Let’s start with the visions of digital finance. Cryptocurrencies are stable and independent from authorities and governments. All finance services go digital, customers get access to their services through digital channels, and paper documents are a thing of the past.
Nice. Now for the reality. Cryptocurrencies are still subject to government control, including things like sanctions. Digital channels are still tightly controlled and hard to use as easily as consumers do. And for KYC you still need a stack of papers.
Obviously the vision and the reality of digital finance are still very different. This doesn’t mean we won’t see changes and a paradigm shift in the finance services. However, we should be mindful that making change happen is much more challenging than it might seem at first glance. Furthermore, we should remember that governments will not give up their role in controlling finance services.
Financial Times reported that a senior Credit Suisse investment banker was removed from his position earlier this year after he was found to have used unapproved messaging applications with clients. He was a senior banker with 28 years of experience. Reports also indicate many senior-level bankers have had issues with commonly used messaging services like WhatsApp or personal email. It is just another reminder that the banking business is highly regulated and typically all communications must be on officially approved platforms.
The Russian sanctions have been a reminder for crypto services that they also must follow finance regulations. The government has a monopoly on violence and between COVID-19 and Russian sanctions, we are being reminded that governments can really control people and businesses.
Cryptocurrencies also have a hard time for other reasons, due to a combination of factors. A fundamental issue is that cryptos and their value are still often isolated from the real economy – i.e., crypto value has gone up when certain communities have wanted to buy them, but the value hasn’t been based on underlying factors of the real economy. The value of shares is based on things such as the development of the company in question. A currency is based on value on the economy of its home country, or the value a financial instrument on its underlying assets. Of course, this is not totally black-or-white – some other instruments also have speculative value, and some cryptos are tied to real assets. However, cryptos are still quite isolated islands, meaning they can become very speculative.
In my previous article, I explained that paperless and digital are not yet a reality, especially if you want to open a bank account, or in the context of many financial transactions. This also means that the use of data is not yet very effective. Some years ago, I participated in a discussion about how a big debt market company in NYC could better collect data from many sources and also attach relevant metadata to debt instruments to make the pricing of the instruments based more on the latest real-time data. But this was just too complex to implement in reality due to complex regulations, internal processes and attitudes.
Most fintech success stories have been startups that focus on “simple” things like credit card transactions, money transfers or a basic bank account as a mobile app. It is also interesting that many successful fintech startups (e.g., unicorns) come from outside of Silicon Valley or the US. One possible reason is that Silicon Valley is good at ignoring regulations and rules – but in finance and other tightly regulated sectors, you must understand enough about the regulatory requirements to get something to work in reality.
The fintech situation can be simplified into two types of active actors, both of whom have their own fundamental problems.
First, banks talk about grand digital finance visions and set up special fintech units. But they cannot implement significant changes partly because of complex regulations and their existing IT systems that make it very hard to introduce new things. Second, fintech startups offer niche financial solutions that are hard for them to expand to the mainstream because the regulations make things expensive (and those who want to ignore the regulations get into trouble sooner or later). Both groups are sometimes too idealistic about what they can actually accomplish.
The future of digital finance is when?
It is quite evident that finance services must change, become more digital and utilize better data. Nevertheless, it’s slow going, and in the meantime we are still waiting a few days for a SWIFT transfer and providing paper documents to our banks. Furthermore, we are forced to talk with a banker only via a clumsy official banking chat or email, and we do not have digital finance instruments that would automatically have metadata to automate processes and pricing.
The good news is that one day all this will change. We know the future of digital finance is coming – it is really just a question of timing. What’s needed right now is existing and new finance companies that can create realistic new services, and are also willing and able to take on big enough challenges. If you only change small transactions or details, the fundamentals of the services don’t change.
It is also fundamental for financial services to utilize data better. This means that financial institutions, insurance companies, and consumer finance services should build their processes based on more accurate and real-time data. Consumers should be able to bring their own data to tailor their own services – consumer data should not be tied only to some official banking services. Only more modern and better data models will enable fundamentally new fintech services.