In banking, every action and deal has to be based on a contract that defines rights and duties. However, traditional contracts written on paper seem to be outdated in the modern digital era: their issuance is time-consuming and inefficient, they are easy to forge and destroy. Human factor plays a crucial role in their enforcement: people sign contracts and monitor whether all the conditions are being fulfilled. Humans are not as attentive and sincere as machines are — they make mistakes and break promises. Traditional financial contracts rely on physical documents, lead to delays, inefficiencies, and increased exposure to errors and fraud. Smart contracts address these issues by writing the terms of the contract between buyer and seller directly into lines of self-executing computer code.
With smart contracts, you can forget about these imperfections. Smart contracts are software, codes that include rules and penalties around an agreement as traditional contracts do, but when the conditions are fulfilled the smart contract is enforced automatically.
Smart contracts in the banking industry are easily applicable. With their help clients can exchange money, shares, property or whatever else. Here we bring you just a few examples on how smart contracts can change banking.
1. Mortgages
Mortgages are an important driver of growth for the banking industry, but the current mortgage loan process is overly complicated, time-consuming, and expensive. The application of smart contract technology could enable buyers and sellers to clearly name their terms based on predetermined conditions, eliminating surprises and dodgy deals.
Smart contracts are essentially self-executing and highly secure programs stored on a blockchain, they can be used as a core component of Business Process Management and document management systems, which are known to result in savings between 6 and 15 percent for mortgage lenders.
Individuals can use private keys to digitally sign transactions. Cryptography makes these signatures impossible to forge or reproduce by other users. Additionally, each user has a public address, linked to his or her private key.
This functions like a street address or email. It is safe to share with other users or the public at large, and it can be used to both send and receive. Only the users who own the private keys associated with a public address can execute transactions from that address. This allows transactions on the Blockchain to be securely tied to an individual’s identity.
Summing that up, what can we get using smart contracts for mortgages:
- Identify the type of loans a customer is eligible for based on credit score, savings etc.
- Transfer title to the new owner, post loan funding.
- Add a certain loan to a specific Mortgage Backed Security pool based on tranche criteria.
- Streamline all agreements.
- Notification of current status across the board to required parties.
- Fees to multiple third-party entities. As a step up from P2P lending, smart contracts could reduce or eliminate the need for a third-party intermediary in the mortgage process and instead allow parties to interact directly.
- Compliance requirements to maintain transparency at every step.
- Acknowledgement and confirmation at every step by multiple parties. Every transaction is recorded on a distributed ledger, that is incorruptible, transparent and neutral. Smart contracts define and enforce exit criteria for each step, shape the workflow and maintain complete visibility.
2. Know Your Customer (KYC)
Banks are required to verify and identify their clients in order to comply with Anti-Money Laundering (AML) laws and regulations. This process, called Know Your Customer (KYC), is costly and inefficient. Smart contracts could be used to automatically check and verify customer information against approved central records to greatly reduce the cost of customer acquisition and decrease the time it takes for a customer to open a new account.
Smart contracts can also make provision for a situation where the customers change their address, currently an administrative issue that can cause significant delay. The coding in the smart contract would require the customer to be notified automatically that they need to resubmit their proof for it to be acceptable again by the participating bank without having to require the bank to do this manually.
Here is the example how KYC works, using Blockchain technology. An institution, for example a bank, sends a request to the Blockchain network in order to access your identity data. In this architecture, such an action can only be performed with suitable user consent.
To grant consent, a user has to log in using a One Time Password (OTP) and allocate a private key to the data. The data can then be accessed by a third party who can then use it to confirm the subject’s identification. Such an immutable data source offers transparency as well as empowers users in regards to how and when they use their data.
The concept of a Blockchain based KYC platform is already being implemented by IT giants like IBM. The Shared Corporate Know Your Customer (KYC) project assures an efficient, secure and decentralized mechanism to validate, collect, store, refresh and share KYC information for customers.
It is impossible to tell how smart contracts can impact banking in one article, so we will tell you more next Tuesday. Stay tuned for updates and try to create your own smart contract on Smartz platform.
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