Blockchain is creating a lot of buzz—and a lot of confusion. Primarily, this technology offers the capacity to record and monitor transactions in what is called a distributed ledger (a decentralized database). Each block is a record of new transactions that is added to the previous one to create a chain of blocks—hence blockchain.
Transactions are recorded in real time in blocks and are visible to everybody with permission on the network. These transactions are tamper-proof once conditions are agreed and written into the ledger because each transaction block is tied linearly to the previous ones.
Think about it for a second—real-time recording of transactions, full visibility, and tight security: These are all factors that the mortgage lending and servicing industries need. Lending and mortgage servicing processes can have significant risk and low levels of trust from origination to servicing of the loan. We need to consider any approach that would reduce that risk and improve trust levels.
Benefits for the Mortgage Industry
Blockchain’s defining elements such as distributed ledgers, smart contracts, inherent security, and digital payments could add efficiency and transparency to the working of the mortgage servicing industry.
Blockchain technology uses decentralized databases called distributed ledgers. Instead of one party holding the information on a central ledger, the data gets stored on a public blockchain that offers a distributed way of validating a transaction.
A distributed ledger could be created to contain real estate titles, planning permissions, deeds, and any other information relevant to the mortgage industry. This technology allows for shared control of data—specifically who can alter or supplement the data and how they are authorized to do so. The blockchain network is distributed across multiple computers, creating a virtually unbreakable chain of protection against transaction falsification and speeding up the collection of mortgage-relevant information by maximizing the ledger’s accessibility and availability.
The process tracks digitized transactions, so when authorized users validate on the blockchain, they enhance transparency for audit and compliance purposes. Banks and lenders get a clear line of sight of precisely what happened during the lending process—the parties involved, the individuals managing the authoritative copy of the digital assets, and the ultimate owner of the assets.
In blockchain banking, multiple network computers record transactions, which are settled by many individuals.
Smart contracts, also called self-executing contracts, help exchange items of value in a secure, transparent way without relying on an intermediary. The concept works on much the same principle as a vending machine, with the required item (e.g., digitized mortgage documents) supplied on the fulfillment of the required terms. Smart contracts operate on an ‘If-Then’ premise, so they define the rules and penalties around what the contract does as well as enforce those obligations.
The decentralized ledger could be used for smart contracts to digitize mortgage documents for storage and tracking by the network of computers that run the blockchain and would also result in ledger feedback such as automated mortgage payments. This, in turn, would result in a substantial drop in operational costs and processing time of mortgage transactions, which would be beneficial to both the consumer and mortgage industry players.
A report by Capgemini Consulting called “Smart Contracts in Financial Services: Getting from Hype to Reality” states that the adoption of smart contracts by the mortgage loan industry could potentially save consumers between $480 and $960 per loan. It also calculates that banks could save between $3 billion to $11 billion annually by reducing processing costs in the origination process in the U.S. and European markets. These savings would result from the automation, process redesign, shared access to digitized legal documents, and access to such external documents associated with smart contracts.
The length of the mortgage-lending lifecycle and the sheer number of contracts and sensitive documents involved make it vulnerable to risk through all stages from origination to fulfillment of the loan. Many financial institutions still rely on paper for such valuable materials as mortgage notes, whose value disappears if they are lost or destroyed. Even electronic loan documents require strict oversight of the chain of custody and ownership to maintain the integrity of the loan and the overall lending process. The distribution of the blockchain network across many computers creates an intrinsic layer of security that makes it incredibly challenging to falsify transactions. Additionally, because each transaction block is tied to all previous transactions, it cannot be tampered with once the conditions are agreed and written to the ledger. Cryptography authenticates and verifies transactions, maintains privacy, and allows participants to see only the parts of the ledger that are relevant to them.
Blockchain’s first and most famous application is centered on digital currency. Bitcoin was invented in 2008 as blockchain’s public ledger and digital currency remains an intrinsic feature of this technology. Digital payments can be exchanged automatically for digital assets such as property titles in a synchronized process without the intervention of a notary or legal representative. Ultimately, if central banks created digital ﬁat currencies, they would have tighter control of monetary policy and improved oversight of financial payments, but they are likely to proceed cautiously. Commercial banks could speed up the process by creating their private digital currency to allow clients to transact directly among themselves. If successful, they could inspire central banks to follow suit.
The mortgage servicing industry is not known for embracing innovation early and it will take several successful implementations before blockchain is adopted as a viable technology. In any case, blockchain is not without its challenges, and must overcome the following technical obstacles before it is accepted in the market:
- Data privacy concerns are a significant issue in an open distributed environment. More work needs to be done in math and cryptography to reduce the trade-offs between privacy, efficiency, and trust.
- Security can be an issue with private blockchains. Any changes made to the database should be sent to all users immediately so that the record is secure. Once everybody has a copy of the data, the integrity of the overall database can withstand hacks on some users.
- Regulatory uncertainty hangs over the technology. The U.S. federal government has not regulated blockchain to the exclusion of states; so, the states may introduce their own rules and regulations. So far, Arizona has recognized smart contracts, Vermont now accepts blockchain as evidence, Chicago is running a pilot project on real estate records, and Delaware has an initiative pending that would allow registration of shares of Delaware companies in blockchain form.
Despite these technical challenges, the future of blockchain in financial services seems unavoidable. The transparency, efficiency, and security benefits of employing the technology suggest that blockchain will be an integral part of mortgage servicers’ future, and those institutions that embrace its benefits early will be the ones that gain most.
Industry thought leaders will address blockchain in mortgage servicing at the inaugural Five Star Fintech Summit in Nashville, Tennessee, on March 21–March 22, 2018. Sean Ryan, CEO, Aspen Grove Solutions is among the experts participating in a discussion on how the new technology could increase transparency and reduce the costs of regulatory compliance at the event. Other speakers at this session include Katie Jo Keeling, Managing Partner, McCarty & Holthus, Marvin Stone, SVP, Business Integration/CFPB Program Manager, Stewart Title, and Jessica L. Fox, Management Consultant, Freddie Mac.