How Digital Banks Utilize Blockchain Technology and APIs

Banking and the blockchain have had a rather rocky start to their relationship. Cryptocurrency, one of the most popular use cases of blockchain technology, was originally created to be an alternative to traditional banking. 

As such, it’s of no surprise that there has been a long-standing reluctance and sometimes downright refusal from the banking world to accept cryptocurrency. 

But today’s banking customers are fast-evolving— they are global, digital, and growing more and more interested in cryptocurrency.   

We are now entering an era where digital banks are beginning to embrace blockchain technology. Integrating it with core banking systems using APIs enables digital banks to expand their services to consumers and businesses, and allows them to stay current and competitive.

Before we look at how this is made possible, we’ll dive into why it’s necessary.

The Road to Acceptance

The emergence of Bitcoin just so happened to coincide with the financial crisis of 2008, in which the central banks played a key role in instigating through bad policymaking.

When Bitcoin’s Genesis Block was launched, creator(s) Satoshi Nakamoto embedded an encrypted message into the block which read, "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks."

It's likely that Satoshi would have been working on the Bitcoin blockchain long before the financial crisis, it is clear from Satoshi posts to the cryptography community that the state of centralized banking was a motivating factor behind the technology. They wrote:

“The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.”

As such, Bitcoin and its underlying blockchain technology were heralded as having the potential to bring down the traditional banking system. The blockchain’s decentralized peer-to-peer platform was, and still is, an attractive alternative to a central authority that has the ability to affect the economy of entire countries.

At the time, however, banking institutions dismissed the notion as nonsense, declaring cryptocurrency as nothing more than a scam and a novelty. 

In fact, back in 2017 when Bitcoin was still a fledgling crypto on the rise, J.P. Morgan CEO Jamie Dimon called it “a fraud”. Despite Bitcoin’s steady growth over the years and its mainstream adoption, Dimon kept on saying  Bitcoin is “worthless”. But as the client demand for cryptocurrencies was rising, in 2021 J.P. Morgan gave its wealth management clients access to several crypto funds, allowing them to add Bitcoin to their portfolios.

Although the billionaire CEO seems to have a distaste for Bitcoin, he does believe in blockchain technology for banking. JPMorgan has had its own blockchain network called Liink since 2017 and launched its own stablecoin, the dollar-pegged JPM Coin, in 2019. 

Over 400 institutions have signed up to the Liink blockchain which allows them to share complex payment information and move tokenized U.S. dollar deposits with the JPM Coin. 

The tide is changing on the banks’ views of blockchain and cryptocurrencies, with more and more institutions investigating how they can use it and dipping their toe in the crypto pool. 

In fact, some of the biggest banks in the United States have started to use cryptocurrency for custody services, trading, and wealth management.

The Challenges of Implementing Blockchain Technology for Digital Banks

Even though blockchain can replace old processes and improve areas such as contracts and data ownership, the technology is very expensive to implement and slow to be deployed.  

This is especially true for smaller banks (those without the financial reserves of JPMorgan!). For starter digital banks, Neo Banks and FinTech applications there is a huge barrier to entry. 

Plus, blockchain technologies and cryptocurrencies are still not that user friendly— they are hard to set up and maintain. 

Blockchain Infrastructure

Accessing cryptocurrencies requires implementing blockchain infrastructure and integrating it with older non-compatible systems and processes.

As any other business and institution operating with cryptocurrencies, digital banks also need to communicate with blockchain nodes. Nodes act as a decentralized network of “servers” that work to store the ledger of accounts, validate transactions and create new blocks in the chain.

The running of nodes involves having a significant budget for expensive equipment and hardware, and for hiring the specialist expertise to set up, run, and maintain it. 

Read more: Blockchain Nodes Explained 

Instead of a simple regular bank account, customers will need a crypto wallet— a software program or hardware device that enables users to buy, sell and trade cryptocurrency and digital assets.   

Unlike a bank account, a crypto wallet doesn’t actually store any cryptocurrency. The wallet stores a set of paired cryptographic keys— a public key and a private key.  

If the public key is like a public address or bank account number that can be shared and allows anyone to make a crypto payment to the address. 

The private key is like a key to the whole bank vault. When used, the private key acts as a “digital signature” proving ownership of any cryptocurrency or digital asset therein. 

Developing a customized wallet for end users is a costly and labor-intensive task for developers needing specialist blockchain knowledge.   

The most challenging part of implementing blockchain infrastructure is security. 

Security

Currently, in the traditional system digital banks control all operations such as refunds, chargebacks, and blocking of accounts. 

With the blockchain, the situation is totally different. Everything is based on cryptography and the one who has the private key can simply control and withdraw the funds. The banks are no longer in control.

This makes securing the private keys of customers a number one priority. In addition to that, digital banks need to comply with strict legal and regulatory requirements which limits the type of third party solutions they can use for key management. 

How Crypto APIs Helps Digital Banks

Crypto APIs is a blockchain infrastructure provider with a full product suite which includes a Wallet as a Service allowing digital banks a quick and secure way to open up the cryptocurrency market to their customer base. Our WaaS feature enterprise-grade security and can be fully customized to allow banks to retain full control. 

MPC Based Omnibus Wallet

MPC is a proven approach for enhancing data security. It is a cryptographic technology applied to crypto wallets to give absolute security of the private key. MPC stands for Multi-party Computation (MPC) and is the enterprise-preferred approach to wallet security.  

MPC wallets remove the concept of the private key, replacing it with key shares distributed between a number of unconnected and independent signers (parties). In this “keyless” system, no single entity ever has access to all of the key parts. 

This technology also uses a Threshold Signature Scheme (TSS), meaning banks can set a group of signatories (signing nodes) and set a threshold of signatures to be met in order for a transaction to be authorized.  

Since these processes take place off-chain, there is no way to see how many signers there are and no way of knowing which signatories out of how many signed, ensuring protection against both internal and external compromises.

On Premise Wallet Key Management 

Crypto APIs offer different wallet types for different key management and business needs.

- Hosted: Key Management (MPC Nodes) are hosted and protected by us

- Shared: The nodes are shared between Crypto APIs and the customer

- Custom: Nodes can be set to be on-premise, fully hosted by the customer

The most useful for digital banks is the custom key management as the MPC nodes can be hosted on-premise in their infrastructure allowing them to retain 100% control. At the same time the risk is distributed on different physical servers or locations, etc. - depends on the setup they need. 

Query & Transact (Locally Signed Transactions) 

Hierarchical Deterministic wallets, or HD wallets for short, are a standard wallet structure particularly useful for custody companies, software companies, and accounting. However, managing HD wallets can get confusing. 

Read More: Everything You Need to Know About HD Wallets

Using Crypto APIs powerful endpoints for HD Wallets, digital banks can receive complete and accurate HD Wallet data (from xPub, yPub, and zPub) including balance, transactions, change and receiving addresses, as well as UTXO data.    

A Blockchain Infrastructure Layer for Digital Banks

Crypto APIs is a perfect solution for digital, neo banks and FinTech startups as our product suite allows institutions to retain full-control, use the highest levels of security to protect funds, and get access to blockchain infrastructure.

Using a blockchain infrastructure provider like Crypto APIs means digital banks can harness the advantages of the blockchain much faster. They can be more innovative and deliver a wider range of services that are more cost-effective and efficient than traditional banking methods.

To find out more about our MPC Wallet as a Service and how Crypto APIs can help your digital bank compete in the new blockchain banking era, contact the team today.