Rodrigo Neto
Financial Markets
Gonçalo Moutinho
Financial Markets
António Tunico
Financial Markets
João Menezes
Financial Markets
In recent years, blockchain technology has emerged as a transformative force in various industries, with the financial sector at the forefront of its adoption.
Blockchain, often referred to as a distributed ledger technology (DLT), is a decentralized and transparent system that enables secure and immutable transactions. Its impact on the financial industry has been profound, revolutionizing areas such as finance and payments, smart contracts and automation, as well as regulation and security.
This article explores the growing importance of blockchain technology in the financial services industry and its various applications.
Blockchain in Finance and Payments
Blockchain technology has the potential to reshape the financial landscape by streamlining operations, enhancing security, and reducing costs. In day-to-day financial operations, blockchain finds application in areas such as cross-border payments (operations between institutions in different countries), remittances (payments that migrants send back to their families), and digital currencies (e.g. Bitcoin), relying on those with its value-proposition, Peer-to-Peer transactions, that do not require a centralized authority. By leveraging blockchain, financial institutions can facilitate faster, cheaper, and more transparent transactions.
One example of blockchain’s impact is in the realm of cross-border payments. Traditionally, such transactions involve multiple intermediaries and can take several days to complete. Blockchain-based solutions eliminate the need for intermediaries, enabling near-instantaneous peer-to-peer transfers. This not only reduces costs but also minimizes the risks associated with delays and potential errors. But how does it work?
Imagine you and your friends have a special notebook called a ‘blockchain’ to keep track of toys and who owns them. Each page in the notebook is a block with a list of toys and owners. Once something is written, it can’t be changed. You all have copies of the notebook, and when someone gets a new toy or gives one away, you write it on a new page. To prevent cheating, you play a cool game. To add a page, you solve a puzzle or math problem. The first to solve it adds the page, and others check it. Since everyone has a copy, if someone tries to change their notebook, others will notice. So, it’s a secure way for everyone to keep track of it.
After that intuitive explanation let’s address some of the advantages of blockchain technology in the finance and payment industry. Firstly, blockchain enhances transparency by providing a shared, tamper-resistant ledger accessible to all participants. This transparency mitigates fraud and facilitates effective auditing. Secondly, blockchain enables improved security through cryptographic protocols and consensus mechanisms, making it highly resistant to tampering and fraud. Finally, the decentralized nature of blockchain reduces dependency on centralized authorities, promoting greater financial inclusivity and reducing systemic risk.
Smart Contracts and Automation
Smart contracts are self-executing agreements with predefined rules encoded on a blockchain. These contracts automatically trigger actions when specific conditions are met. The introduction of smart contracts has the potential to transform numerous industries, including finance, real estate, supply chain management, and more.
Blockchain technology enables the automation of contractual agreements, eliminating the need for intermediaries and reducing associated costs. By removing the reliance on manual verification and enforcement, smart contracts promote efficiency, accuracy, and trust in transactions. For example, in the lending industry, blockchain-based smart contracts can automate loan disbursement, repayment, and collateral management, reducing administrative overhead and minimizing the risk of human error.
Furthermore, smart contracts can seamlessly integrate with emerging technologies such as the Internet of Things and artificial intelligence. This integration creates a foundation for innovative applications such as automated supply chain management, autonomous vehicles, and self-executing insurance policies. By combining blockchain with these technologies, the potential for increased automation, efficiency, and reliability becomes substantial.
How Fintech is Changing Banking
Fintech is a term that combines the words “financial” with “technology” and refers to the use of technology to provide financial services and products to consumers in the sectors of banking, insurance, and investing. It is now feasible to open a bank account online or to link it to our smartphone and use it to pay for goods with the money in our account.
Fintech poses a challenge to traditional banks, with the main threats being the loss of market share and pressure on margins. Notably, banks face competition from companies such as PayPal and Revolut, as well as large technology companies including Meta, Apple and Google, with the rapid growth of digital payments provoking a fall in consumers’ demand for cash.
As a result, banks have begun to implement digital innovations such as branchless banking, biometric sensors, and artificial intelligence (AI). Chatbots, e-wallets, and m-banking have also been created to give more user-friendly customer support. As a result, the bank’s approach has been to imitate fintech rivals’ goods and services, as well as to acquire these companies to gain access to intellectual property and know-how, as JP Morgan Chase and Goldman Sachs have done.
Regulation of Blockchain
As blockchain technology continues to gain prominence in the financial services industry, regulatory frameworks have been established to ensure compliance and protect participants. Governments and regulatory bodies around the world are actively working to strike a balance between embracing the benefits of blockchain and addressing potential risks.
The Portuguese government is taking action, beginning with the Lei do Orçamento de Estado 2023, shortly after the first property was acquired with cryptocurrencies in 2022. From the outset, the legislation defines a crypto asset as “any digital representation of value or rights that can be transferred or stored electronically using Distributed Ledger or similar technology” and distinguishes fungible crypto assets that can be traded for others of the same type, quality and quantity (such as cryptocurrencies and stablecoins) from non-fungible (NFTs), which correspond to ownership right over a unique digital asset (such as a unique digital image) that is not exchangeable or divisible. These were excluded from the Portuguese tax concept of cryptoasset, which means that there is still no defined tax framework for NFTs.
Regarding taxation of income and wealth, the adopted legislation is similar to the one used with stocks. Regarding assets held for less than 365 days, the difference between the market value at the date of disposal and the net acquisition value of the part qualified as capital income will be taxed at a fixed rate of 28%, with the possibility of aggregation if the taxable person chooses. Long-term gains originating from alienated assets held for more than 365 days are free from taxation under the proposed law. The Stamp Tax rate for free transfers with cryptoassets as their goal will be 10%.
The tax laws adopted do not address all gaps, and uncertainties may arise, making it difficult for taxpayers and authorities to apply them efficiently, therefore legislative adjustments will be required, particularly in an environment of constant evolution such as that of cryptoassets.