How Blockchain Boosters Say It Can Protect the Global Economy

During the 2008 financial crisis, Lehman Brothers collapsed just months after posting $4 billion in earnings, brought down by troubles hidden in opaque accounting and complex financial instruments. Nearly 15 years later, history repeated itself when FTX’s collapse wiped out $12 billion in customer funds that many had trusted would be their life savings.

Proponents have long said blockchain technology, born after the 2008 crisis, offers a potential solution to these financial catastrophes through radical transparency. Blockchain’s distributed ledger system could make deceptions like those at FTX nearly impossible by creating an immutable, shared record of all transactions.

While significant hurdles remain—from technical challenges to the kind of institutional resistance Sam Bankman-Fried himself decried while committing his own massive fraud—the technology’s promise of transparency and security has led many of today’s corporate giants to invest hundreds of millions integrating it into their processes. Below, we take you past the marketing and hype to explore the real possibilities ahead for this technology.

Key Takeaways

•  By creating a shared, tamper-proof ledger of transactions, blockchain technology might enable regulators, investors, and the public to verify the accuracy of financial information in real time.
• This could mitigate fraud, improve risk assessment, and increase accountability within the global financial system.
• The transparency, immutability, and traceability inherent in blockchain can be used, proponents say, to improve processes in supply chain management, manufacturing, healthcare, and other industries.
• They argue that this could improve the tracking of goods, increase efficiency, reduce costs, and ensure far better data security across the global economy.

The Case for Blockchain in Financial Security

Blockchain offers shared digital ledgers that everyone can see but nobody can alter without everyone knowing. It’s much like how a group of friends might use a Google spreadsheet to track shared expenses, except this ledger is encrypted, permanent, and extremely difficult to fake.

The technology’s advocates emphasize its potential for protecting the global economy through transparency. When a bank or investment firm makes a transaction on a blockchain, they argue, it’s like writing in permanent ink— there’s no erasing or hiding it. This visibility, they suggest, could help prevent the kind of hidden financial troubles that led to disasters like the 2008 financial crisis.

For example, blockchain supporters point out that if Lehman Brothers had been operating on a blockchain system in 2008, regulators might have spotted their dangerous levels of risky investments months before their collapse. Similarly, they argue that such transparency could have revealed FTX’s misuse of customer funds before billions were lost.

Many people rely on banks to safeguard their life savings and provide capital when needed through loans or credit. Brokerages hold billions of dollars in investment accounts, and money flows between people, institutions, and governments using third parties. Thus, trust is one of the most important factors driving the need for blockchain or something similar. Sitting right beside trust on the financial importance scale is verification. No matter who or what an entity is or claims to be, the trust in them should always be backed up by verification.

Blockchain proponents argue that the technology takes care of these needs by providing any other interested party the opportunity to verify the trust they place in people and institutions.

For blockchain supporters, the idea plays out as follows: A central bank would no longer rely on individual bank reports to review their operations and records. Because there would be a shared record of transactions, regulators could monitor cash flows as transactions are made, which means central banks would always have a realistic picture of liquidity and the distribution of risk. They would also have an understanding of how each individual financial firm is behaving. This could remove large amounts of uncertainty from the process of assessing the financial system’s health. Regulators would know in advance when there’s instability in the markets, and they could adjust monetary policy accordingly before a crisis develops.

Financial Institutions and Blockchains

The adoption of blockchain technology requires buy-in from a wide range of financial institutions, from global banks to local credit unions. However, many major financial players have already developed private blockchains for their internal operations rather than embracing the transparent, public systems that advocates have envisioned.

While these private blockchain implementations aren’t necessarily designed to deceive, critics worry that they may fall short of providing the public accountability that could help prevent future financial scandals. Blockchain advocates argue that only systems allowing public or regulatory scrutiny could effectively deter misleading practices, as participants would know their actions could be monitored by any interested party.

Private Blockchains in Financial Services

Major financial institutions like JPMorgan Chase & Co. (JPM), Goldman Sachs (GS), and Citigroup Inc. (C) are developing private blockchain networks that offer some of blockchain’s promised benefits. These private or “permissioned” systems give institutions more control while still providing the following:

• Internal transparency: Transactions between departments and subsidiaries can be tracked and verified instantly.
• Operational efficiency: Automated settlement and clearing processes cut down on the time and costs for international transfers, trade finance, and securities trading.
• Selective data sharing: Banks can share specific transaction data with regulators or partners while maintaining confidentiality of sensitive information.
• Smart contract automation: Standardized agreements and processes can be executed automatically, reducing manual processing and potential errors.

For example, JPMorgan’s Kinexys platform uses blockchain technology to process billions in daily transactions between institutional clients, and the HSBC-backed Contour network aims to simplify trade finance documentation between banks and businesses.

However, these private systems don’t provide the public accountability that blockchain advocates say is necessary to prevent future financial crises. Critics argue that by keeping their blockchains closed, financial institutions maintain the same opacity that enabled past financial scandals, just with more efficient technology.

Challenges and Limitations

Despite blockchain’s promise, several hurdles remain before widespread adoption could occur:

• Technical scalability: Present-day blockchain systems can process only a fraction of the transactions that traditional financial networks handle daily.
• Regulatory framework: The lack of clear regulations around blockchain technology creates uncertainty for institutions considering adoption.
• Implementation costs: Converting existing financial systems to blockchain requires significant investment in infrastructure and training.
• Energy consumption: Some blockchain systems, particularly those using proof-of-work verification, require substantial computing power and electricity.
• Industry resistance: Financial institutions may resist changes that increase transparency and reduce their control over financial data.

The Road Ahead

While blockchain technology offers potential solutions to many financial system vulnerabilities, its implementation will likely be gradual. Some industries may adopt blockchain more quickly for specific use cases, such as the following:

• Cross-border payments and remittances
• Trade finance documentation
• Securities settlement and clearing
• Supply chain financing
• Digital identity verification
• Regulatory reporting and compliance

The success of these applications could pave the way for broader adoption across the financial sector, though the timeline and extent of this transformation remain uncertain.

How Will Blockchain Affect the Economy?

Blockchain’s impact remains uncertain, but proponents say it could reduce transaction costs, increase transparency across industries, and help prevent fraud. The technology might make financial systems more efficient by automating verification processes and removing intermediaries. However, significant technical and regulatory challenges must be overcome before such changes could be realized.

How Can Blockchain Help Emerging Economies?

Advocates suggest blockchain could help emerging economies by reducing corruption, lowering the cost of cross-border payments, and providing financial services to unbanked populations. However, implementation would require significant investment in technology and training.

What Are the Drawbacks for Implementing Blockchain?

Major challenges include the following:

• Technical limitations in processing large transaction volumes
• High energy consumption, particularly for proof-of-work systems
• Regulatory uncertainty across jurisdictions
• Integration difficulties with existing financial systems
• Industry resistance to increased transparency
• Data privacy concerns
• The costs of implementation and training

The Bottom Line

While blockchain technology offers potential solutions for increasing financial transparency and security, its widespread adoption faces significant hurdles. Financial institutions are exploring private blockchain systems to improve their internal operations.

As with any technology, the ultimate impact of blockchain will depend not just on its technical capabilities but on how institutions, regulators, and markets implement it.