Smarter Payments

Deep Dive: A Blockchain-Based Payment Rail?

Could blockchain be the next big thing in payment rails?

U.S. corporates currently have a range of options available when they need to send funds, including ACH, Fedwire, The Clearing House (TCH) and credit card networks. ACH is the most popular, according to a recent PYMNTS survey of 500 corporates and government agencies, with 59 percent of respondents planning to increase their same-day ACH (SDA) credit usage and 48 percent saying the same for SDA debit.

Blockchain’s entrance may cause a potential shakeup in the payment rail market, which operates via distributed ledger technology. It offers several features that make its payment settlement role appealing, too, including those related to security. After all, blockchain solutions use cryptography to protect the funds being transferred.

The following Deep Dive examines the ways blockchain could prove transformative, offering banks, FIs and other players greater transparency into how transactions are executed, which parties are active on the service and how data is being altered.

What do banks want from blockchain?

A recent survey found that nine of 10 bank executives are exploring potential blockchain use cases, but the right infrastructure must be in place for banks to utilize them. FIs will need to build a global network using blockchain-based solutions, a move that will assist them in transforming payments at scale.

It’s currently unclear how such a global network will look, but executives agree it should meet two key criteria to be effective.

First, the network should outline participants’ defined rights, obligations, controls and standards. Second, it must offer efficient onboarding that will allow FIs to “plug and play” into it. These two points are the only ones upon which the industry now agrees, but related players will need to reach consensus on how to structure the rules of engagement before a blockchain-based network can be put to use.

Decentralized appeal

Blockchain’s decentralized nature reveals plenty of potential to disrupt the payment settlement ecosystem. That the ledger is not stored by a central institution, like a bank or a government agency, is a key selling point for blockchain-based solutions. It is instead stored in multiple locations across a decentralized network, meaning data cannot be changed by a single party. This makes it nearly impossible for the information to be adjusted or manipulated without detection.

Ledger-connected computers can only make alterations that align with “consensus protocol,” an algorithm requiring a majority of computers on the network to agree with the proposed change. Attempted changes that fail to reach consensus are rejected.

These rigid requirements make blockchain-based solutions more secure. The technology relies on algorithms to verify the identities of involved parties — rather than tapping into FIs or clearing houses to act as intermediaries — providing a transparency level that ensures the transaction is trustworthy.

A potential safeguard against economic instability

The benefits of a more reliable settlement system are outlined by an example from more than 10 years ago. Lehman Brothers, backed by auditor Ernst & Young, reported record-high profits in 2007. Its success was short-lived, however, as the value of its assets collapsed nine months later — an event central to the 2008 financial crisis.

The collapse produced many key lessons, including that figures cited in the preceding year’s reports were untrustworthy. Lehman Brothers was not alone in learning this, as banks in both the U.S. and Europe were forced to dole out billions in fines and settlements to cover losses from inflated balance sheets. It can be extremely risky to rely entirely on data from a centralized entity like an auditor. The decentralized nature of blockchain could have provided greater transparency and insight into Lehman Brothers’ condition, thereby potentially avoiding these problems.

Blockchain is both distributed and public, meaning its alterations can easily be recorded and viewed. Its system data can also be downloaded and distributed with involved parties’ identities shielded by cryptography, while still making all other data widely available.

An anti-fraud safeguard?

Blockchain’s transparency and trustworthiness could also prove helpful in fighting fraud, a top concern for many FIs now that SDA is a reality in the U.S. Such transactions may offer faster payment capabilities, but they also give FIs less time to mitigate fraud before a transaction clears and settles. That said, there is no evidence that SDA has led to a rise in fraudulent activities.

Banks and FIs would have access to an open record of who was active on the service with blockchain systems in place, making it more difficult for fraudsters to hide their activities without attracting the attention of other computers on the system. The technology is still in its early stages, though, with a low implementation rate of just 10 percent. As a result, financial services players will likely have to wait a few more years before blockchain-based systems become more mainstream.


Exclusive PYMNTS Study: 

The Future Of Unattended Retail Report: Vending As The New Contextual Commerce, a PYMNTS and USA Technologies collaboration, details the findings from a survey of 2,325 U.S. consumers about their experiences with shopping via unattended retail channels and their interest in using them going forward.