How it will pay in the mortgage industry
BY DEBBIE HOFFMAN, CHIEF LEGAL OFFICER, DIGITAL RISK & MATT OGUZ, FOUNDING PARTNER, VENTURE-SCIENCE
Bitcoin — that is what most people think of when they hear the term blockchain. However, blockchain has morphed into an incredible technology tool that can be utilized across industries in a variety of capacities, including in mortgage lending. Blockchain is a ledger system stored on a decentralized database which can consist of one or multiple owners across many computers or “nodes” linked together. Records are linked in the form of timestamped blocks. It was initially utilized in the technology used by bitcoin – the electronic cash system. When the open source code for bitcoin was released in January 2009, the technology of blockchain was brought forth.
What does blockchain have to offer?
“Entries on a blockchain ledger become timestamped blocks which mean that there cannot be hidden alterations to the chain.”
This technology allows for documents to be stored and transferred in a process that cannot be altered or tampered with, enables validation and is less error-prone than current methods. The decentralized nature of blockchain can result in increased productivity since multiple parties can access the network and can work on files simultaneously.
Blockchain promises many advantages; two of the most important ones are cyber breach protection and document security, both critical to the mortgage process. For mortgage lending, this could mean saving millions of dollars.
First, in addition to a more streamlined and technology workflow, there could be a reduction in the cost of using third-party vendors due to automation. Second, blockchain allows for transparency in the storage of data. Entries on a blockchain ledger become timestamped blocks which means that there cannot be hidden alter- ations to the chain. By using blockchain for document management, such immutable data could help in regulatory compliance tracking and ultimately in customer confidence because of the transparency of such data.
Another benefit to using blockchain is the characteristic of document authentication, which confirms that data is placed upon the network belongs there. When information is placed on the network, the document blocks are
] coded with specific hash sequences which must match the specific hash sequence of the network. If the sequence does not match, the data will not be saved onto the blockchain.
Blockchain technology is highly versatile and can be applied to many industries, including those that utilize payment and money transfers, stock trading, voting capabilities and reliance on secure storage of data. Such industries include law, healthcare, insurance, car leasing and sales, online music, stock trading, supply chain management, storage and, of course, mortgage lending.
The downside to blockchain
While blockchain offers many advantages, there are a few factors that need to be considered, including the “51% attack,” energy consumption of the networks and regulatory oversight. The proposition that blockchain offers a secure network relies on the principle that the network cannot be tampered with by cybercriminals unless they have the energy resources to hack into a majority, or 51%, of the computers on the network to gain control of the blockchain.
Thus data and records that are stored on each computer that has access to a particular blockchain would not be precious to a cyber thief. While an attack on a full network of computer nodes is unlikely, private blockchains have an added layer of security by requiring credentials and permissions to gain access to nodes. Should a cyber attacker have the computing power and time to gain control of the nodes, these permissions and credentials further the difficulty needed to enter the network and manipulate the blockchain.
In a 51% attack, the majority of the computing power on the network is attacked, and hackers can interfere with the process of recording new blocks. The interference prevents other users of the blockchain from completing new blocks, allowing these cyber attackers to monopolize the input of data on the blockchain. While this type of attack could be devastating, the amount of computing power a hacker would need to possess to launch an attack on a blockchain is massive.
With regard to energy consumption, the distributed nature of the network calls for continued power in the multiple locations housing the nodes. According to environmental researcher Sebastiaan Deetman, the blockchain network that bitcoin is housed upon is expected to consume energy somewhere between an amount equal to the output of a small power plant and the consumption of a small country such as Denmark by the year 2020. Deetman’s study further cites that the bitcoin network currently consumes enough electricity to power 280,000 homes in America.
Given that blockchain is an emerging technology, there are not yet formal regulations about it, however, there is the guidance that addresses its characteristics, such as privacy and security, as well as governance of its use and implementation. U.S. regulators, including the Securities and Exchange Commission and the Treasury Department, have indicated that there are risks and uncertainties, such as cybersecurity and regulatory oversight associated with blockchain which will need to be monitored.
The Treasury Department’s Financial Crimes Enforcement Network issued guidance in 2013 that discusses the applicability of the Bank Secrecy Act regulations to blockchain and individuals distributing, exchanging or transmitting virtual currency. While the Consumer Finance Protection Bureau has not yet made a statement about the use of blockchain, it has issued warnings to consumers regarding risks associated with bitcoin.
Transaction processing time is also a concern among those developing blockchain networks. Currently, the size of a block is one megabyte, and the blocks are mined every 10 minutes. With the limited scope of the blocks and mining time of 10 minutes, this means that only about seven transactions per second can be recorded. The limited number of operations may be a barrier to entry for the blockchain network in the mortgage industry; however, as the technology advances, blocks with larger storage capacity and increased computing power in mining blocks should make blockchain a more attractive option for the industry.
Use of blockchain in mortgages
In the mortgage industry, blockchain can be utilized across the entire loan lifecycle from origination to audit and all the way through service. First, blockchain allows for document authentication, tracking, and correction on data inputs and data storage. These features capture the borrower’s data points throughout the life of the mortgage more accurately than the conventional process. Thus, if blockchain technology were adopted across the mortgage lifecycle at application, through origination, fulfillment, servicing and secondary functions, it would create an efficient, streamlined and accurate process for a mortgage to be processed. The challenge, however, is the complexity of the mortgage lending infrastructure, including all the various type of industry participants – lenders, loan purchasers, servicers, title companies, county recorders, and others.
Since the blockchain process helps prevent altercation or falsification, there will be fewer data input errors. When inputting data, each transaction is verified by “miners” or the individual users that control the network from each of the decentralized network of nodes on the blockchain. Through various algorithms used for entry of the transactions and verification, if a transaction is entered incorrectly, such transaction will not appear or will not display correctly on the blockchain. This alerts the user immediately, whether unintentional or fraudulent, and the user can fix or investigate the error and re-enter the transaction on the block accurately.
Another significant benefit to using blockchain is document verification. The verification process is used to determine if the data input on the blockchain actually belongs on it. This works by assigning a hash sequence to each block placed on the network. When subsequent blocks are placed on the blockchain the hash sequence needs to match the previous block or the data is rejected.
In summary, incorporating blockchain into the lending process inherently will create more automation in the mortgage loan lifecycle and less reliance on third parties,
“The challenge, however, is the complexity of the mortgage lending infrastructure, including all the various type of industry participants – lenders, loan purchasers, servicers, title companies, county recorders, and others.”
Thus resulting in a lower cost to the lender in mortgage production. Also, the lender will have more control of the entire process, utilizing an in-house approach, and less reliance on third-party intermediaries. A 2015 study by Capgemini Group estimated that if blockchain was used, based upon the average cost for a $200,000 mortgage loan of $4,350 in lender processing fees per loan, there would have been a reduction ranging from $480 to $960 per loan in fees. The report, which utilizes 2015 data prior to the implementation of TRID, which increased the cost of processing fees per loan, concludes that lenders could have saved $1.5 billion during 2015 on loan processing.
While the concept of blockchain is relatively new to the financial and lending industry, there are already several participants that are moving forward in such endeavors. Companies such as Factom, Mphasis, ThoughtMachine, HSBC, Context Labs, Coin and Chain are paving the way.
Factom promises data validation and data audit solutions to the mortgage industry, and the company has developed the Factom blockchain, a decentralized open-source, public network that the company uses to secure its applications and data. Factom markets that this network can be used for auditing, data, and systems integrity, IoT security protections (such as protections against denial-of-service or “DoS” attacks) and public infrastructure testing. Factom also offers an audit and due diligence room to aid in collecting data which can assist in regulatory compliance, quality control, and servicing.
Mphasis, a technology services provider, has created the first center of excellence for blockchain-based services and solutions in India. The focus is on enterprise solutions based on private/permission blockchain. Mphasis’ center is primarily experimenting with different platforms and horizontal integrations for financial services. Use cases initially developed are in the areas or industries of trade finance, loyalty, mortgage, pharmaceutical, airline, and insurance. Mphasis has developed three use cases to be used in the mortgage industry including storing loan origination data to the Mphasis blockchain, the authenticity of documents, and recordkeeping and fraudulent transaction detection.
ThoughtMachine markets that it is creating Vault OS, a technology is seeking to provide an end-to-end banking system that can manage loans, mortgages, and other financial products. Furthermore, the company promotes that the Vault-OS systems utilize smart contracts – self-executing electronic contracts – to enable parties to sign contracts that are securely coded onto the blockchain digitally.
Many entities are developing new ways to utilize blockchain that parallel the mortgage industry. HSBC has partnered with the Bank of China to implement blockchain technologies for property valuation services. JPMorgan Chase and Citigroup have completed a blockchain trial where the technology was used in tracking credit-swap defaults. Barclays and Santander Bank have joined fintech startup R3 to investigate different use cases to tackle payments and securities settlements.
Attorneys discussing blockchain are intrigued by the benefits that it potentially has to offer in the legal profession, including authentication and timestamp validation. For example, this could be extremely beneficial to a litigator who needs to tackle discovery and evidentiary burdens, mainly because of the transparency into who has access to the blockchain, the time period and what is stored on it.
The uses of blockchain are being explored worldwide in China, India, Europe, Central America, and the Middle East. The Dubai government announced that it has recently launched the Dubai Blockchain Strategy and plans to use the technology for all government documents to make the government more efficient while achieving global leadership in the blockchain technology field.
Factom has partnered with the Honduran government and title software firm Epigraph. The partnership aims to develop a secure and permanent land title record system in the hope of curbing the alleged corruption and mismanagement within the Latin American country’s government over land rights.
The United Kingdom’s government has launched a blockchain competition seeking distributed ledger technologies and has offered to award up to 15 million pounds to companies that develop technology to increase productivity and performance.
Blockchain is quickly expanding across the globe and in a variety of industries. The mortgage industry has not historically been one that embraces technological advancements ahead of other sectors, but it finally seems to be catching up as the cost savings are irrefutable. The question is whether now, as the lending industry embraces technology development, it is also able to take a giant leap forward and take hold of a new technology that has across the board advantages in the mortgage lifecycle for document storage and transmittal as the industry knows it today.