Banks don’t trust anyone, and it’s expensive. Blockchain and DLT can change that

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Antony is a star contributor for Tech in Asia and publishes exclusive, high-value content that serves the Asian tech community. Read more from star contributors here.

While most people think banks are stable and trusted, they actually operate based on a zero-trust assumption (or simply trust no one). Every employee is constantly under check and control (there have been too many stories of insider hacks, misuse of customer money, and money laundering).

Regulators like MAS or HKMA enforce multi-layer risk control mechanisms, generally known as the three lines of defense. The first line is the process owner or the department manager who executes each transaction and follows bank policies. The second is a centralized or independent risk management department. Risk managers do not execute daily operations but oversee the overall operating environment and set risk parameters, operating procedures, and advise first-line managers on risk mitigation strategies.

The third line is what I was doing—risk assurance. Auditors verify high-risk transactions and give their independent opinion to the board.

All three parties and numerous checks and control build a strong risk management mechanism internal to the bank. There are two other layers external to the bank that ensure critical risk controls are not circumvented: third-party independent auditors (PWC, EY, etc.) and financial regulators.

So, one customer transaction at a bank branch could have five different teams reviewing it (line managers, risk managers, internal auditors, external auditors, and regulators). This explains why there are so many transaction records, signatures, approvals, and a huge paper trail when you simply deposit US$100 in your personal account.

Running a zero-trust organization is costly and inefficient, and internet banking doesn’t solve this crucial and fundamental problem (in some cases, it even amplifies distrust). But blockchain, when taken together with distributed ledger technology (DLT), can. This sets the backdrop for my second post on why blockchain matters.

Trusted system

The problem blockchain is trying to solve is how to run a trusted system with trustless people. (Note: I’m not implying that people are trustless or that we live in a trustless world, but a rotten apple spoils the bunch.)

To be more precise, a trusted system refers to a transactional system that produces results according to a rule book. It’s not always legal (i.e. in compliance with the law), but it has to be resilient and stable/predictable. A trusted system gives a consistent truth that can be verified without relying on another system.

Transactions in a trusted system can’t be repudiated—which depends on record immutability—and are irrevocable. However, immutability in software before DLT was vulnerable because of the human factor (e.g. system administrator misconducts). System administrators had all-access rights and were able to alter system parameters.

But a system can only be as good as the people running them in terms of their trustworthiness, diligence, and capabilities. A few malicious or careless human actors can circumvent all advanced security controls. They are the Achilles heel of a secure system.

Immutability alone does not produce a trusted system; it has to decouple from the operating team. Humans, with souls and feelings, are just too erratic to produce consistent and predictable results.

Blockchain and DLT

Blockchain and DLT together eliminate the vulnerability of human interference, as a system built with both technologies can operate without having to trust system administrators.

Game theory

Drawbacks and risks