The financial services industry is one of the few leading industries that technology hasn’t completely disrupted. But the fintech revolution is now underway, thanks in part to massive capital inflows Cryptocurrencies.
So what is changing and what will the financial landscape of the future look like? To answer this question, we must first look at the structure of the financial industry, which has been around for decades.
The status quo so far
Traditionally, financial institutions had a custody account with their customers. They act as administrators of their clients’ wealth and offer them a relatively limited range of services. This relationship defines the structure of the banking, insurance, and wealth management industries.
The custody account relationship means that customers only have limited access to third-party services and external service providers have no access to an institution’s customers.
Institutions can maintain the status quo because they are classified as trustworthy. Customers trust institutions that are considered stable, well funded and regulated.
The structure of this industry makes it difficult for startups to compete even if they can offer a better product. This also results in few incentives for traditional institutions to improve efficiency.
This is one of the reasons bank transfers still take days, despite the technological advances of the past few decades.
Two concepts now enable technology-oriented companies to question the status quo: blockchain technology and open banking.
Blockchain breaks the monopoly of trust
Cryptocurrency transactions and ownership are recorded on a blockchain, which is a decentralized database. Blockchains are not only decentralized, but also immutable. This means that once a transaction has been completed, your records cannot be changed.
Other assets and transactions can also be recorded on a blockchain. Securities, property, contracts and even works of art can be tagged and traded on a blockchain. In this case, their ownership and transaction history is also recorded on a Ledger that cannot be changed.
For the financial sector this means that the institutes no longer have a monopoly of trust. When individuals can trust the technology, they no longer have to rely on a custody relationship with a brick and mortar bank or traditional financial institution.
Open banking and the democratization of finance
New rules on data exchange allow consumers to give third parties access to information about their bank accounts and other financial products. Consumers, not institutions, are now in control of their information and who has access to it. This is the concept of open banking.
Open banking enables outside organizations to provide financial services to individuals, with institutions acting as platforms rather than gatekeepers.
Perhaps the best-known example is PayPal. PayPal users can link their account to a bank account and then use PayPal to make payments. However, the concept is now being applied to insurance, financial markets, and other financial services.
The decentralized model
The combination of blockchain technology and open banking paves the way for a completely new financial ecosystem. Instead of a small number of large institutions offering financial services to their customers, consumers have access to a large number of technology platforms that they can use to buy and even sell services.
These platforms act either as marketplaces or as platforms that provide a service. The barriers to entry are low, so more entrepreneurs can compete. More competition, in turn, leads to lower prices, more innovation and improved efficiency.
The peer-to-peer economy
The decentralized financial model is more democratic and in many cases amounts to creating a peer-to-peer economy. Institutions no longer have a monopoly of being the intermediary between lenders and borrowers for whom they deserve high margins.
Peer-to-peer lending platforms like Upstart and Prosper charge borrowers lower interest rates and pay lenders higher interest rates than banks.
The risk can be reduced if loans are pooled and distributed among numerous lenders. Artificial intelligence is also increasingly being used to predict the risk associated with any loan.
Insurance policies can also be offered on peer-to-peer platforms. Typically, policies are drawn from pools made up of a large number of people. With the expansion of this model, the premiums can be reduced as the risk is further diversified.
The relationship customers traditionally had with asset managers and stockbrokers is also changing. Investment firms need to be innovative if they are to stay relevant. As a result, they are now offering their customers a wider choice of products and tools at a lower cost.
Large investment firms are no longer the only way to offer investment services. By investing in marketplaces, tools, and data, anyone can conduct secure transactions, invest in various products, and make profits without the intervention of traditional systems.
One example is copy trading platforms where successful traders can have other traders copy their trades for a portion of the profit. Another example is marketplaces where developers can sell or lease algorithmic trading systems to fund managers.
Banks are catching up
The investment industry has developed significantly over the past two decades. Banks that have more reason to lose have changed more slowly. One of the reasons is that the decentralized economy still seems risky and difficult to understand for many, and its revenues are still not that high compared to traditional banks. But that is changing.
On April 14, 2021, the Coinbase cryptocurrency exchange became a public company when it was listed on the Nasdaq Exchange. The listing should bring Coinbase a market value of nearly $ 100 billion.
Goldman Sachs is currently valued at $ 110 billion, but it took the bank 150 years to reach that valuation. Coinbase reached this size in just eight years.
This type of value creation is what draws traditional banks’ attention.
It is probably no coincidence that Goldman Sachs recently announced that it is expanding its product range to include cryptocurrencies.
Banks and other institutions continue to play a role in the financial ecosystem. They enjoy certain privileges due to their regulatory status and will not lose those privileges for some time. However, they have to be innovative if they want to be part of the new financial ecosystem.
The financial services industry of the future will ultimately be decentralized, digital and transparent. Instead of being controlled by some big corporations, it will be democratic.
The ecosystem will consist of platforms and marketplaces where individuals buy, sell and insure assets, and borrow, lend and invest. Many of these platforms are currently being built for the crypto economy – but they will end up being deployed across the economy.
Everyone has access to any financial service offered, and anyone can provide a service. More competition will lead to more innovation, so we can expect constant improvement and efficiency.
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