Three challenges to traditional finance
In our last post, we introduced DeFi — Decentralized Finance, a solution that would potentially empower individuals against legacy financial systems.
We also touched upon the shortcomings of traditional finance; excessively large, slow and bureaucratic as well as working in silos… We will look into those areas in detail later, but first, let’s look at a couple of challenges that traditional finance faces today.
While we are transitioning from analog life to a digital one, financial players have been among key winners. Financial services, after all, require limited physical effort and are perfect fit for a digital setup.
As for us, the consumers, we love the perks of digitalization: No need to go to a bank anymore, just use my own phone to meet all financial needs.
Financial players? They loved this consumer demand: No need to keep more tellers to serve us: While demand for financial services has grown exponentially, banks were able to meet this demand with limited additional resources, thanks to digital tools. Result: Skyrocketed fees, profits, and market capitalizations for almost any financial player.
Well, life comes in cycles and nothing lasts forever. Such profits attracted outside attention pretty quickly: “They have all the fancy offices yet they fail to provide basic services properly” says the consumer. “They have all that financial muscle, yet they are reluctant to allocate enough resources to meet our regulatory requirements,” says the government.
|Image by antonynjoro from Pixabay|
Here is the catch: Customers and government authorities, now have the power to act rather than simply complain. How? Let’s have a closer look at what they have inside their arsenal.
Key challenges for financial players
Nowadays, financial actors are feeling the cold breath of three main external parties (if they are not, then I am sorry for their ignorances, they will be hit even harder in the future).
Those are mainly: Individuals (i.e., their customers), governments (i.e. central banks), and tech giants (i.e. Facebooks and PayPals of the digital world).
What is the common theme here? All three will use the power of technology to challenge banks and other financial institutions. How? Let’s have a deeper dive on each one:
Individuals (or public)
Why do individuals need financial institutions? Two key needs: Financial and transactional.
First, humans accumulate wealth, through either working hard or inheriting from their families. They need a safe place to store their wealth and prefer to have some additional benefits such as interest income. Banks provide the most optimal solution for such needs.
On the other side, other people need financing for immediate needs or longer-term investments. Who would provide that better than banks? In short, banks are ideal places to store value and provide this value to those in need.
Second, people get into arrangements with each other, to buy and sell ‘things’ and transfer a financial value in exchange. How do they do that? Using the comfort and trust provided by banks and other financial institutions.
Sure, but all these benefits that banks provide, come with some cost and certain restrictions (which we discussed in our previous post).
What if people were given an alternative option? Such as, a secure and cheaper value storage with full control? In other words, store your wealth at almost no cost and transfer it to anybody around the world, at any time you want, with no strings attached?
After being around for ten years, cryptocurrencies have reached a maturity level to be a solid candidate to store and transfer wealth. Now, slowly and surely they are also attacking the other parts of financial services, such as lending, borrowing, insurance, exchanges, and so on… That is what DeFi is for and we will continue to explore this area in our future posts.
Governments (or central banks)
Central banks deal with banks and other financial institutions to conduct monetary policy. Mass public has almost no interaction with central banks. Instead, banks act as an intermediary between the central bank and the general public.
|Image by Michal Jarmoluk from Pixabay|
On the other hand, governments have full control over fiscal policy. In an overly simplified manner, this is how governments spend money to bring services to people and incentivize the economy.
What if we coordinate monetary and fiscal policies under one roof such as central banks?
In order to have a much more effective policy, they need direct access to individuals so that they remove inefficiencies created by banks. Do they need that? Let’s think about it for a second:
By creating a bank account for each and every citizen, central banks will have direct access to every individual. Example: Let’s say you are planning to provide some incentive to apple growers. Rather than using intermediaries like banks, you can directly put money into the accounts of those registered as apple farmers. Furthermore, you can track and even control how they use this incentive (such as permitting them to use it only for fertilizers).
Is this even feasible? Well, with a Central Bank Digital Currency, this is certainly possible. There are many more benefits for governments and several drawbacks for individuals but let’s leave that for another post.
Tech giants (or Facebook or PayPals of the digital world)
Facebook has already announced that they will create a digital currency. Initially called Libra now changed to Diem, it will be a stable currency (meaning pegged to a fiat currency such as dollar or euro). This digital currency will be used to accommodate all the financial transactions in the Facebook world (in addition to many other partners in the network).
|Image by Gerd Altmann from Pixabay|
PayPal has already accepted cryptocurrencies as a payment method. Their announcement of a native digital currency will not surprise anyone. The question is not if, more like when. Amazon has already started exploring digital currency in Mexico, so it is just a matter of time before they introduce it to the North American market following by the rest of the world.
Why is this important for banks? These tech giants hold the end customer under their hands (via their apps). Customers already use them for buying and selling. Now, these giants will hold their grips on the financial side of that transaction as well.
They will not let banks touch to their customer. If you do not touch your end-user, then the game is over for you — you are out.
Individuals, central banks, and tech giants are the three major challenges for banks. Sure, but what do banks do to tackle these issues? Let’s have a look at them in our next post.
This piece is first published in BlockchainIST Center on Feb 24th, 2021.
None of the views expressed in this article should be considered as investment advice