Banks are croaking in unison that they want to be seen as tech-companies with banking licenses
Executives feel that thirty years after the birth of the internet the digital world will also swallow laggard industries. What they often don’t realize is that while banking has been introducing appealing web-services and banking apps for end-customers, the underlying systems and processes have remained stuck in the age of paper. Even the new breed of direct banks relies on the very same complex and heavily intermediated set-up. In many cases the IT-infrastructure dates back half a century or more. So why should this change now?
Enter the blockchain. Initially a technology developed in order to bypass financial incumbents and make them obsolete by algorithmically moving around digital tokens of value, it is a powerful new tool to slash multiple layers of trusted middlemen. Very simplistically explained, it is a distributed ledger technology that replaces a multitude of siloed ledgers with one that is shared. Each node in a network has a copy of the entire ledger. When changes are done, each copy is updated automatically, ensuring the participants of the network do not have to match multiple databases with each other. And it does all that in a cryptographically secure manner with a validation mechanism that has not yet been tricked.
The blockchain was initially developed to power cryptocurrencies, specifically bitcoin, but banks have realized that the mechanism in the background could be separated from the currency-idea. Thus they deployed it also to make the handling of fiat currencies more efficient. In another step banks have then moved on to more centralized models as opposed to the initial design of bitcoin, resulting in a semantic differentiation: These centralized models are increasingly referred to as Distributed Ledger Technology (DLT). Given the right technological set-up, the blockchain has two major advantages: lowered costs and increased speed. These are the very promises of the digital age and with the blockchain they could be delivered to banking.
The reason why the potential is so large in banking is the very underlying paper-logic, yet sometimes there are even physical manifestations of that logic. Take trade finance as an example. Bills of lading and letters of credit are in many cases still printed and mailed by mail or fax. Banks, together with tech and logistics companies, have piloted using blockchain and brought the length of a financing down from 10 days or more to a matter of four hours. No printing, no mailing.
But when banks are moving their business to the digital arena, they are not entering a vacuum. Powerful tech giants have captured many industries that have made this transition. Retail, music – the list of former incumbents groaning under the domination of Silicon Valley is long. To be sure, banking is a different story. Shielded by the powerful banking-license and various regulation, most areas of banking are off limits. Payments is not. When you are moving other people’s money without taking hold of it, you are facing laxer rules. Indeed data giants – whether those from Silicon Valley or their Chinese counterparts – have been extremely active over the past two years. Google is the second-largest investor into the blockchain. Ant Financial has enabled Hong Kong’s Filipino migrant population to send money back home using the blockchain. With banking moving onto their turf, data behemoths have the right competencies to battle banks. They are also assured by the way the payments market has unfolded in China. The majority of payments and transactions – though not via the blockchain – is done via Alibaba (Ant Financial), Baidu, or Tencent (WeChat). Union Pay is the only traditional institution of relevance.
In this new space race to use blockchain to dominate payments, it is noteworthy that the much feared fintechs are not the big disruptors, but see their main objective in seeking cooperation. The other side is endorsing their cooperative spirit. Banks are pumping money into startups, building incubators, organizing hackathons, and founding their own blockchain fintech companies such as R3. Google is partnering with Digital Asset and invests into companies such as Ripple. Facebook had discussions with Stellar. Amazon offers all kinds of companies the Amazon Web Services (AWS) infrastructure to build Blockchain-as-a-Service (BaaS) apps. The fight to stay ahead in the blockchain race is also one fought with alliance-building.
While banking is more privileged than other industries, data giants are working hard to utilize the blockchain to enter payments. Whether they will succeed will eventually hinge not so much on the technological implementation, but which actors and actor groups make the right choices in terms of corporate strategy.
About the Author
Igor Pejic is Author of Blockchain Babel: The Crypto-Craze and the Challenge to Business. Blockchain Babel looks at blockchain alongside innovation diffusion, competitive dynamics and management strategy. Shortlisted as one of the three best business book proposals by McKinsey and the Financial Times for the Bracken Bower Prize in 2016, this is a must-read for business leaders and aspiring leaders wanting to grasp blockchain and put it into context and understand the practical implications it may have.
