Blockchain technology could be the banks' answer to mobile money
Digital ledger software, such as blockchain, has captured the interests and imaginations of researchers, banks, real-estate companies, insurance companies, innovators and entrepreneurs and everyone else interested in the next big step in technology. It is safe to say that blockchain has the whole globe buzzing and every sector moving to be the first to use this technology and reshape their sector.
Transactions and trust
You might know all about it or heard talk about or know nothing about it; blockchain is a complicated system to grasp but the idea is simple. Through every transaction the most important element is trust. You see the item you want to buy, bring it to the cashier, they tell you the price, you pay and get your brand new item. A simple transaction filled with trust because you were physically part of it and you know it happened. The cashier also knows it happened as he too was there and received the money in return. A fully trustworthy transaction.
Now, bring this transaction online. You see something you want online, you buy it and then what? You don’t have your brand new item in your hand, in fact you can’t honestly know where it is. On the other side how does the cashier know if you are who you say you are or if the money was truly sent? Without a doubt online purchases are filled with uncertainties, however that is why we have a third party actor, a middle man acting as the mediator to ensure safe and secure transactions online. But a middle man comes at a price. A typical online transaction using a debit/credit card goes through six intermediaries before the payment reaches the seller bank account. The payment request from the merchant goes through an aggregator like Authorize.net who sends a request to the card network like Visa. Visa initiates a payment request from the buyers bank which issued the card and then another intermediary is responsible to settle the transfer from the sellers bank and the buyers bank. The actual transfer of money can take several days. Most notably each and every one of these intermediaries takes a cut of the transaction amount.
The third party will charge for their services and will take something of the total price, a transaction cost, meaning every time you purchase something online, a book, stocks or air fare, you will also pay the mediator. So, why not have a system that is just as trustworthy as a real life transaction, like the one where you are in the store, but online?
Bring in Blockchain
The appeal of digital ledger software is that it takes out the third party and therefore the removes the transaction cost. Through its participants a blockchain system can confirm all transactions within the network. The participants being a connection point for all the networks that are part of the system and have an identical copy of the entire ledger. In the online shopper scenario, the payment transaction initiated by the buyer will result in direct debit to the buyer’s account followed by a direct credit to the sellers account in the digital ledger. There are no intermediaries. Each transaction will be processed by the participants and as soon as the majority of participants confirm the transaction, it is added to the digital ledger for good. This creates a system that is hard to cheat as everything is recorded by everybody. A participant cannot sell a product twice as the system will recognize the earlier transaction and likewise the same value cannot be sent twice as it too is recorded. Thus creating a safe and transparent system.
Furthermore, removing a third party allows for transactions to be more efficient. Many settlements can take days to confirm which creates costs. To take away the intermediate that has to make phone calls, negotiate, check credit etc., a distributed electronic ledger software will save both time and money.
Most commonly the blockchain system has been associated with money transactions, however another favourable attribute to this system is that it can work for all sorts of “transactions”, whether it is money, identity records, real estate ownerships, car leasing and company licenses. Though other sectors are moving to implement blockchain, it is the banking sector that has a lot to benefit from this system. The blockchain system has already been tried and succeeded when it comes to money transactions. Bitcoin, the most widely used, is a form of digital currency based on blockchain technology. Computer manufacture Dell and overstock.com have about 20 percent of the payments through Bitcoin. So what does this mean for the banking sector in Uganda?
In Uganda the telecom (telco) have given the banking sector a run for their money with mobile payment systems. With more than half the population with access to a mobile phone, money transactions can easily happen without having a bank account. What might have been a threat to the banking sector is actually a door of opportunity.
Worldwide the banking sector has been at a standstill while new innovations and platforms are created daily thanks to technology. Now the blockchain system has the whole sector buzzing and major banks, such as JP Morgan, Goldman Sachs and Barclays, are taking the much needed initiative to explore how Blockchain can be used to better their systems and better compete in a mobile world.
A blockchain system offers a great opportunity to save time in all parts of a transaction, something that would greatly benefit the banks in Uganda. Today if someone wanted to move money from their bank account to their mobile money account, there are three different systems that must record this transaction. First the bank has to update its ledger. To access the telco mobile money system about this transaction, the bank has to go through an intermediary “aggregator” who has to record this transaction in their ledger as well. The intermediary will then request for this transaction to be recorded into the telco’s mobile money ledger system. One transaction results in three different ledgers affected, which leads to a long stray of delays, security vulnerabilities as the transaction is propagated between the different entities, and of course accounting bottlenecks resulting from incomplete transactions at any one stage of the transaction. The latter can cause settlement and reconciliation to be an operational pain. Today it’s common for banks, Telco’s, and other institutions to maintain suspense accounts holding billions of unsettled funds. This happens when the bank initiates a payment to a recipient e.g. Umeme on behalf of its customer electronically. If the recipient does not confirmed receipt of this payment to the banking platform for whatever reason, the transaction will be considered incomplete and therefore will be left in a suspense mode until settlement and reconciliation is complete. This is very common since systems loose connectivity, servers malfunction and so forth. Very many times the systems banks are using are not built to manage these potential outcomes.
With a blockchain system, the transaction is recorded once and cannot be changed ever. Any changes are recorded as blocks of new transactions. All subscribing entities to the platform are informed in real time of the transaction. The blockchain ledger is maintained by a network of computers which all have a copy of all transactions. These computers will primarily be connected to each other over the internet. This means that a request to add a transaction must be accepted by all other participating computers which makes it hard to manipulate by one single person. In practice this would mean a couple of financial institutions would be nominated to host the different nodes belonging to this network of computers and the rest i.e. utility companies like Umeme, National Water and Sewerage Cooperation, small and large businesses, NGOs, SACCOS, Microfinance institutions, etc. will just be users. Participants can move money from a bank account to a mobile money account and vice-versa regardless of telco network or bank. This effectively gives mobile money users access to banks accounts and vice-versa which gives banks access to the millions of “unbanked” consumers banks have been “drooling” about. The telco’s have a lot to gain as well. Some of their mobile money customers collect part of their revenues through the mobile money system but have to pay suppliers with cheques or electronic transfers. Other customers especially individuals, might want to enjoy the benefits that mobile money brings like a large agent network distributed across most parts of the country. To these customers, these agents are like ATMs. The customer moves their money from their bank account to their mobile money account and all of a sudden there is an endless supply of agents where cash can be withdrawn.
Figure 1: Using distributed digital ledgers like blockchain, banks and mobile network operators can all be participants in one distributed digital ledger that is transparent to all. This allows several possibilities to like instant transfer of funds from one bank to another or from one bank to a mobile money account
For the banking sector in Uganda changing from a paper based system to a fully digital one can seem as a scary undertaking, however once the concerns are addressed there is no reason why Uganda can’t be a first mover for better and more efficient banking systems.
Security is a major factor when talking about one platform that will store all transaction information between parties. However, a blockchain system has a major security factor in its favour as there is no human element part of this system. Each transaction will be processed and confirmed through trusted connection points (nodes) with no human interference necessary. This means that no one actor can exploit vulnerable information and manipulate the system.
In addition to removing the human element from the process of transactions there will be more transparency within the banking sector. Though the system is based on an open source platform it can be tailored for each specific bank allowing them to protect not only their client’s private information but also their own without physically having to do it. No files will be hidden or lost yet they are still safe and private.
The future of Banking
Optimistically blockchain and digital ledger systems like it, will change every sector that has transactions whether it is the banking, finance, real-estate, retail, insurance, etc., in fact it has already started. Nevertheless, realistically there is still a way to go before such a system is fully operational and can be implemented into each sector.
The important thing is that there is no reason the banking sector in Uganda can’t join the efforts to revolutionize its banking systems. Especially with qualified software companies easily available locally and ready to be their partner in a brave new world of global banking technologies.
Timothy Musoke is Co-founder and Head of Consulting and Technology at Laboremus Uganda
This article was published in Financial Services Magazine, December 2016 issue