The power of the protocol – creating the platform for enormous market disruption
In five short years digital currencies have grown from a hobby project to a multi-billion dollar global finance industry. With new competing alternatives and technology advancing beyond simple currency-based payments to all manner of value exchange, financial instruments and smart contracts, everyone is waking up to the fact that digital currency was just the beginning.
Arriving just in time for the great convergence of mobile payments, digital branchless banking and value exchange, digital currencies and Digital Finance 2.0 promises a major disruption of global finance.
Originally an outlier technology, the business of digital currencies, and its broader digital money applications, has now grabbed the attention of nearly all major financial institutions, consumer technologies and regulators all over the world. We will explore the tension between decentralization versus the new channels to market play of the various incumbents.
Inspiring the next generation financial ecosystem, startups and investors
Today digital finance is a new and emerging area of finance that encompasses the areas of financial technology, digital payment systems, digital financial products such as digital derivatives, digital securities, digital carbon credits, and a wide variety of digital forms of traditional financial products.
In his seminal paper A peer-to-peer electronic cash system, dated November 2008, Satoshi Nakamoto envisaged a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.
From this simple premise the digital currency phenomenon has grown in scope (1 million users) and size ($8 billion market cap) to grab the attention of media headlines worldwide. Bankers and regulators don’t entirely trust digital currencies and may confuse business malpractice with the legitimate applications of a highly disruptive financial innovation.
But what is unstoppable is the convergence of two major financial technology sectors with that of protocol technology – the crossroads where Digital Banking and Mobile Transactions meets the protocol(s). Will this be as natural convergence or a collision?
The Internet of money: A radical new business model
What will drive the adoption of the overlapping technologies and the efficiencies and disruptive business opportunities? Customers, consumers and users become the new co-creators of value. This requires a value transfer system that rewards each respective contribution incrementally and directly, regardless of the kind of the services or goods being offered, anywhere in the world in real time. The protocol fits the model perfectly offering elegant new forms of value exchange, including for the internet of things.
Digital value exchange – the distributed autonomous zone
The distributed autonomous zone will become the virtual marketspace where distributed organizations and communities connect to barter, exchange, transact and interact around different modes of digital value exchange.
Digital finance 2.0 will be distinguished from the old ways of banking and traditional financial legacy systems through the convergence of digital banking, mobile value exchange and digital currency applications in a variety of forms suited to different jurisdictions, market evolutions and the differentiated needs of the banked versus the underbanked (estimated at 2.5 billion) worldwide.
Branchless banking is the key distribution channel strategy used for delivering financial services without relying on bank branches or also be used as a separate channel strategy that entirely forgoes bank branches. Overriding even this will be the fact that the majority of customers now prefer online or mobile banking.
Internet access (all devices, but especially mobile) with customer centricity, affordability, ease of use and affordable secure access anywhere, especially at Point of Sale becoming the key drivers.
- Mobile is a lead driver for change in payments technology – specifically the remittances and money transfer markets. A third of all online sales are now made over mobile devices.
- Business models, technology, and consumer behaviors are changing. Electronic payments, digital commerce, predictive analytics, and mobility are converging, along with contextual marketing, digital advertising, couponing, loyalty, and social media. The opportunities to enable magical new commerce experiences for consumers and more meaningful interactions between brands, merchants, and their customers are endless..
- Dramatic uptake of smartphone devices and mobile phone penetration in emerging markets. 67% of the people on the planet now have a mobile phone conducting and estimated 300bn transactions valued at $860 billion. There are already 1 billion mobile banking users.
M-Pesa – lessons for merchant and consumer adoption?
A leading example, and great case study for alternative digital transaction adoption, is the emerging market success story in Kenya, namely M-Pesa.
It was originally designed by Safricom (Vodafone) as a system to allow microfinance-loan repayments to be made by phone, reducing the costs associated with handling cash and thus making possible lower interest rates. Once you have signed up, you pay money into the system by handing cash to one of 40,000 agents (typically a street vendor or a corner shop selling airtime). It has since broadened to become a general money-transfer scheme, loans and savings products, bill and salary payments, etc. Having established a base of initial users, M-PESA then benefitted from network effects: the more people who used it, the more it made sense for others to sign up for it.
The emerging protocol
The blockchain’s greatest potential is as a global payments network, to power transactions that are extremely low-cost, virtually frictionless, and easily flow across national borders. In a nutshell, digital currencies allow for the simple and secure transfer of value online, without intermediaries (although intermediaries are often good to have, see below). Their strengths explain why it potentially pushes out legacy payments players — like credit card networks and card-processing companies — that rely on skimming transaction fees for their revenue.
Despite these barriers, there is a belief that its efficiency and low cost in comparison to legacy payments tools like credit cards, money transfer services, or letters of credit will ultimately prove too tempting for merchants, individuals, and business-to-business billing. This value will hold even when intermediaries are involved. Digital currency processors charge only 1% to process transactions, compared to the 2 to 3% often paid by merchants for credit card processing.
Interoperability – the integration challenge and opportunity
The challenge is that emerging financial technologies don’t trust or have access to established financial institutions and services whilst they in turn don’t trust or have access to the emerging technologies. Both worlds are already exploring strategic partnerships and relationships and soon we will see a large-scale convergence and meshing of legacy and emergent digital finance offerings and delivery platforms. Imagine centralized meets cloud meets distributed solutions. Here lies the true competitive advantage and innovation for digital finance 2.0 players.
The future of money won’t be about cash or the form it takes. The future of money and commerce will be about breaking down barriers and increasing access for more people across both geographies and incomes. Why? Because with the right payment systems and new innovations in place, how you pay for things drives greater equality of opportunity in society.
Delivery platforms from every sector of the industry will vie for a stake in this lucrative and necessary business – from the so-called over to under banked parts of the world. Some argue that perhaps the financial system needs an overhaul, or at the very least sound and viable alternatives to the current legacy system driven offerings and the latest innovations emerging through branchless banking and mobile transactions/payments.
Future players should consider improving their operations to compete with the vast resources of the incumbent players in the financial sector, to win the regulators over (or at least build common understanding) and to provide room for the evolution of disruptive innovation, and last but not least, convince the consumers that this can work for them.
Challenges to adoption in Canada
Key criteria for adoption: Consumer confidence; Ease of use and security; Regulatory tolerance.
There is currently healthy and justifiable consumer skepticism based on the media highlighting the financial crime problems – justifiable concerns on the one hand – but, at the opposite end also just part of a much bigger picture of a range of positive applications and benefits. But, they will only believe this when they experience it first hand and there is broader adoption.
Until regulators determine regulation, none of the financial institutions will be first movers in this space. The audit, governance and risk implications are too great for anyone to risk their brand or license at this early stage of the game.
The sector should demonstrate positive opportunities, innovation, adoption and user friendly, merchant adoption at POS, secure, beneficial applications as an alternative to the plethora of other options available to the consumer from mobile payments, to online banking to credit/debit cards.