The widespread adoption of digital technologies and increased mainstream acceptance of cryptocurrency protocols and blockchain applications are poised to irrevocably alter the banking industry. “Innovation occurs when intermediaries are replaced and efficiencies are introduced. Force multipliers then make these innovations exponentially better,” author and cryptocurrency entrepreneur Simon Dingle told a recent GIBS Forum.
Dingle has been on the founding teams of several fintech firms, including cryptocurrency exchange Luno and open banking provider Curve.
In their book, Beyond Bitcoin: Decentralised Finance and the End of Banks, technology and finance experts, Steven Boykey Sidley and Dingle discuss how decentralised finance (DEFi), which allows financial transactions to take place directly, person to person, without the involvement of financial institutions, will redesign the concept of trust in finance and call into question the future of banks.
Decentralised finance is shaping the future of financial services, including banks, asset and wealth management, and insurance companies. Is banking destined to become obsolete?
Trust, innovation and intermediaries
“The core offering of banks and financial services can be done without any human intervention,” Sidley explained. “The services that we all know and use can be done cheaper, better and in a more inclusive and trustworthy manner. Banks, as we know them, will come to an end; only those who accept the new reality will survive.”
Sidley said the current relationship between financial services institutions and their customers was asymmetrical: “The power sits with the banks and the shareholders, and you are paying too much for that trust.”
Dingle argued trust is not a necessity in a decentralised system: “Don’t trust, verify. Decentralised finance allows individuals to interrogate the blockchain ledger of transactions as they are able to directly access the source code on the network. On the network settlement layer, trust doesn’t enter into it.”
Banking customers need to understand that banks are optional, he added: “It is possible to obtain a loan or an insurance contract on the blockchain protocol. It is far less complex than you think, and it is permissionless.”
However, it is unlikely that intermediaries would be done away with entirely. “Many customers and individuals don’t want to deal with the underlying complexity unless they are techies. The missing piece of decentralised finance is the intermediary, and there are opportunities for traditional financial institutions to adopt protocols and build on-ramps.
Product offerings such as Visa’s Stable Coin bridges the worlds of digital and traditional fiat currencies. Backed by the US dollar, it settles transactions with Visa over Ethereum, one of the most actively used open-source blockchains.
“One of the problems with cryptocurrencies has been their volatility. Stable Coin has the advantages of crypto but removes this volatility,” Dingle explained.
Unequal power dynamics have challenged banks to adopt better ways of doing business, as seen with the open banking movement, which has forced people to rethink their relationship with their banking providers.
Open banking allows third-party financial service providers access to consumer banking, transaction, and other financial data through the use of application programming interfaces (APIs).
By relying on networks instead of centralisation, open banking can help customers to securely share their financial data with other institutions, enabling them to switch accounts from one bank to another. The API can also look at consumers' transaction data to identify the best financial products and services most suited to their needs.
“People realise they own their financial data, it belongs to them, and they demand to be able to access it on other platforms,” Dingle said.
Risk and regulation
As centralised organisations, traditional banks carry legacy costs and requirements for shareholder profits. The cost base of decentralised finance is a fraction of traditional banks, and these savings are passed on to consumers in the form of higher interest rates, Sidley explained.
However, as it is an immature industry, there is a risk gap, he conceded: “There are greater risks in these things, and we can’t avoid that truth.”
For example, decentralised finance participates in a number of exotic experiments where the potential yield is massive, which traditional banking aren’t able to offer.
“Reward is always attached to risk, and this is as much of a component of decentralised finance as it is of traditional banking,” Dingle said. “Things happen faster, but those fundamentals are still there, and they still apply.”
The current financial services order has enabled our society to scale, “but it has also let us down, sometimes pretty badly,” Dingle said.
Regulation certainty is still a while away, he explained, and it will help or hinder the decentralised finance movement. “Good regulation can be an enabler, although too many regulators are trying to shoehorn DEFi into existing frameworks. Regulation needs to be well-considered.”
While it will be years before banks are able to offer decentralised products to clients, “it is naïve to think that we will have a world without intermediaries,” he said.
“Regulation is necessary, as it will mature the industry and foster innovation,” Sidley said. However, it is problematic for regulators to keep pace with the speed of innovation.
Regulators need to “develop an appreciation that we are dealing with a new asset class, and develop guidelines that treat it as such,” he concluded.