Unveiling the First Layer: The Business Use Case. This is part one of a three-part journey that will delve into Technical Design and Implementation next.
This is a Non-Crypto or Central Bank Digital Currencies Use Case.
The finance industry is changing fast with the rise of blockchain and Web3 technologies. Traditional banks need to adapt, unlocking innovation in products and services for clients. This document explores how banks can use blockchain. The focus is on enhancing client services through transparent lending for construction companies. By embracing innovation, banks can generate revenue streams while supporting businesses and retail clients. We discuss the proposed solution, incentives, and key insights to guide banks in adopting Web3 successfully, crafting offerings that align with the evolving business landscape.
Traditional banks have already created ecosystems that can quickly become new ways of doing banking business by meeting the unmet needs of their customers.
In this use case, we showcase how Web3 and blockchain business models are not a threat but a major opportunity for banks to transform their strategy from intermediation to enablement.
For this use case, we identified unmet needs within two distinct client segments of traditional banks:
- Retail clients with a low-risk aversion and growing expectations for interest rates: These are individuals looking for alternative investment options beyond the conventional low-risk, low-interest choices like saving accounts and mutual funds.
- Medium-sized and small business construction companies: These companies require access to additional credit lines to cover unforeseen costs, using promissory notes from their clients as collateral. Banking regulations often lack the flexibility to evaluate this lending risk accurately, or banks' interest rates are exorbitantly high.
This leads us to an important question: Can a traditional bank devise an innovative solution to meet the needs of these client segments? The answer is yes. A traditional bank can meet these needs by implementing a blockchain-based solution with the potential to evolve into a Web3 application.
The Use Case
A construction company requires an additional line of credit to cover unforeseen expenses, such as client-requested feature enhancements. The company proposes using promissory notes from its customers as collateral.
Unfortunately, the company's primary bank is unable to issue the loan due to stringent business rules. To address this, the bank introduces a blockchain-based solution with the following functionalities:
- The construction company publishes its loan request on the platform.
- The bank publishes customized interest rates based on its risk assessment of each loan.
- Retail bank clients invest to fund all or part of the loan amount. This provides the required capital.
- The loan is issued only once fully funded by the group of investors.
- Customers of the construction firm confirm their payments on the platform.
- Each payment is distributed to the investor accounts to repay their investment.
While all features have the potential for evolution, the initial design was intentionally straightforward.
At Encora, we've developed this solution by drawing from prevalent practices in the Peruvian financial ecosystem:
When a construction company acquires clients without prior financial history, it evaluates their payment capacity and issues a series of promissory notes. These notes often mandate frequent installments, such as weekly or daily payments, to accommodate clients in informal sectors like taxi driving or house cleaning.
To streamline the collection, construction companies send batches of these notes to a bank, which then charges a fee for payment collection and management, including initiating legal action in cases of default.
Use case assumptions:
- Loans are needed to address unexpected construction costs.
- Retail micro-investors funding these loans require assurances on payments.
- The construction company accepts clients who make periodic payments to receive a property.
- The bank manages the collection of payments from the construction company's clients.
- Retail investors must be vetted by the bank (they should be existing clients) to prevent money laundering before accessing the investment platform.
- The current focus is on implementing smart contracts rather than a fully decentralized Web3 model.
Use Case Ecosystem and Incentives
Additional Incentives for All Members
- Transparency: All stakeholders can track the loan’s progress on the blockchain.
- Security: All transactions are encrypted and tamper-proof, preventing fraud.
- Efficiency: Smart contracts expedite the execution of business rules, making loan processing quicker and more efficient.
Banks must adapt to emerging innovations like blockchain to retain and grow market share. As shown, the strategic adoption of Web3 can allow banks to expand products and revenue while leveraging existing client ecosystems and trust. The proposed lending platform solves the acute needs of construction firms and investors. By enabling this solution, banks could be framed as pioneers in the emerging era of Web3 and blockchain.
Read our next article that dives deeper into implementing this use case.
- Crypto or CBDCs are not the only options for banks adopting Web3 and blockchain solutions.
- Banks, with their established customer ecosystems, can more easily implement these types of lending platforms and gain client trust
- This model has the potential to evolve into a more decentralized Web3 business model, with the bank enabling additional features such as:
- AI tools for risk assessment and interest rate suggestions.
- Blockchain features that allow members other than the bank to propose or view AI suggestions, agree on new or modified business rules for risk evaluation, and set interest rates.
- Metaverse technology to visualize construction progress in real-time, especially concerning new required features.