Banking in a disrupted world: The impact of blockchain technology on the banking system

Will banks be able to successfully transform themselves to rise to this challenge?

Alexander Lips, Douwe Werkema

November 2018

Banking on blockchain

“Bitcoin was the first virtual currency that made use of the blockchain technology in 2009. Soon it became clear that the technology behind the Bitcoin could shake up the financial sector. The blockchain-technology has the potential to reinvent the global transaction traffic, if not the total financial system.”

The quote above taken from ABN-Amro indicates the impact the blockchain can have, especially within the global banking system. We think there are a lot of challenges related to the subject of blockchain technology. Because of this possible huge impact, it is possible to assess this topic from different perspectives. The first perspective is that of a regulatory point of view. One can think of questions related to the stability of the banking system or will it make banking, for example, more efficient.

Another way of looking at it is from a fraud-sensitive point of view. Is this new technology more likely to promote fraud, like money laundering? Obviously, there is a reason why the New York Department of Financial Services gathers information to get a better picture of Bitcoin, in order to get a broader picture of anti-laundering programmes, consumer protection measures and, investment strategies. A lot of companies working with crypto-currencies do not abide by the law, according to the report written by Munsterman in 2013.

The subjects described above are just a few topics related to the blockchain. However, The topic we will discuss is a combination of the two topics as described above. The regulatory perspective and the fraud perspective are opposites of each other. That is also why we think they go hand in hand. With the Swiss bank secrecy laws under pressure (at least in the Netherlands), will blockchain be the new Holy Grail in financial secrecy?

Before plunging into the world of blockchain regulation and the opportunities blockchain may create. We first need to establish a clear definition of the concept of the blockchain. For most of the people, the blockchain concept is very hard to grasp. Throughout the internet, there are a lot of definitions trying to summarize what blockchain means. The definition of blockchain according to Kakavand et al. (2017) is: “Blockchain technology is the use of a distributed and decentralized ledger for verifying and recording transactions. The technology allows parties to send, receive, and record value or information through a peer-to-peer network of computers.”

Fin- and/or RegTech

It is clear that blockchain is a booming development, there are sounds that it may be as impactful as the internet. But what is the status from a regulatory perspective? One should think that a technological development like blockchain, that has the potential to impact the global financial system is subject to heavy regulation. Anyway, that is our opinion.

There are multiple relevant regulators. Those are the European Securities Market Authority (ESMA), the UK Treasury and multiple US regulators (SEC, CFTC, FinCEN). ESMA recognizes its “…. its potential to streamline financial processes and to save costs.’’ But what about implemented concrete regulation? Looking at the ESMA report, we can conclude that is still reserved in concrete regulation. “At this stage, ESMA believes that it is premature to fully appreciate the changes that the technology could bring and the regulatory response that may be needed, given that the technology is still evolving and practical applications are limited both in number and scope.”

Is this the overall sentiment among regulators? The UK Treasury comes up with recommendations regarding global perspective, disruptive potential, and privacy among other things. But just as the ESMA the UK Treasury reports that the “Government needs to consider how to put in place a regulatory framework for distributed ledger technology. Regulation will need to evolve in parallel with the development of new implementations and applications of the technology.”

When looking at the US regulator it is already possible to see concrete evidence of applying the blockchain technology. For example, the SEC intends to approve the filing of a common stock (Overstock’s S-3) where the issue of this stock is via the blockchain platform, “...which would make it the first world’s first public blockchain security.”

Looking at the multiple reports of European regulators and US regulators regarding the blockchain technology it is fair to conclude that overall tenor is the same. That is, regulators are able to recognize and identify potential advantages as well as potential risks and/or threats.

Then the question arises. What is the impact of regulation on privacy? Especially in the setting of bank secrecy laws. Is blockchain indeed capable of substituting the Swiss banking secret?

Switzerland’s best-kept secret

In order to find an answer to this question, it is wise to take a closer look at the current situation in Switzerland. As many people know, the Swiss bank secrecy laws prohibit people from working in the Swiss banking industry to disclose any information regarding their clients. According to Reuters: “Swiss bankers have long adhered to an unwritten code similar to that observed by doctors or priests. Bankers do not acknowledge clients in public for fear of exposing them as account holders; they often carry business cards with just a name, rather than bank or contact details; and, at least until the 1990s, they never advertised abroad.” Bank secrecy is in the DNA of the country, just as the watches and their chocolate.

It took one man to force the Swiss government to loosen their bank secrecy laws and made the banks pay a significant amount in penalties. Bradley Birkenfeld was an American banker working for UBS at that time in the United States. He is one of the only four people known in the Swiss history that ever blew the whistle. He ultimately gave up the names of 4,450 wealthy Americans that were clients of UBS. These clients all owned holdings in Switzerland for tax evasion reasons. Besides the prosecution of these tax evaders, UBS plead guilty to charges against them claiming to help American citizens evade taxes, and was fined with an amount of $780 million. Birkenfeld received 40 months in a Federal Penitentiary for his cooperation in evading taxes. However, later on, he was awarded a compensation of $104 million for helping the United States government recovering a lot of otherwise not paid taxes.

This event was the beginning of a series of other governments openly accusing the Swiss banks of helping their inmates to evade taxes. The European Union is putting a lot of pressure on the Swiss government to force their banks to disclose information about their clients. This pressure means uncertainty for a lot of clients who are not trusting their money to be safe from the government in Switzerland anymore. An uncertainty like this can of course increase the demand for new ways to hide the client’s money. Ways that maybe include making use of the blockchain technology.

The rise of Swissborg

Rising demand for certain services means that there are new companies that are trying to fill in the gap between demand and supply, newcomers like Swissborg. Swissborg is one of the many initial coin offerings (ICO’s) that make use of the blockchain technology to tackle some sort problem that comes with a current technology or industry. In 2015 Cyrus Fazel and Anthony Lesoismier took the leap and began working on a start-up that is now called Swissborg. Both already had extended experience in the financial industry, Cyrus quitted his job as a Senior Hedge Fund Advisor, and Anthony was working as a Derivatives Equity Trader before he deep-dived into the world of Fintech start-ups.

While working in the financial industry they encountered multiple problems which could not be solved unless they would develop an entirely new technology on which the financial institution would be built on. The answer to their problems was the blockchain. According to Swissborgs founders ‘Off-Chain’ Financial Institutions had the following problems which needed to be solved: they were not accessible for everyone, a lack of transparency, high fees for using them, and time-consuming. The existing ‘On-Chain’ crypto solutions also had some problems of their own: a poor user experience, no democracy, not secure enough, and a lack of robust investment solutions. To tackle these problems, Swissborg is one of the first companies that are investing in new ICOs using a democratic investment policy. This means that the Swissborg community, which consists of the early Swissborg investors, all get a vote in the investment process of the company. Once the community selects a project to invest in, Swissborgs in-house analysts review the selection to make sure the risk-taking is acceptable. An important note to make is that when Swissborg talks about transparency, they are talking about the transparency of the company’s operations, not the traceability to the owner of a certain cryptocurrency. Since the cryptocurrencies are always connected to certain portfolio address, you can only track down the size and the address of the portfolio. Since there is no name connected to the portfolio, it is practically untraceable. Which reminds us of the numbered bank accounts quite often used in Swiss banking.

Is this democratic business model the key to greatness? Only time will probably learn. But, there must be some reason that people are willing to invest a total of $52 million on the day of the ICO. So, what is the catch? Do people really have that much faith in the company’s blueprint, or is there some other reason. According to Peter Hody (an author of, the underlying reason for this huge confidence in Swiss ICO’s can be tracked down to Switzerland’s need of finding a new competitive edge over rival financial markets, now the banking secrecy laws appear to loosen up. “Switzerland has the best conditions for business with so-called cryptocurrencies: this claim doesn’t ring hollow given the dynamic surrounding the cluster of companies established into crypto valley in central parts of the country around the city of Zug, making it the crypto capital of the world.” Zug is even the first community in the world that accepts Bitcoin as a currency to pay taxes, just as the National Railway operator SBB and the Lucerne University. So, it seems that Switzerland really wants to be a pioneer when it comes to the usage of blockchain technology.

To blockchain or not to blockchain

So, what does the future hold for us? Evaluating the current situation would show a bright future when it comes to blockchain banking. The technology is all over the news, people are investing great sums of money in it, and regulators can’t get their heads around the answer to the question: ‘what to do with the blockchain and its currencies’. Globally the answer differs widely. The mighty United States show a tendency to have some aversion against the implementation of such technologies in the financial industry. Which can, of course, be understood, it is very hard to track down the owner of a portfolio on the ledger. You will find Switzerland on the other side of the spectrum, the country that seems to welcome the financially-enabled blockchain technologies the most. Is this just a coincidence, or is the historically neutral country looking for the next big competitive advantage? The demand for certain financial services that hide the owner’s identity seems to be there if we take a look at the capital invested, and the global interest in these blockchain technologies. But do people really want to hide their money in portfolios that exist of a currency as volatile as the Bitcoin, only time will tell. It will depend on a combination of the regulator’s willingness to accept blockchain technology to co-exist with the common financial services and their ability to monitor the technology.