By Jesse Hemson-Struthers, Co-Founder and CEO, BVNK
Customer demand for digital-first services
Traditional banks often have a poor reputation when it comes to the quality of their service with customers routinely expected to endure long queues, opaque fees and excessive charges. But customer demand for intuitive, digital-first personalised financial services is driving the emergence of new providers and the transformation of the sector. Much of the innovation we’ve witnessed in recent years has been at the level of the user experience. But blockchain technology and cryptocurrencies have the potential to effect a much deeper transformation of global banking systems and processes.
Along with customer expectations, there are a number of other catalysts for the ongoing transformation of the financial services sector. Open banking is one factor with incumbent providers opening up access to the customer data they hold for other third-party service providers. Sharing data between banks and non-banks over modern, secure channels provides a new layer of connectivity that serves as a basis for creating new apps and services. Visa’s USD 2.15 billion acquisition of open banking platform, Tink, and its failed bid to buy Plaid, another open banking service provider, point to the potential seen in the sector. The fintech sector is flourishing in markets across the globe as new entrants look to capitalise on the opportunities of open banking.
The emergence of neobanks has been yet another catalyst for change. The challenger banks met consumer expectations of a smarter banking experience in a variety of ways: with mobile- and digital-first services, transparency on fees, by presenting transactions in a more easily understood manner, and by allowing customers to develop personalised savings and money management plans. Their success in acquiring millions of customers in markets across the world vividly illustrated that traditional service providers were falling short of customer expectations.
In reality, however, open banking and neo-banks have changed very little about the underlying banking systems. Much of the innovation has happened at the user interface or application level. The services are still being built on top of the outmoded, pre-digital banking infrastructure that serves all providers. For instance, SWIFT, the global network for international payments, laid down the foundations of its systems in the 1970s.
Blockchain and digital assets – doing to infrastructure what neobanks did to the user experience
Today, global banks spend millions of dollars maintaining and updating their legacy technology to tackle flaws and inefficiencies, such as separate systems struggling to talk to each other, excessively long settlement times in a digital era, and the difficulty of innovating on top of creaky infrastructure. Digital assets and cryptocurrencies present us with the opportunity to build anew and facilitate faster, higher-performing digital services with lower transaction costs and fewer intermediaries between end users. Blockchain technology and cryptocurrencies are doing to banking infrastructure what the neobanks have done to the banking experience.
Digital assets offer the promise of instant, decentralised, cross-border exchange with low fees. These intrinsic benefits are serving as a catalyst for players in the space to consider how they can be used as a basis for building better financial services. And we’re seeing considerable resources being deployed across the cryptocurrency space to mirror and enhance what is on offer in the world of traditional finance.
Digital asset-powered banking services
Take international payments for instance. In contrast to the globalised, digital world we live in, the industry for cross-border payments is fragmented and subject to a swathe of regulations, constraints and requirements depending on the regions and countries involved. To offer a truly international proposition, merchants must call upon a range of payment service providers to cater for the currencies of each of the markets they operate in. Similar challenges apply with SWIFT payments and the difficulties of managing a variety of bank accounts denominated in frequently used currencies. This fragmentation and complexity leads to a lack of transparency, lengthy settlement times, and high transaction costs.
Using blockchain and cryptocurrencies as a basis for international payments solves these challenges and eradicates this complexity. Funds can be transferred almost instantly between digital asset wallets wherever in the world they’re located at low costs without the need to pass through a chain of rent-seeking intermediaries.
Interest paying products based on digital assets are also outperforming their traditional finance alternatives. The last couple of years have seen large scale interventions from central banks with funds pumped into protecting economies and jobs. A fifth of all the dollars ever created were printed in 2020. This has reduced the value of fiat currencies and resulted in ongoing low and even negative interest rates.
In comparison, digital asset markets and the high yields they can generate offer an attractive alternative. Financial service providers can convert corporate treasury fiat reserves into crypto assets that are placed into liquidity pools. Arbitrage traders, speculative traders, cryptocurrency service providers and retail borrowers are the key groups that dip into these liquidity pools to borrow digital assets on more attractive terms to the lender than exist in the world of traditional finance. High yields are possible because borrowers believe they can make bigger profits with the loaned assets than it will cost them in interest rates to borrow those assets.
Digital asset yield products are tailored to corporates seeking more transparency. They provide full visibility of the factors that influence risk and reward. Service providers deploy client funds to multiple prime brokers based on a dynamic risk model – which takes into account security, creditworthiness and risk profiles – to optimise yields on a regular cycle.
Loan services based on digital assets are already running in parallel to the fiat economy, and are well on their way to becoming an established part of global financial management systems.
The final aspect of digital asset-based financial services that is worth looking at is Decentralised Finance or DeFi. This harnesses the strengths of blockchain technology – trustless transactions and smart contracts – to orchestrate financial services and exchanges without the need for middle men. Smart contracts automate transactions and deals according to the fulfilment of pre-agreed criteria. In the business banking space, DeFi is very much in the early stages but it has the potential to transform commercial lending products and access to credit
A fitting foundation for banking services in a digital world
Blockchain and digital assets are a fitting technological infrastructure for financial services in a digital world. What we’re seeing now in the cryptocurrency sector is innovation based around a rethink of how blockchain and digital assets could transform core banking – where and how can they make processes and systems quicker, more efficient, and better performing with lower costs.