Next-gen digital technology, a.k.a. Web3, is here to leave an everlasting impact on how the world looks at banking.
What is Web3, you ask? Web3 is a resilient and scalable World Wide Web iteration that promises to optimize industries worldwide, and banking isn’t going to escape it.
Touted as the future of the Internet, Web 3.0 is essentially a blockchain-based Internet solution driven by its open standard and protocols — a surefire way to decentralize modern banking.
Why incorporate Web 3.0 anyway? Isn’t the current state of digital banking good enough?
The world moved to digital banking since traditional banking was time-consuming, storage-intensive, and riddled with security and sustainability issues. In contrast, digital banking promises easy accessibility, quick transactions, superior accountability, and reliability.
However, modern digital banking doesn’t account for one important concept—decentralization. Now that we already deploying important technologies like blockchain in banking, we must understand Web3 from the inside and out.
Understanding Web3 for the Banking Sector
Web3 is a term that describes a completely new vision of a better internet founded on principles of blockchains, cryptocurrencies, and NFTs (non-fungible tokens)—giving the power to the users instead of large tech companies monopolizing the web.
It is the next generation of Internet technology, driven by the core principles of permissionless decentralization. In other words, the Internet is no longer going to be controlled and owned by centralized entities. Every builder and user will have equal access to Web3, turning the Internet into a space where people can essentially “Read-Write-Own.”
Web3 transforms traditional banks and banking activities. It extends easy transactions through cryptocurrency, allowing users to move away from outdated banking and payment-processing infrastructures. The best part of Web3 is that users will no longer have to trust third parties (monopolies) for any transaction since the technology is incentive-based.
Essentially, Web3 is a giant step toward a decentralized Internet. With it, users and companies can develop decentralized apps and services like financial planning and transactions while using blockchain technology to securely manage the data without intermediaries. Blockchain allows Web3 to extend quicker transactions, increase openness, and make the entire process cost-effective.
Differences Between Web2 and Web3
How do Web2 and Web3 differ? Here are the key distinctions between Web2 and Web3.
| Key difference | Explanation |
| Technology | While Web2 is driven by AJAX, RIAs, social media, web APIs, and other collaborative technologies, Web3 thrives on blockchain, IPFS, smart contracts, SSI, and web assembly. |
| Governance | The power and ownership of data within Web2 is with centralized entities like governments, banks, and tech giants. That’s not the case with Web3. This permissionless technology runs on community governance models like DAOs, and users get to partake in the decision-making processes. |
| Censorship | Since Web2 is regulated by corporations and governments, imposing censorship and blocking information is easy. Web3, on the other hand, is largely uncensored. |
| Ownership | While data ownership and control remain with the users in Web3, centralized authorities make the most out of user data in Web2. |
| Privacy | Since control remains with corporations, they can easily track user activity and leverage data for targeted advertising. However, user privacy in Web2 is protected by law. In Web3, only users have control over their data and can extend it in whichever way they want. |
| Security | The centralized entities are responsible for ensuring security in Web2. Users will have to place their trust in blockchain algorithms and infrastructure when it comes to Web3. |
Now that you have a better understanding of the differences between Web2 and Web3, we will explain how Web3 works for financial institutions.
The Concept of Web3 for Financial Institutions
Let’s take a look at what Web3 means for banking, along with its advantages, risks, and challenges, as well as how it differs from traditional financial institutions.
What is Web3 Banking?
Web3 banking describes the use of Web3 technologies—blockchain, cryptocurrency, smart contracts, NFT, DAO, and more—to conduct banking-related operations. It makes the most of blockchain technology that allows users to leverage cross-border payments. With Web3, banks are bound to offer simplified fund management, secure and efficient infrastructure, faster processing, and overall reduced operational costs. Let’s dive deeper and discuss the advantages Web3 has to offer in banking.
Advantages of Web3 for Banking
Security
Web3 comes with a distributed ledger system that makes sure transaction details and important information are encrypted without the intervention of intermediaries. However, like any other technology, the banking-related security regulations for Web3 will be developed over time.
Transparency
The users involved in the transaction can simply refer back to it and trace the movement of assets. Such transparency is made possible through trustable blockchain algorithms and infrastructure.
Efficiency
Blockchain-based technologies can implement automation to reduce redundancy, automate time-consuming routine tasks, improve workflow performance, and boost overall operation efficiency.
Cost Reduction
Since detailed financial data are embedded into transactions, blockchain-based Web3 makes accountability easy. Decentralization saves customers from paying bank processing fees and other platform charges.
Accessibility
Web3 makes sure accessibility guidelines, personalization, customization, languages, and visuals are taken care of to make banking products and solutions more democratic, inclusive, and accessible.
Risks and Challenges
This concept is also subject to market risks because the cryptocurrency market is known for its volatile nature. This can impact the value of assets bought through Web3 solutions and services.
Now, let’s discuss the challenges Web3 for banking needs to overcome.
Regulatory Concerns
The lack of regulatory clarity around Web3 and its banking application is quite concerning. Since there are no central authorities manning Web3 transactions, verifying the identity of customers and preventing fraud is a major challenge. Without any solid regulations, Web3 platforms might face privacy-related legal challenges.
Security Vulnerabilities
Smart contracts consisting of transaction details are vulnerable to hackers if not properly encrypted. Decentralized Exchanges or DEXs are vulnerable to security breaches too, and the 2021 multi-million dollar hacking incident involving THORChain is a prime example. Users are susceptible to phishing scams involving private keys, which can result in the loss of digital assets.
Scalability Issues
Issues like limited network capacity, increased complexity, and lack of interoperability between blockchain networks make scaling a major challenge. The frequency of transactions on a given blockchain network is also an issue.
Adoption and Understanding
Not all customers are educated or technologically advanced enough to use Web3 solutions. One of the most challenging aspects of rolling out Web3 solutions is developing awareness and pushing customers to learn about the same. Marketing Web3 in banking as a more efficient and safer medium for online transactions is critical.
These risks and challenges highlight the need for careful consideration before these banking services reach the end customer. Financial institutions should invest in machine learning-driven verification tools, asset management tools, credit and risk scoring tools, and blockchain security tools to build an infrastructure that extends proactive compliance.
Role of Blockchain and Cryptocurrencies in Web3
There are two main roles of blockchain and cryptocurrencies in Web3 banks.
Blockchain Technology
Blockchain technology is essentially a distributed ledger that ensures secure and transparent online banking without any intervention from intermediaries. It enables a decentralized infrastructure built on trust and immutability. Another fundamental pillar of banking services in Web3 is smart contracts.
Cryptocurrencies and Digital Assets
Since this type of virtual banking is independent of traditional intermediaries, it uses native payment technologies like cryptocurrencies, smart contracts, DOAs, and NFTs for spending and sending money online.
Digital assets such as stablecoins, NFTs, CBDCs, security tokens, and other cryptocurrencies provide users with a wide array of digital payment mediums.
However, these digital assets come with challenges like unsupervised trading, inconsistent customer protections, hacker attacks, phishing attacks, market risks, data manipulation, and other critical risks.
Transaction and Settlement Fees
By leveraging digital currency within the Web3 framework, the traditional hurdles of intermediaries and complex currency conversions are sidestepped, potentially reducing transaction times and minimizing associated fees.
Transaction Fees
Traditional banking systems come with high processing or transaction fees and long settlement times. Banking in Web3 eliminates the intermediaries or the need to convert complex currencies.
The payments on Web3 can be settled within minutes through smart contracts, keeping users from paying an intermediary to get the job done; hence, no transaction fee incurs.
For example, a customer paying for groceries can simply use a dApp or decentralized app, wherein the estimated amount for the transaction shows up. Upon entering the private key, the shopping fee amount will be deducted straight from the token balance of the native payment system.
Settlement Fees
Web 3.0 banking simply does away with off-shore settlements, a common occurrence in digital banking. This is because such settlements are not instantaneous and usually take 5 to 7 days. With blockchain technology-driven banking, finance institutions are able to make settlements within seconds at negligible costs. Simplified faster settlements, delivered!
Potential Benefits and Drawbacks
With Web3 technology, financial institutions will experience relatively lower pressure on their systems since transactions and settlements will happen on the blockchain. Decentralization allows for lower operational costs while improving the speed of transactions and settlements.
However, the unpredictability of Web3 networks is quite concerning. These networks can often get congested and expensive, especially when there is high demand. Even volatility can make transaction and settlement fees surge. In these cases, banking institutions will have to set a limit or minimize the transaction frequencies on the network.
Web3, Digital Currencies, and the Future of Banking
Web3 will revolutionize banking through DeFi, tokenization, smart contracts, open banking, privacy-preserving payments, micropayments, crowdfunding, financial credit services, and other blockchain-driven solutions.
With the integration of digital currencies and the focus on liquidity management, the landscape of financial operations is set to experience unprecedented growth and diversification. Furthermore, areas like foreign currency remittances will be positively impacted, providing faster and cheaper global transfers.
The future of banking is promising, given the likelihood of strong mainstream adoption, decentralized finance, interoperability, integration, enhanced access and data ownership, collaboration, and financial inclusion.
However, institutions should be mindful of regulations and stay compliant, considering bodies like the financial crimes enforcement network. It’s crucial for both stakeholders and consumers to stay informed and strive for the quick adoption of these banking-related technological advancements.
FAQ
What is Web3 banking, and why is it Important?
Web3 for banking is the use of blockchain technology to conduct banking operations based on a decentralized economy. Web3 software development is important to enable quick, seamless, cost-effective, permissionless, and secure online transactions without the intervention of a financial institution.
How does banking in Web3 differ from traditional and digital banking?
The major difference between traditional or digital banking and banking in a Web3 landscape is that the former is manned by a centralized financial institution while the latter functions on decentralized blockchain technologies.
What are the risks associated with Web3 for banking?
Web3 banking needs to overcome risks related to privacy, security, technical complexities, and compliance.
How are cryptocurrencies and digital assets used in Web3 financial services?
Web3 makes the most of native payment technologies like cryptocurrency, smart contracts, DOAs, and NFTs for enabling online transactions. Digital assets such as stablecoins, NFTs, CBDCs, security tokens, and others have opened up new ways to make payments online.
What role does Blockchain play in Web 3.0 banking?
Blockchain enables a seamless, secure, and decentralized distributed ledger that ensures transparent online banking without any intervention from intermediaries.
