The marriage of blockchain and traditional finance constitutes a paradoxical relationship.
The financial services, banking and payments sectors are among the most regulated in the world. As for blockchain? The Web3 space has traditionally been a bit more of a free-for-all when it comes to regulatory frameworks and their compliance.
Financial institutions (FIs) process sensitive data that must be kept confidential to comply with regulations such as the General Data Protection Regulation (GDPR), California Consumer Privacy Law (CCPA) and rules specific to the banking sector such as Basel III. These rules mandate strict data confidentiality, capital adequacy and anti-money laundering (AML) compliance. Big banks cannot afford to expose their counterparties, transaction details and trading strategies on public blockchains.
At the same time, the operational philosophy of blockchain is built to a disruptive level of transparency, decentralization and openness. The 2009 Bitcoin whitepaper explicitly sought to remove the need for FIs as centralized intermediaries, largely by making transactions immutable and visible to anyone with access to the Internet.
This tension between the transparency inherent in blockchain and the need for FIs to preserve customer confidentiality and privacy presents a paradox that FIs must resolve. if they aim to unlock the transformative potential of blockchain.
However, as comments made Tuesday (January 21) by Bank of America CEO Brian Moynihan to show, The US banking industry will adopt cryptocurrencies if regulators allow it. Bank of America owns more than 80 blockchain-related patents, making it one of the leading financial institutions in terms of blockchain intellectual property.
However, President Donald Trump inauguration On Monday (January 20), there were no concrete policy announcements regarding cryptocurrencydespite rumors and promises to the contrary.
Read also: 5 Blockchain Projects The World’s Largest Banks Are Behind
A paradox of transparency and confidentiality
For traditional financial institutions, blockchain technology poses an existential question. How can they use its effectiveness without compromising customer privacy or running afoul of regulators?
On the one handblockchain transparency promises greater accountability, auditability and efficiency in areas like cross-border payments, supply chain finance and securities trading.
On the otherFinancial institutions must protect sensitive data, such as counterparties, transaction details and trading strategies, which public blockchains inherently expose.
The answer may lie in emerging models of hybrid blockchains and privacy-enhancing technologies (PETs).
Hybrid blockchains combine the best of public and private blockchain frameworks. They enable financial institutions to manage sensitive transactions in a private environment while utilizing the security and interoperability of public blockchains. For example, J.P. MorganIt is Onyx blockchain uses Quorum, an Ethereum-based platform, to facilitate private and secure transactions while maintaining interoperability with public Ethereum networks.
JP Morgan published a white paper last year, titled “Project EPIC: Powering Tokenized Finance with On-Chain Enterprise Privacy, Identity, and Composability,” showing the use of blockchain technology to improve confidentialityidentity and composability within financial ecosystems are increasingly explored by traditional banks and financial players.
PETs also address the challenge of confidentiality. Proofs without knowledge (ZKP) and secure multiparty computing (MPC) are also emerging. ZKPs allow a party to prove the validity of a transaction without revealing the underlying datawhile MPC allows multiple parties to compute a function collaboratively without exposing their individual inputs. Both solutions are increasingly being adopted by financial institutions to ensure compliance with privacy laws while embracing blockchain capabilities.
See also: Why Banks Might Want to Have a Blockchain Strategy
Benefits of blockchain in financial services
The PYMNTS Intelligence report «The benefits of blockchain for regulated industries” discovered that blockchain technology has many potential benefits to meet the unique needs of regulated industries, including finance.
“As more and more banks integrate blockchain capabilitiescustomers will have greater choice when it comes to value transfer,” FV Bank CEO Miles Paschini told PYMNTS this month. “We are paving the way for a future where blockchain is just another means of payment.”
Yet without robust privacy mechanisms, blockchain adoption in financial services may be limited to niche use cases that do not require strict data protection.
“The largest financial institutions are keen to explore tokenized assets“, but they require regulatory certainty to do this at scale, Nikola Plécasmarketing manager at Visa Crypto, told PYMNTS in October.
Ultimately, the relationship between blockchain and traditional finance illustrates the broader tension between innovation and regulation. By accepting this paradox and investing in privacy-friendly technologies, collaboration frameworks, and regulatory clarity, the financial sector can transform blockchain transparency from a challenge into a competitive advantage.
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