Cryptocurrencies and related distributed technologies need a proper ecosystem to become a significant and meaningful part of the finance ecosystem
Blockchain, ICOs and digital securities (e.g. cryptocurrencies) have become the new kids on the finance block – and of course opinion is divided. Some believe they will take over the entire finance industry in a few years and make all traditional finance instruments and institutions obsolete. Others see ICOs and cryptocurrencies as the biggest bubble and/or scam of our time – in the US, there are now plaintiff lawyers that only focus on ICO lawsuits.
Maybe the reality is something between: these solutions have a lot of potential, but they need a proper ecosystem to become a significant and meaningful part of the finance ecosystem. It is easy to print money, but the real test is if you can use that money to buy something.
Let’s look at some fundamental problems of these instruments and systems that point to a missing or weak ecosystem:
- Most cryptocurrencies, ICOs and technical solutions are independent of each other. Companies and projects issue their own tokens that are often based on their own underlining assets (security tokens) and services (utility tokens) which correspond to plans and promises. Even if it is technically possible to exchange them with other digital securities or traditional currencies (fiat money), exchange rates and values are hard to evaluate. Bitcoin, which is based on mining, is more like a commodity (e.g. gold), but most of the other cryptocurrencies are based on other assets or asset promises.
- The services and instruments are not linked to fundamental regulatory requirements, e.g. Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) requirements. It is hard to believe regulators would allow anonymous users and transactions on any significant finance market. KYC and AML are not only linked to finance regulation, but also to things like national security and anti-terrorism activities.
- The services have no link to the bigger financial ecosystem to underwrite, syndicate or trade securities. Each service’s target is to have its own assets and investors, when different cooperation models in the traditional finance sector are the key to success.
- There are no common models to acquire and use data to value, monitor and rate assets. A slide show or white paper is not enough to analyze any asset and – perhaps more importantly – track how the value develops.
- There are no independent third-party models and services to analyze, rate and value assets. Common models, practices and independent evaluations are an important part of the system to evaluate assets and keep the market stable. ICOs often include opportunities to manipulate the market.
To be clear, I fundamentally believe these new solutions and models can change the entire finance ecosystem. And obviously, we cannot expect to create the whole new ecosystem overnight. At the same time, it is crucial to understand the need to have a properly working ecosystem, some ideas on how to develop it and find the fundamental missing links. Otherwise, some failing services and instruments, and even illegal activities, can cause too much harm to hinder development of that ecosystem.
We can compare this development to the history of crowd and p2p finance, starting with equity crowdfunding for early phase startups. I remember a venture capitalist said years ago, “I think this online crowdfunding is a great model, but why has it started with the most difficult asset class, startup equity?” This comment comes to my mind when I look at ICOs.
P2p lending, online real estate finance, and later, stable-phase company equity have become more important markets than startup equity in the crowd and p2p finance market. Institutional capital and investors have also taken an important role in these markets, and often they represent greater than 50 % of the capital committed. These markets still also have their issues, where too many platforms try to be totally independent and just get their own deal flow and investor bases to work. But securitization, syndication and cooperation of different services have become important in this market.
There has also been a lot of work done with regulation and regulators in the crowd and p2p market. There are platforms that don’t follow all regulations, but all significant platforms want to do it, and they must. In many countries there has also been quite constructive cooperation in developing key regulations. This is needed for the distributed finance solutions market as well.
Missing ecosystem components
The missing components in the ecosystem are essential new business opportunities. Let’s take a few examples:
- There are many new ways to identify users and fulfill KYC requirements. We no longer need the old model of walking into a bank branch with an ID card and utility bills. There are many e-KYC solutions, but there are also totally new models to manage digital identity and personal finance data that can work with distributed models too.
- Real-time data, data analytics and AI can be used to evaluate and value digital securities and underlining assets. Of course, there is never a solution to value mere slideware and fancy plans.
- When ICOs and smart contract models for digital securities are developed for assets classes that are better known and easier to value, like loans, real estate and later phase companies, it will be easier to get more investors, including institutional ones, involved in the market.
- Industry players need clearer roles and compatible tools to interact in a true ecosystem. This probably also means a marketplace and issuer cannot be the same actor – independent marketplaces are needed.
- Many needed components, like identification, data collection, third-party markets and evaluation can be done based on new distributed technology models and solutions.
- Blockchain still has its technical issues like capacity and latency, and its implementations vary. There are some new candidates to create similar concepts, like Hashgraph, but there is still a lot of room for developing distributed ledgers, smart contracts and database solutions.
FinTech, along with distributed technology, is changing the finance industry. But in order to have a real impact, it requires systematic development, getting different services to work together and offering reliable finance instruments. We must not leave this development only for those trying to make some quick money with their ICO – we need many parties to systematically develop their own parts for the ecosystem. In that way, we can really change the finance industry for the better.