Cryptocurrencies have captured the imaginations of individuals and emerging businesses drawn to their potential to serve as alternative stores of value, to reduce transaction costs by eliminating intermediaries, and―most notably in popular culture and media―to provide eye-catching opportunities for speculative investing. Coin valuations for well-established players Bitcoin and Ethereum have fallen sharply since late 2017/early 2018, and new players continue to enter and leave the marketplace. As noted previously in this blog, regulators are taking interest.
Much less appreciated and often overlooked is the business potential for the distributed-ledger, or blockchain, architecture that makes cryptocurrencies possible. Distributed-ledger systems present enormous opportunities for businesses to operate more efficiently and mitigate risks. The financial-services industry in particular stands to gain from the adoption of blockchain technology due to the significant variation and complexity of products, business processes, and relationships among industry participants. We have seen great interest in blockchain technology in the banking and securities industries in particular.
First, Some Terminology
A distributed ledger is a decentralized database system that records transactions and analogous data inputs using the cooperation and collaboration of numerous actors that together possess, maintain, and update a distributed database using blockchain. We’ll spare you the technical ins and outs here and instead refer you to two blockchain-industry participants that have done a nice job illustrating the concepts in a straightforward way.
A conventional blockchain is publicly accessible and operated and maintained by numerous unrelated actors working independently from one another. However, the same framework can be used to record and hold information in what is called a permissioned blockchain, which limits access to approved participants, or even within a single organization by various departments or business units.
A smart contract is a preprogrammed transaction that occurs in an automated manner when a predefined event or action occurs―think of it as a series of “if-then” events agreed to by the parties. The event or action is represented as an input that, leveraging distributed-ledger technology, is recognized and followed by an exchange of value once the agreed-to conditions are met. An example preceding the digital age is a vending machine: No intermediaries are necessary to effectuate these transactions—they just occur when the predetermined inputs are made and verified.
Blockchain in Auto Finance
To illustrate the opportunities that distributed-ledger technology presents for achieving efficiencies and managing risks in the financial-services industry, we discuss below numerous use cases for auto finance.
In the future, individuals’ personal information may reside on a blockchain database that is updated regularly as they interact with other parties. This raises consumer-privacy issues that policymakers will have to work through as distributed-ledger technology becomes more widespread. A credit applicant could consent to allow potential lenders to access his or her unique blockchain record reflecting employment history, rental history, utility billing or cell-phone/data-plan billing history, income information, and various other data. While this opens up the potential for further use of non-traditional credit scoring to expand credit access, it also raises the potential misuse of information to deny applications in violation of the Equal Credit Opportunity Act and Regulation B if safeguards are not included within the framework.
Credit Bureau Reporting
As noted above, various parties with whom a person interacts could provide data onto a personal blockchain feed to which creditors and potential creditors are granted access by the borrower. This in effect would create a new credit-reporting system. Data furnishers would report information to the chain and pull information from the chain, potentially eliminating the need for an intermediary to serve the function currently served by the big three credit bureaus. This could result in a shakeout in the credit-reporting industry, or perhaps they will coopt this model and find a way to continue to draw revenue from credit reporting. Compliance with Fair Credit Reporting Act requirements could be simplified in such a world, as complexity will be reduced, and we might see a large decrease in identity-theft claims and a quicker resolution of those that are asserted.
Dealer Inventory Identification and Tracking
Distributed-ledger technology shows great promise for tracking items through a supply chain. Auto-finance companies could leverage this use to track the origin of new and used-car inventory to confirm that vehicles have the features that the dealer represents and thereby avoid potential manipulation of information to fraudulently inflate loan-to-value calculations. Floor-plan lenders in particular could utilize blockchain to track lot sales and trigger smart contracts that automatically result in payments from dealer to lender as vehicle purchases are completed.
Lenders will have a more complete picture of vehicles’ conditions in a world where third parties that interact with vehicles and drivers input data into a blockchain database. Service centers, body shops, and even the vehicles themselves could transmit information regarding maintenance, repairs, and vehicle condition to a distributed ledger with a unique identifier for each vehicle. Lenders using this information could more accurately assess the value of a used car before a purchase loan is made or a refinance transaction occurs. Once a loan is made, lenders could monitor significant events relating to the vehicle through the blockchain, and even issue notifications or reminders to customers to have their oil changed, for example. On a macro level, the availability of this information would allow a lender to better assess its portfolio-wide credit risk by fine-tuning its valuation calculations for the underlying vehicles securing its loans.
The above applications would also benefit an auto-leasing company, which could leverage distributed-ledger technology to monitor vehicle status in real time. This would create opportunities to implement smart-contract processes to increase fees appropriately as vehicle mileage is exceeded or wear and tear increases. It also would allow lessors to calculate residual value with greater accuracy.
Titling and Registration
Distributed-ledger technology offers significant potential efficiencies in the titling and registration processes. Currently, drivers, dealers, and lenders navigate and rely upon an often-unwieldy government bureaucracy as their intermediary, even with advances in electronic titling. In a blockchain future, the processing of new registrations and transfers and title issuances and changes could be connected to a distributed ledger utilizing smart contracts. Automation would become possible and with it, the avoidance of potential human error. Transaction participants would also enjoy an enhanced ability to track a vehicle’s ownership and registration history and greater confidence in the accuracy of their information.
Account Histories and Origination and Servicing Information
Auto lenders could implement their own private databases that leverage distributed-ledger architecture to allow various units or departments within their organizations to provide data they create or acquire to a centralized repository and to access and read that information for business purposes. All account “touches” could be recorded on the private blockchain, including receipt of payments and communications to or from a borrower, and the organization could create its own automated processes based upon smart-contract methodology. For example, the lender could automatically trigger its lien-release process upon receipt of an account payoff.
Loss Mitigation and Recovery
In the future, recovery vendors may utilize data from distributed ledgers to locate borrowers and vehicles, to confirm account status immediately prior to a repossession event, and to transmit repossession information to the lender so that required notices are generated and account information is updated. The notices could be created and issued using smart-contract methodology that occurs automatically upon recording of the repossession by the recovery vendor. Vigorous sampling will be needed in this high-legal-risk part of the business, but blockchain would likely reduce errors from the breakdowns that can occur in loss-mitigation processes from time to time.
Innovate, but don’t reinvent the wheel
Distributed-ledger technology offers remarkable potential benefits to financial-services firms and the businesses that support them: reduced transaction costs, greater efficiency, increased speed, and fewer errors. But organizations would be well served to realistically assess their current capabilities to ensure that they are solving an identifiable problem or obtaining a benefit that will truly move the needle for them before spending tech resources on adoption for a particular use. If your servicing platform works for your organization, for example, don’t change it―at least not yet.
Distributed-ledger technology won’t make anyone rich overnight, and it’s not as fun to read about as Bitcoin millionaires. But it is likely to have a more significant and widespread impact on business and society over the long term than cryptocurrency. As adoption of this architecture increases, there will be more opportunities for financial-services participants to collaborate with each other and third parties to input a variety of data to blockchain databases and to benefit from that information in their routine business processes.
In the near term, companies don’t have to wait―they can experiment with internal uses of the distributed-ledger framework to better connect their departments and participants, streamline the intake, flow, and reading of data, and find opportunities to implement smart-contract methodology to achieve greater efficiency.