Monthly Archives: May 2019

Today when we think of loan or a financial product, the first thing that comes in our mind is bank. You want to have mortgage, go to banks, you want to have credit card, go to bank, you want to make a deposit, you go to bank, you want to wire, you go to bank. Though many may argue that they use online banking but that’s still a bank and unless there is a very strong reason for you to go to a 3^rd party, you try to consolidate financial matters through one single institute & the first choice is bank.

Their brand power, accessibility & trust factor is unprecedented. 3^rd party vendors are not more than your corner convenience store where you go when you need something in emergency, but weekly/monthly grocery is through Walmart or any big retail store. While price is certainly a factor, availability everything under one roof is also very convenient. Same is the case with bank however as opposed to big shop pricing discount services at bank are often expensive as opposed to 3^rd party. There is a premium to exchanging currency or do a wire transfer. Though lot of it is attributed towards the fact that they can charge that premium without churning a big chunk of their business, but the other factor is high operational expense that they’ve to occur. While our parents were used to banks, we’re using a combination of services to well fit our need, but it’s diluting the dependence on bank. As the shift grows banks have to take a different approach competing with startups & they’re well poised to do so.

While they’ve the customer base, well capitalized and have the infrastructure & regulatory clearance.  They however may lack the thirst to innovation & are slow to move. I however think that the best approach for them is to partner up with startups & built a marketplace.

Now while banks have their own arrangements and partnership for every product they offer, they do operate more like a close loop system, but I think it’s time to change it. They should instead turn into a hub to offer multiple services. May be like Amazon but white label. At the moment they’re operating more like United Airways but what if they shift their model to Expedia with a white label badge. You want to transfer money from A to B, you’re presented with 2 options. Be there in 4 hours, it’s cost $10, be there in 2 days, cost $1. On backend banks have APIs of startups which provide those services and banks can use those startups to find the most efficiency way to perform a specific service. Win for banks and win for customers. Customer churn rate will reduce and banks will keep their branding.

There has been recent cases where banks have partnered up with startups providing them the branding but if they do it well, they should just actively pursue it as a business line. I don’t expect big banks to buy into this idea soon, but the one that does will emerge as a winner and won’t provide space to startups to displace them.

My bank of future will have very few branches and will have partnered up with 100s of startups offering services and competiting for best quality & cost.

Let’s see who that’ll be in 5-10 years

I wrote about Trust & it’s importance in the last blog post here. I’ll try to cover more on Open Financial also known as decentralized financial systems AKA DEFI. You can pickup thee term as per your liking but as much they’re interchangeable they’re also subset of each other depending on the reference that you apply.

An open system can be decentralized or centralized depending on your definition of centralization & same with openness where it could have so much high barrier to entry so it’s not truly open. Example is being a bitcoin miner where you can’t participate unless you run a very sizeable operation. Theoretically it’s decentralized but there are couple of entities that control majority of the hashing power.

Trust in finance is super important & that’s the basic of any transaction.

When you look at all the financial system around us, we believe they’re open, but they’re not regardless if they’re in developing or developed country. They’re operating more like silos. They do interact but with permission very inefficiently. If you had to transfer money from one bank to another bank in us, it’s quite doable but you’re at the mercy of bottle necks involved in every party involved in the transaction.  I still have restrictions in performing multiple tasks that require branch visit. We do have SWIFT, Interac, SEPA & other systems which are comparable to protocols but they’re inefficient with no visibility into the process.  There’s a reason why majority of the world is unbanked because cost of banking is high. There is an argument that unbanked don’t need a bank because they are poor but in fact they’re poor because of barrier to financial tools.

To bring down cost of banking or access to other financial tools, unbundling of the system has to be done & DeFi makes it possible. I’ll give you example of how that can be done. Right now if you look a the process of loan origination, there are mainly 3 parties at a financial institute that make it happen. They’re

• Debt Raiser
• Debt Issuer
• Underwriter

Debt issuer makes the business case for the loan, while underwriter assess & approves the risk & loan, and debt raiser finds the money to fund the loan. Though they all belong to same institutes but there is a friction between them since they’re responsible for their own departments. Now hypothetically what if all three work independently and are able to scout outside their institute, that’ll ultimately benefit the customer. Chances of success are much higher due to participation of more and more players. Now the biggest pain point here is trust. Would they trust each other now that they’re dealing with outsiders ?

That’s where DeFi & protocols become important. Now I’ve simplified it a lot, but this is how it’s supposed to work. E-Mail is based on Simple Mail Transfer Protocol

(SMTP) which is common across the globe so your interface can be whatever you like it be but for transmission it has to follow SMTP standards.

I’ve been particularly excited about Decentralized exchanges & protocols which empower small players to build interesting applications. ERC20 based tokens on top of ethereum were a success which lead to thousands of applications being built serving different used cases. While different chains don’t talk to each other at the moment, but that’s going to change in coming days.

No one size fits all and that’s the case with financial apps too. Needs are different based on demographics so niche apps are required to serve them well. While protocols are scary for the majority but  there isn’t any neeed to be paranoid about the utility. What percentage of people around us knows how does SMTP work. They just use gmail, Hotmail etc.
It wasn’t possible to transact online without using a 3^rd party. Decentralized exchanges make it easy. Now we have tools to hedge, lend, borrow that are gaining popularity on the internet as well. I am very excited about this development because it opens up the financial world to everyone with internet access, which is billions of us. Local, national, international all can enjoy the tools without any discrimination. 

Coming back to trust issue where I laid the importance of trust in financial transactions. Protocols make this job easy & playing field for every participant. As long as you satisfy the protocol rules, you’re in. Your app doesn’t need to have a track record of centuries or decades to participate. Rules of pedigree are broken here.

 Status quo enjoys the trust, regulatory barriers & support of the top movers & shakers but soon their kingdom will be challenged. There’ll be a revolt by the millennials where they’ll move to alternative options which probably will be built on decentralized financial system which is open, non-discriminatory and fair to to every one. It’ll be a war where incumbents have to innovate, competitive to a very rare breed of smart and intelligent engineers globally who’re building tech apps to serve the customers much better.  I expect majority of the incumbents to give up or find intelligent ways to build partnership & integrate into the decentralized system.

Some of these things might look alien, tails from utopia but there is serious work in progress where transactions are growing with more and more participation from community and institutes alike. Tech companies have tendency to go parabolic once they find market fit & I expect this the case here as well.