been a better time to be a banker with an eye for Web3 innovation.