Web3 in banking: Unfolding the future of banking

As we are speedily entering the age of web3 and the metaverse, we are witnessing that new technologies and business models are evolving that promise to change the working of banks. Web3 in banking has significant implications for all parties involved. It entails enhanced services for end users—retail banking users, investment bankers and corporates. Other benefits for users include an immersive experience through a metaverse-simulated environment, the ability to provide continuous platform updates and improved interactiveness with AI modules incorporated into metaverse avatars. Interestingly, web3 technologies like blockchain, smart contracts, and NFTs, bring new and advanced capabilities to the entire banking sector.

In web2, net banking is the norm. However, web3 can take the experience of net banking a notch higher as metaverse banking offers a more intensely personalized user experience and data visualization. Some banks have already announced the launch of metaverse virtual spaces, expected to deliver better banking experiences to customers. Customers can roam around in the metaverse space and gain information about banking activities like loans, deposits, digital initiatives and government welfare schemes like the real-world experience.

There will be no place for the middleman as web3 in banking takes center stage. Smart contracts will be widely used for the purpose of asset swaps, remittances, insurance, and trade finance. Consequently, users will experience automation efficiencies.

This article will demonstrate how web3 in banking will impact the banking business, especially in terms of lending, borrowing and certain other use cases.

• The disruptive potential of web3
• What does web3 mean for banks?
• Benefits of web3 in banking
• How will web3 in banking benefit daily banking customers?
• Use cases of web3 in banking
• Lending and web3 in banking: How do smart contracts help?

The disruptive potential of web3

Web3 marks the beginning of the third phase of the internet (hence web3) and its core feature is decentralization. The first version of the web was built using open protocols, which allowed anyone to build it. User data was not at all captured in web1. However, the model evolved quickly into the second version, i.e., web2, which is a more centralized version of the web where user data such as credit scores, identity, transaction history and identification are collected, aggregated and sometimes sold. Apps are developed, delivered and monetized in this model. All decisions regarding their functionality and governance are made by prime stakeholders, especially the owners. And the revenues are divided among shareholders and management.

Web3, the most recent version, could potentially change that power structure and shift users back to the center, thanks to open standards and protocols. Control is no longer centralized on large platforms but is distributed via “permissionless” decentralized smart contracts and blockchains. Governance, which is the most difficult aspect of web3, is undertaken in the community and not behind closed doors. With some incentives, revenue can be returned to creators and users to finance user acquisition and growth.

What does this all mean in practice? It could become a paradigm shift for digital application-based business models by making disintermediation a key element. With respect to data, functionality and value, intermediaries may not be necessary anymore. Creators and users could have the upper hand. Open-source applications would be more beneficial than proprietary ones. This would encourage developers to build, test, scale, and innovate.

Web3’s disruptive concept is built around three fundamentals— blockchain stores, asset ownership data and history of transactions. Smart contracts can perform specific tasks independently and are primarily used in the web3 structure for the execution of app instructions.

What does web3 mean for banks?

Web3 and decentralized finance go hand in hand. New ventures have already begun to combine the two. They believe people don’t need banks to save money and spend it. These brave new platforms are accessible via smartphone. In 2022, the global smartphone penetration rate will reach 83%. Stablecoins and DeFi supporters believe that this allows a large portion of the world’s population to borrow, spend and use digital money without having to submit any documentation or meet the regulations required by traditional banks. They can also do it via anonymous web3 accounts.

How can traditional financial institutions work with the new world? Banking using web3 allows creators and users to connect to the financial system directly. These pioneers will need to keep their money safe, protect assets, and have a reserve fund. The Office of the Comptroller of the Currency (OCC) in the US suggested that banks could offer safekeeping and custody for cryptocurrency users. This includes the ability to access private and “cold” wallets where users keep their assets.

A digitally enabled bank with the right information systems and technology will succeed, whereas a legacy-based bank will fail. Web3 platforms were built with API-led cloud-based, decentralized technology. This new world needs a modern payment platform that can transact and work with a variety of digital currencies.

Benefits of web3 in banking

These are the key opportunities blockchain solutions offer to today’s banking industry:

Quick financial transactions

In banking history, it has been impossible to transfer money and settle at near instantaneous speeds. Settlement clearing, which can currently take several business days, will become faster. It will move from days to seconds regardless of the time and day. For foreign currency remittances, transaction and settlement fees will be greatly reduced. These improvements are made in the backend without the user needing to be aware of the underlying blockchain technology.

Credit reports based on blockchain

Customers’ financial lives can be dramatically affected by credit reports. Blockchain-based credit reporting can impact customers’ financial lives more than traditional, centralized credit reporting. It also allows companies to consider nontraditional factors when calculating credit scores. This was a major bottleneck in traditional credit distribution in the financial sector of the 19th and 20th centuries.

In web3, it is possible to provide high-quality, blockchain-based credit histories. This will greatly increase consumers’ access to both traditional credit products and blockchain-based loans. Blockchain-based solutions for extending financial credit services will soon be able to automate credit lending and borrowing, securely verify credit histories, and reduce administrative costs for consumers and companies.

Compliance at a lower cost

Blockchain solutions provide transparency for stakeholders, full auditing and a real-time overview of essential documents that regulatory agencies would normally request access to. Federal regulations in the United States require that licensed banks file suspicious activity reports on behalf of FinCEN (Financial Crimes Enforcement Network). Regulators rely on the banking sector to manage fraudulent transactions. Blockchain solutions allow detailed financial metadata to be embedded into a transaction, making it much easier for financial institutions to keep a record of suspicious activity.

How will web3 in banking benefit daily banking customers?

Already, we are seeing subtle changes in how blockchain solutions impact the financial and banking industries. Some fintech companies allow you to send and purchase cryptocurrencies. These cryptocurrencies can be used in conjunction with traditional fiat currencies. Countries with a developed banking infrastructure will soon introduce bank transfers that are quick and easy to settle and have low fees for foreign remittances. This is the first significant impact blockchain will have on everyday banking consumers’ lives. Blockchain solutions can create a new financial system in countries lacking a banking infrastructure. These consumers will embrace new markets, regulations and financial services concepts more readily if they have internet access in countries without an adequate banking infrastructure.

Blockchain-based solutions are also open to consumers who aren’t tied to the existing banking system. They are global and decentralized, allowing anyone to move assets, reputation and identity just like a bank transfer. Consumers in these markets have huge incentives to access all kinds of value-added services at a low cost and for economic empowerment.

Use cases of web3 in banking

Here are some of the possible use cases of web3 in banking:

Tokenized securities and assets

Investment banks already use tokens representing custom securities, bonds and other assets. You can get two key benefits through the tokenization of these assets:

• You can easily create securities and bonds as per customer needs for seamless trading.
• The asset can initiate auto trading using smart contracts, which allows banks to build an algorithm that can minimize risks and maximize returns.

An example of this scenario is where high-value physical assets like diamonds or fine art are tokenized using NFTs. This also allows the trading of the item.

Digital currency backed by central banks

Central or Federal banks are working on digital currency that banks will back. As per the recent announcement of RBI in India, they are planning to launch Central Bank Digital Currency (CBDC) ahead of the crypto-bill enactment in the parliament. In addition to that, as per the announcement in the Union budget, there is a plan to introduce CBDC in FY23, which will consider CBDC as bank notes according to the financial act. This will be treated at the same level as fiat currency. Some pilot projects are also planned on the same. This will enable Indian users to use CBDC for trading using digital platforms.

Game monetization through bank payment options

Online gaming is fast gaining traction. With web3 in banking, payment integration is possible in the virtual world for banks. For example, a neo-bank recently announced the creation of an exchange system to exchange value from the virtual world to the real world. Here, the bank provides the player with a loan by holding the game tokens and allowing them to play with them.

Virtual banking

A virtual visit to banks through the metaverse is a crucial use case of web3 in banking. Using their custom avatar, consumers can visit a virtual bank branch, interact with the staff, and make transactions virtually. Interestingly, remote services have become a trend post-pandemic. With the immersive nature of the metaverse, consumers can interact more comfortably with advisors from the comfort of their homes. Some services that can be facilitated by leveraging the power of the metaverse are financial planning, financial reviews, virtual annual portfolio reviews, mortgage advice delivery and the like. Once a customer finalizes any decision, transactions can be made via token-based assets, which will, no doubt, revolutionize customer banking experiences.

Employee onboarding

Employee training and 1:1 virtual meeting are possible through the metaverse in web3. Banks can utilize these technical capabilities of web3 to eliminate communication gaps between employees working in tier2 and tier3 cities and tier1 city employees. This promotes a strong bonding among employees and streamlines the process of customer handling, making the onboarding process smooth and more effective.

Lending and web3 in banking: How do smart contracts help?

This is not surprising that depositors seek to earn interest on their deposits in web3, but the funds’ mode will differ. In web3, instead of depending upon banks or non-regulated platforms for funds, customers will themselves hold their funds in a non-custodial wallet which is nothing but an account on the blockchain. Here, both the ownership and transaction data reside on the blockchain instead of with the bank or nonregulated body. Customers don’t need to depend on banks or intermediaries to lend out their funds. Instead, they can lock their funds into smart contracts. The smart contract escrows these funds and only disburse them if certain conditions are met. The difference between traditional and web3 lending is that people can still look for loans, but smart contracts only release funds when the borrower produces sufficient collateral.

Smart contracts play a vital role here as all terms and conditions, including interest paid, loan-to-value ratio, and liquidation threshold, are predetermined by the smart contract logic. These are transparently available to all participants. Borrowers still pay interest, but that doesn’t go into the management or shareholders’ pocket. Instead, it is governed by a DAO that has no claim on the revenue earned. Borrowers pay the interest on loans through smart contracts, which then gets disbursed to the original depositors.

Endnote

There are many opportunities for banks to embrace the future web, i.e., web3. Web3 for banking allows banks to reach new audiences beyond traditional touchpoints. Customers can access key services by integrating online platforms, digital wallets, or currencies. One option is to secure storage at the institution level for digital collectibles, virtual money from video games, and NFTs. Banks can use the connected web network of web3 to create an ecosystem of verified collectors, merchants, exchanges and service providers. This helps maintain and enhance the bank’s reputation as both a financial backstop and a trusted partner in the customer’s financial development.

If you are planning to implement a web3 solution in your banking business, LeewayHertz web3 experts can help you. Contact us for enhanced banking solutions in web3.