Ethereum: A Valuable FinTech Sandbox
Daniel Cawrey looks at how #Ethereum‘s potential in #blockchain experimentation will help bring about a new digital asset-based economic paradigm.
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Tagged: fintech Toggle Comment Threads | Keyboard Shortcuts
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In London, Researchers Look at Blockchain Beyond Financial Services
CoinDesk speaks with a senior researcher from Imperial College #London‘s #cryptocurrency R&D efforts.
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How the Blockchain Can Avoid the Perils of Futurism
Is the #blockchain community too focused on #futurism? In this opinion piece one developer argues the answer is yes.
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Exploring Banking as a Platform (BaaP) Model
I co-authored this post (and its sequel which will be published shortly) with David Brear, Chief Thinker at Think Different Group
The integration and delivery of financial services is changing as new channels, products and partnerships are being explored. #Banking as a #Platform (#BaaP) is one of the alternatives. Platform strategies require a radically different approach to how a business is architected. Owning an entire business stack may not be feasible nor desirable anymore.
In 2015, it became almost the expected cliché slide at any self respecting financial #technology conference that someone would stand up and reference the interesting infographic highlighting the success of new ‘sharing economy’ players. The references, first discussed by Tom Goodwin on TechCrunch, illustrates how the middle men get cut out and how companies that take over the customer interface are the ones to gain.
If the presenter had an updated slide, they may have referenced Deliveroo, the biggest restaurant delivery service that makes no food.
These companies have grown exponentially in both popularity and success in the last 4 years. They have scaled their business models and platforms to cover more geographies and locations than even the largest global #banks. But while platform strategies have taken the world by storm in many other industries, platform strategies haven’t worked out in banking or insurance.
By platform strategy, we mean those that IBM, Cisco, Intel, Microsoft developed in the 80s and 90s. Equally, Amazon, Google, Apple and the firms previously mentioned have also employed more recently.
The only exceptions in the banking sector may be found with Visa and MasterCard who, as networks, had to develop a platform strategy where issuers, acquirers, startups, various payments service providers and merchants are symbiotically linked. In that sense, most banks are part of Visa or MasterCard’s platform strategy, but do not have a platform strategy of their own. In insurance, developing a network of agents, brokers and master general agents does not really qualify as a platform as it is limited to a distribution channel.
Why Didn’t Financial Services Organize As Platforms?
There are three main reasons why financial services industry incumbent did not organize as platforms:
1. Current Business Models – Banking and insurance company business models do not currently lend themselves to network effects. They do benefit from economies of scale – although this may be hotly debated – but not network effects. Without the benefit of network effects, it makes more sense to own one’s stack entirely and not share it. Why create a platform with partners when the benefits will be linear at best?
2. We’re Number One, So Why Change? – Up until recently, banks and insurers were the perfect intermediaries. They were the best positioned to make credit or underwriting decisions. Why create a platform with partners when no one else knows how to lend or insure better than the current players?
3. We ‘own’ the customer – Up until now, how individuals or corporations interacted with one another and between themselves lent itself to a top down organization for the selling of financial services. If the industry owns the narrative of how a financial product gets pushed to an end user, why create a platform with partners?
These conditions have been unique and protected the financial services industry incumbent players from the reality faced into by many other industries and individual organizations. Today, though, we live in a world where computers and algorithms are proving to be very adept at pricing credit and underwriting risk. And where in the past data that was not readily available, it is very abundant and available in real-time today.
Technological innovations, coupled with significant regulation changes, have lowered the barriers of entry into these markets to a staggeringly low level. Completely new organizations like Mondo Bank in the UK, Simple and Moven in the US, and some of the largest technology firms, like Apple and Google, now move freely into these markets at will.
As this occurs, banks and insurers run the risk of losing their dominant position as primary intermediaries for customer interaction and engagement.
Network Effects Have Changed The World
Network effects impact us all on a daily basis, via social networks and other marketplaces. These same social networks and marketplaces, after having gotten us used to interacting with one another in a different way, are now encroaching on financial services, with payments and lending initially being their target.
Smartphones, broadband internet, the 24/7 availability of commerce and data, and social networks have made us organize ourselves very differently than in the past. The Millennial generation, weaned on this new paradigm, now have completely different expectations than their parents or grand parents of communication and commerce.
There are other reasons why financial services industry incumbents need to shift to a platform strategy. For example, financial services startups, competing against these incumbents, is one narrative brandied about. Frankly, the startup competition is a by-product of the root causes rather than a driver.
Without #fintech competition, financial services industry incumbents would still need to think about platform strategies, as the root causes are much more fundamental than that. Financial services industry incumbents need to transform into “fintech incumbents,” with a complementary platform business #model to better compete.
We recommend the book Platform Leadership by Annabelle Gawer and Michael A. Cusumanoto to those who want to explore further what platform strategies are. In the book, the authors’ outline four sets of strategic choices that are part of platform leadership:
- Determine the scope of the firm: Is it better to create product complements internally or let someone else do it? How far into the technology value chain should a firm extend?
- Design the product with strategic intent: What degree of modularity is appropriate? Should product interfaces be open or closed? What information should be disclosed to other companies?
- Shape relationships with external complementors: How can the company balance competition and collaboration with outside players? What’s the best way to create and sustain relationships with complementary product providers?
- Optimize internal organizational structures: What processes and systems will allow the company to manage internal and external conflicts of interest most effectively? What’s the right way to resolve the tensions between industry players?
7 Levels of FinTech Platforms
For a bank or an insurance company to become a platform for financial services, profound transformations need to happen. Becoming a “digital bank”, if taken in the strictest sense of the term (i.e. bringing distribution channels to the digital realm) is not enough.
A platform architecture implies transformational changes across the business/technology stack as well as fundamental choices that dictate how product, service, technology and HR resources are articulated between, 1) What is delivered internally by the core; and 2) What is delivered externally by partners active on the platform.
The distinction is important as it defines the company and the core differentiator in the market. What do we have to be awesome at? What can we let other people do? How do we exceed consumer expectations?
Below is a potential view of a financial services industry incumbent platform state. For the purposes of the analysis, we dissected the levers into 7 components (vs. the four in the Platform Leadership book).
Because of current legacy mindsets and structures, a platform play would be very difficult to implement for the vast majority of organizations.
Making a Platform Play in Banking Possible
It is clear that any success in developing a platform strategy for banking (BaaP) will be largely dependent on wholesale cultural and technology mindset changes. Traditional business models are far easier since banks are in full control. Financial services industry incumbents created products and sold them to their customers. Value was produced upstream by the banks and consumed downstream by the consumer.
Unlike traditional models, a Banking as a Platform structure does not just create and push products. The BaaP structure allows users to create and consume value. At the technology layer, external developers can extend platform functionality using APIs. At the business layer, users (producers) can create value on the platform for other to consume.
This is a massive shift from any form of financial services model that exists today. Creation of network effects is more important than simply bringing in users or charging all users to make money.
In this model for financial services, software and technology are not the end product. Instead, they simply serve as the underlying infrastructure that enable users to interact with each other. Most importantly, the business itself doesn’t create all the value.
This post originally appeared on The Financial Brand in a different format
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Fintech: from Solid to Plasma
Not a day goes by that I do not read or hear about how #technology is finally disrupting the financial services industry. Entrepreneurs and traditional VC firms fueled the first wave of #fintech frenzy by respectively building and funding fintech startups intent on disrupting the status quo. These same actors fueled the second wave where many existing startups pivoted #from b2c to b2b models and started selling to finserv incumbents – many new startups went b2b directly too. We are living the last innings of this second wave in my opinion as most finserv incumbents have now woken up to the reality of technology change in their industry. It remains to be seen how the third wave will shape up &8211; I have my own views which I will reserve for a future blog post.
Most finserv incumbents claim to have seen the light and profess their new found fervor towards adopting new technologies. “Adapt or die” some say. &8220;Let’s partner with fintech startups&8221; others declare. &8220;We have to integrate these new technologies within our existing business models&8221; others assert.
Fine, yes, maybe.
To the risk of being provocative, most of these views are equivalent to peddling horse manure at a fishmongers&8217; market. In other words these views are inadequate and originate from a fundamental misunderstanding of the new norm every corporation, big or small, is or will very soon be faced with when it comes to technology.
Technology should not be viewed as a discrete building block anymore, where one decides on a technology solution, buys/rents/partners with hardware and software, and runs such a solution mostly in the background, separate from and supporting the &8220;real&8221; business. I would characterize this view as the &8220;#solid state&8221; view of technology.
To the risk of being even more provocative, any finserv incumbent that treats enabling technologies and fintech startups as solid building blocks of matter to adapt, integrate and implement within their existing business models will fail.
Rather, technology should be viewed as the &8220;#plasma state&8221; vector that will reinvent how a corporation is architected, where technology and business ideas fuse together to create vastly different ways of delivering value to users, consumers and customers. To be a tad more precise, it will be more and more difficult to discern between business models and technology as technology becomes more pervasive throughout a corporation.
This means finserv incumbents need to think about a) the human resources they need to attract and retain to run a plasma state business, b) the business models they have to or can create due to technology changes, and c) the strategic focus they have to or can chisel due to technology changes. Adapting by mere addition to protect a legacy business will fail. Adapting through fusion to create new paradigms is the key.
The technology world we live in is making available to us new perspectives:
&8211; peer to peer models
&8211; decentralization of decisioning models
&8211; scalable trust graphs
&8211; intelligent automation
&8211; news way to understand and share risk
&8211; instantaneity of transaction processing
&8211; frictionless value transfers and value sharingIt stands to reason that these new perspectives will be part of the core of what it means to be a finserv corporation too.
I do realize achieving &8220;plasma&8221; properties is easier said than done. The best fintech startups exhibit such traits from inception &8211; they live and breathe the fusion of business and technology. For a finserv incumbent the proposition is somewhat more complex. I have the utmost respect for many of the industry&8217;s leaders. To speak only of #banks, most CEOs and Chairmans are sharp visionaries and leaders, and contrary to many pundits I believe they mostly &8220;get&8221; the challenge they are faced with. Their problem, as a very astute Managing Partner of a bank corporate venture fund I know puts it, is the pesky contingencies of day to day life where running behemoth organizations is a non trivial endeavor. In other words, to date, not enough executive bandwidth is dedicated to the plasma view I am outlining.
We are currently witnessing massive a/b testing within the banking world &8211; I use banks as a proxy for all finserv incumbents and my comments apply to insurers equally &8211; where C-suite executives are tinkering with:
&8211; innovation labs
&8211; on balance sheet venture investing
&8211; off balance sheet investing via corporate venture arms or traditional VC funds
&8211; hackathons
&8211; accelerators and incubatorsWe witness this a/b testing via industry buzzwords and initiatives such as API banking, digital banking, omni channel banking, proof of concepts, pilot projects, partnerships and joint ventures with startups.
I am convinced what we are witnessing is but an intermediary stage towards a more comprehensive incumbent response &8211; at least for those incumbents that will successfully transition to the future. I have advocated in previous posts that one of the responses incumbents need to articulate is a platform strategy, see here. I am even more convinced this approach will only be successful if it includes, at its core, a strong fusion of business models and technology.
Focusing back on fintech startups, what I wonder is, both for those vying to be service providers to finserv incumbents as well as those competing against them, what will be their evolving natural responses and business strategies in light of eventual finserv incumbent plasma success.
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Making Bank as a Platform (BaaP) a reality
This is the second post of a two post series I co-authored with David Brear. Both posts appeared originally on The Financial Brand thanks to Jim Marous.
You can read the first post here.
All up to speed? Excellent. As you will already know from Part 1, as a #Platform has never really taken off for various reasons. Traditional approaches and business models are easy as the #banks had full control. Financial services industry incumbents created products, pushed them out and sold them to their customers. Value was produced upstream by the banks and consumed downstream by the customers.
Unlike traditional models, platforms do not just create and push products out. They allow users to create and consume value. At the #technology layer, external developers can extend platform functionality using APIs. At the business layer, users (producers) can create value on the platform for others to consume.
This is a massive shift from any form of financial services business that we have ever known. A platform play within financial services is different from traditional business thinking. Creation of network effects is more important than simply bringing in users or charging all users to make money.
In this model, for financial services, software and technology are not the only end products. Instead, they simply serve as the underlying infrastructure that enables users to interact with each other. Most importantly, the business itself doesn’t create all the value.
We believe that this is the future of financial services business models and will outline how we think this can be pulled off.
7 Layers of #BaaP
We recommend the book Platform Leadership by Annabelle Gawer and Michael A. Cusumanoto to those who want to explore further what platform strategies are. We are borrowing from this book somewhat, especially from the authors’ four levers of platform leadership which we have expanded upon to create the “7 layers of BaaP”.
- Scope of the firm
- Product
- Service
- IP/Data
- Technology
- Relations with Partners
- Internal HR Organization
How do financial services industry incumbents fair?
Against this model it is clear that a platform play would not be successful within the banks with their current setups and mindsets as they have not developed the ability, nor the sophistication, to pull it off.
What would a #Bank BaaP look like?
But across these platform levers what could a bank BaaP be and how could it operate?
Ultimately there will be different platform answers for different banks or insurers given their direction and make up. What is clear though is that being a platform is different from partnering or merely becoming a “digital” incumbent.
6 key questions to enable banks for BaaP
1) What is the focus of your company? – If the core of your business used to be articulated around intermediating between deposit taking and extending credit then what will the new core be around? Is this going to continue to be a store of money or will it be around something else?
This something else could be identity or the data of customers but if not identity and data then what else is of value that you could focus around?
Answering this first question will make it easier to choose a clear strategy for customer centered products based around it. In addition, answering this question may lead a bank or an insurance company to make an acquisition should the part of the core identified not currently reside within its skills set.
For example, we would venture to say that a bank may want to purchase an identity management platform &8211; consensus computer based &8211; and an insurer may want to purchase a cybersecurity consultancy or service provider.
2) How are you going to attract partners to your BaaP? &8211; Once the core and product/service decisions have been made, what partners you choose and how you plan to attract them to the platform will be of paramount importance.
We would characterize this decision across a continuum, from complementary collaborative to competitive partners, and as changing over time based on the needs and demands of the business.
Other industries who have seen success in these strategies have done so through very inclusive practices around the platform. Excluding competitive partners reduces the overarching capability that would be held in the platform and changes the dynamic of the BaaP owner responsibility.
3) How are you going to rethink your architecture to support this new direction? &8211; The technology architecture needed to support a platform strategy is radically different than the current ones implemented into most banking organizations.
This maybe the most difficult lever to re-engineer, given the level of legacy debt in play, but it is one of the most needed. A holistic technology architecture where silos are broken down, open source and open standards are used judiciously, and where APIs are used widely is a must to include partners and interact with them, and to exchange or analyze the right information at the right time within the right situation. Most stakeholders know this, few have the right answer, including most incumbent software service providers. This will change though.
4) How are you going to protect your BaaP? If you think cybersecurity was top of mind for FinServ incumbents, then it will be ever more crucial with #FinTech incumbents and their platform businesses and partners. It is an implicit statement and a crucial one. The only platforms in the financial services industry, that is Visa or MasterCard and their eco-systems, warrant cybersecurity, fraud and data breaches daily.
5) Do you understand what new business architecture is required for your BaaP? – The business architecture is significantly more important to the long term success of any BaaP play than its technology equivalent.
Financial services industry incumbents will need to become governance nerds and fast. Will decisions taken between the incumbents in the platform eco-system be consensus-based, top down, a hybrid? How will differences of opinion be reconciled, how will conflict be resolved? This will depend in part on the incumbent internal DNA as well as the types of partners chosen, i.e. collaborate or competitive ones.
6) HR needs be rethought &8211; which resources are needed for the core and which for the platform? &8211; Internal human resources will need to be rethought. The obvious rethink will develop along the lines of which resources are needed for the core and which for the platform. It will also develop along the lines of which disciplines will resources need to acquire and apply to their businesses. By this we do not mean traditional intra-disciplinary business skills pairs such as marketing and financial engineering, business development and strategy, trading and sales. Rather, I mean legal and coding, trading and data analysis, strategy and information systems management where non-financial services skills are added to the traditional mix.
No platform Vs. Absolute Platform
If we plot these paradigm shifts across these vectors, where the Financial services industry incumbents will have to move the dial from left (current status) to right (absolute platform status), the decisions for each vector become clear. I view these as meta vectors that can apply to front end, middleware, backend processes, people, products and services alike.
BaaP on the horizon
Its clear from our research that BaaP in Banks is possible but will take a huge amount of change to take place.
Examples of BaaP thinking is starting to emerge in Europe particularly taking advantage of favorable regulatory frameworks and market opportunities.
solarisBank
FinLeap’s, the Berlin FinTech startup factory, investment to create Solaris Bank as a BaaP offering opportunities to FinTech companies to take their services to market via an organization who is fully licensed to do so as a digital bank.
Solaris Bank has been born out of the need of FinLeap to gain traction with some of their own startups who have failed to gain the umbrella of someone with a license.
Solaris Bank is looking to offer a full range of transactional services, compliance, capital financing and loans through a range of FinTechs. These are aggregated into one uniformed service to the customer. It remains to be seen how their platform strategy will flesh out and which core services they will focus on and which ones they will partner for.
The Open Payments Ecosystem
The Open Payments Ecosystem (OPE) has been established by Ixaris with European Commission funding.
The purpose of OPE is twofold:
- To make it easier for developers to build payment apps for banks by embracing Open APIs in a pre and post PSDII world.
- To make it easier for banks to safely access new payment technologies by providing resources like curated app marketplaces.
The project features six “sub-systems,” each representing a different stage in the life cycle of payment services.
- A developer environment for payments app development and testing.
- A payments application store.
- A secure execution environment that prevents the original developer from accessing live customer data.
- A compliance system for the life cycle of the app.
- The ability to add additional service offerings for payment service providers
- A comprehensive data warehouse for business intelligence
While not fully a BaaP construct the OPE programme will offer, within the confinds of payments, all of the needed attributes to change how payments services are constructed and how people within the platform are remunerated. In its current guise, the OPE programme is the closest to the iTunes development platform model within banking that we have.
Mondo Bank
While most know Mondo Bank for their Alpha and Beta programme, and selling out of a million pound of stock in 96 seconds, they also made no secret of their longer term intensions to become a marketplace. We would define a marketplace strategy as a sub-set of a platform strategy and are, similar with solarisBank, intrigued by how Mondo’s thinking will develop.
While their focus has been on creating a unique current account for the UK market they see the integration with innovative financial services and technology providers is an obvious step to giving customers control over their money. Instead of thinking that they “own the customer”, as most banks globally do, Mondo intend to give users the power to choose, based on price, convenience and customer-service from a range of services and products that are not created by them.
Tandem
Tandem is the second startup digital bank to have been granted a full license from UK regulators. Although more bank than marketplace, Tandem is focused on customer service as opposed to product offerings. As such this approach forces them to partner with best of breed offerings &8211; not part of their core offering – and integrate such offerings to their platform for their own users’ benefits. Tandem does not give the power to choose, rather it curates best of breed offerings, and delivers a platform experience to its users.
It’s clear that there is a huge amount of benefit to be had for banks to become the platforms for banking in the future.
Building a marketplace does not mean one has built a platform strategy. Ceding control of the old core, i.e. access to checking accounts, without developing a new strategic core will spell doom for those who trend those places.
These new BaaP partners will not only be found within the scores of FinTech startup disruptors but, also outside of the traditional financial services universe such as technology incumbents, social networks, e-commerce giants.
Building a platform strategy without understanding that some control will be lost to or shared with partners will not be effective. Only looking within human resources will make it more difficult execute a platform strategy.
Tech companies such as Amazon, Facebook or Alibaba are already executing from a mature and growing platform. They do not have the benefit &8211; or for some the curse &8211; of being regulated, licensed and able to handle money. Still they are formidable competitors that want to &8220;own&8221; their customers in depth and breadth, and this means a customer&8217;s money, not only a customer&8217;s spending.
Banks who dither and miss the opportunity to reinvent oneself as a platform will find themselves on the wrong side of societal trends. Similarly, regulation and regulators will need to adapt and be educated in the intricacies of platform strategies.
Rather than view this as an impediment we believe this might be a great advantage. Financial services industry incumbents with aspirations to become truly digital players already have a strong and long-standing relationship with the regulators as well as a large number of suppliers who could become partners.
While Mondo, Solaris and OPE have fantastic ambitions who better than the existing banks with all of their investment, employees and existing customers to take the lead, educate and ease the transformation towards the future and BaaP?
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A Marxist Interpretation of Venture Investing
You may find it odd for a #venture capitalist – a capitalist &8211; to attempt to interpret #investing in startups through a #Marxist lens. Be that as it may I enjoyed the thought provoking argumentation and hope you will find humor in this tongue in cheek exercise!
Entrepreneurs, when founding a startup, engage in a revolutionary and subversive act. They self actualize their ideas and dreams as well as themselves and appropriate the capacity to transform the world. In other words, an entrepreneur exerts meaningful labour by leveraging his vision in the real world. This labour is his and his alone, and his relation to it is crucial. (Relation should be read as ownership in this context). The fruits of his meaningful labour are embodied in his startup.
Entrepreneurs need capital in order to achieve their visions. For the purpose of this discussion, let’s assume this capital comes from Capital which is dissociated from Entrepreneurs. In this sense, Capital mediates the social relationship of production and the Entrepreneur gives up ownership of his startup. This is akin to alienation whereby the Entrepreneur loses the ability to solely determine the life and destiny of his startup. Of course the Entrepreneur receives capital from Capital in the exchange &8211; without which achieving his vision may not be possible. Nonetheless the end result is an alienation from his meaningful labour. To what extent is this alienation material or will become actualized is key to the discussion.
Another way to visualize this alienation is to use the term “class struggle”. Here the #interpretation of the term is dual. First, we are confronted with a class struggle between the Entrepreneur/Labour and the VC/Capital in a general sense. Second, we are dealing with separate classes of stock, common shares vs preferred shares, one &8220;struggling&8221; against the other, in a specific sense.
Class struggle permeates the narrative of early stage investing from the start of a term sheet negotiation til the sale of the startup. The major terms found in a term sheet serve to define the investment and the relation between the Entrepreneur and the Venture Capitalist. A different interpretation forces the astute reader to conclude that each term also serves as a means of alienation by Capital. These terms enable Capital to control or eventually take over Labour&8217;s fruits, i.e. the startup and/or its assets: liquidation preference, cumulative dividend, control provisions, governance issues relating to board composition and board election, contract and compensation issues relating to the Entrepreneur, various flavors of anti-dilution. The more protected Capital is, the more alienated Labour will become. Either materially so or potentially so over time depending on specific future events.
Class struggle becomes even more intractable as the capital stack densifies over time and as Labour faces Capital(s). Several classes of preferred shares may alienate one another and in turn individually and collectively alienate the common share class. The ultimate alienation for an Entrepreneur being his removal in whole from his startup. To be clear, alienation can only remain within the realm of potentiality should outcomes develop in a positive fashion.
The old adage that main terms are as or even more important than valuation takes on a vivid dimension when the above Marxist interpretation is taken into account.
As this alienation is inevitable &8211; potential or actualized &8211; Labour needs to choose Capital wisely and concede the right level, both in depth and breadth, of its alienation. Where does the Entrepreneur draw the line and where does the Venture Capitalist accept the line to be drawn are eminently complex questions.
No liquidation preference, no cumulative dividends, the lightest possible control provisions, an Entrepreneur friendly board, benign overall governance will make for minimal alienation. What if no other class than common shares existed and were issued over time? I recently witnessed the CEO of a #fintech startup push back against aggressive liquidation preference and cumulative dividends by stating such terms would work against shareholder alignment. He really meant alienation, unconsciously so. I also witnessed another founder pushing back on special controls and board representation a corporate investor was requiring prior to investing by arguing he feared too much control by one corporate would risk altering the strategic roadmap of his startup. Subconsciously so, he also meant that too much corporate control was an alienation he did not care for.
I think all Entrepreneurs are hidden Marxists in as much as left to their own devices, they would insist on zero alienation. I do not think all Venture Investors are of the malevolent Capital type described by Marx, although it is indeed in their nature, theoretically and sometimes practically, to generate alienation. The best Venture Capitalists intuitively grasp that too much control generates false comfort and negative unintended consequences. I view the &8220;purest&8221; Venture Capitalists as non-interventionists intent on ensuring, to the maximum of their abilities, the visions of the Entrepreneurs they back without undue meddling. Witness the stories we hear and read about top tier VCs who negotiate an investment and a term sheet in a couple of hours over a handshake and who only get high praise and positive reviews from the entrepreneurs they work with. Praise the Entrepreneur that encounters such a VC, as his alienation will be minimal.
The ideology of venture capital investment with its term sheet and final documents accoutrements can also be interpreted as false consciousness, whereby the Entrepreneur is sold the venture capital investment ideology (terms and conditions associated with an investment) while the true nature of alienation is hidden. Caveat Entrepreneur! Be mindful that the venture capital investment ideology is actually true &8211; capital needs to be remunerated, comes with caveats… &8211; but that as the true motives it impels remain hidden from the Entrepreneur, it is therefore false consciousness.
I will leave you with two parting thoughts.
First, there is a cost to the absolute absence of alienation. Freedom is indeed very dear and forces an Entrepreneur to a higher level of solitary fiduciary care. Indeed, the absolute absence of alienation may not be optimal.
Second, I guarantee that no Marxist or Capitalist was harmed while writing this post.
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The Sandbox Network
With poetic license and my apologies to Shakespeare and his fans.
“…2nd Regulator:
By the pricking of my brains,
Something delightful this way comes [Knocking] Open Locks
Whoever knocks!
[Enter #Fintech/Finserv Stakeholders]Fintech/Finserv Stakeholders:
How now, you secret, black, and midnight lord!
What is’t we can all do?&8230;”Something indeed delightful this way is coming. Something that could become essential to the financial services industry, to fintech. Something that is materializing thanks to the keen insights and ground breaking intent of the Financial Conduct Authority (FCA) – the United Kingdom&8217;s financial regulator. That something is the FCA&8217;s regulatory #sandbox (the Sandbox), which is the very first experimentation of its kind.
To date, regulation has been a top down affair, with either legislative fiat or regulatory fiat brought down to the industry. Some will argue that the industry is usually consulted at the regulatory or legislative level. Some will even argue that lobbies meddle and influence legislative or regulatory fiat. They will be correct. Yet, this does not mean these feedback loops that help shape financial services regulation are bottoms up in their approach. Incumbents or lobbies represent an industry do not talk for the base, for innovators, disruptors. I view the FCA&8217;s Sandbox initiative as the first bottom up approach to regulation.
Indeed the stated goals and benefits of such an endeavor are impressive:
for startups and incumbents the potential benefits are =>
&8211; to lower the barrier and costs to testing and experimenting with a regulatory framework
&8211; to lower the risk of misinterpreting existing regulation
&8211; to receive tailored regulatory guidance
&8211; to receive temporary waivers, &8220;no enforcement action&8221; letters in order to test a business model or #technology live
&8211; to build a more optimal path towards compliance and regulatory approvalfor a regulator the potential benefits are =>
&8211; to get educated as to innovation, new technologies and new business models
&8211; to optimize market structure
&8211; to protect consumers
&8211; to inform and shape future regulation
&8211; to modernize their own operations
&8211; to promote healthy competition
&8211; to encourage innovationI wonder if #bitcoin and the bitcoin #blockchain early days and development would have been altered, for the better, had there been a tier one sponsored Sandbox where startups, hackers and incumbents would have been able to experiment and share with regulators.
Now that the FCA is embarking on this Sandbox journey, what next?
I expect regulatory wisdom and foresight to spread by osmosis. From what I understand the Monetary Authority of Singapore (MAS) is working on a similar scheme, unsurprisingly. In the United States, the Office of the Comptroller of the Currency (OCC) which regulates banking, is working on its own project. So is the Federal Depositary Insurance Corporation (FDIC). I know of no other project in the works, which does not mean regulatory brains are not in neuron overdrive at this very moment. Thusly I expect sandboxes to crop up all over the world. How these sandboxes will be architected and how they may, or may not, interact with one another will be fascinating to witness.
These twin &8220;How&8221; questions force us to take a closer look at the FCA. Why was the FCA first to market? What makes the FCA so special?
The FCA is one of the most sophisticated and respected regulators in the world. It rules over one time zone and an industry/economy/eco-system essentially centered around the greater London area. What is a Sandbox if not a platform for constant and incremental testing! The FCA is also a very independent regulatory body &8211; one may say one of the most independent body in the world, unencumbered by political interference. The FCA does not suffer from a proliferation of regulatory competition in the UK as it stands alone with the Prudential Regulatory Authority (PRA). Finally, the FCA is, from what I can gather, an organization that is guided by &8220;philosophical&8221; tenets. This latter point is essential to understand as it allows the FCA to be a pragmatic caretaker of financial regulation that is opened to a/b testing and experimentation.
Let&8217;s take the United States as a counter example &8211; and I will leave aside philosophical arguments centered around market solutions vs government solutions, libertarianism vs central action. The USA financial services industry &8220;suffers&8221; from a very complex regulatory landscape: 50 state examiners for the insurance industry, 50 state bank regulators, the FDIC, the OCC, the Treasury, the Fed, the SEC, the CFTC, FINRA (yes I like to joke around), FinCen (within the Treasury), the CFPB to name but the main ones. These various agencies sometimes overlap and often &8220;compete&8221; against one another which creates either areas of confusion and misunderstanding or gaps where no regulatory clarity exists. There are four time zones (not counting Alaska and Hawaii) and more than one metro geography (NY, Chicago, San Francisco, LA, Boston, Washington DC, Seattle&8230;) that matter. Some will argue that political interference indeed occurs with various regulatory bodies (think of how a new administration impacts how the SEC behaves for example). Finally, main US regulators are guided by &8220;rules&8221; which does not allow them easily to experiment and tinker like the FCA does.
Absent the benefits derived from what defines the FCA, what would be the right architecture for a Sandbox, one that would ensure optimal results? I believe a Sandbox would need to incorporate a) a strong strand of &8220;innovation management&8221; DNA, b) a level of neutrality to ensure collaboration among all stakeholders (between regulatory bodies and between regulators and the industry), c) a level of independence to make sure profit or special interests do not hijack the overall mission and d) a deep and broad sophistication around various subject matters (regulation, legal, technology, financial services business models, startups, innovation).
This translates succinctly into a not-for-profit organization with a stable sponsorship base and an inclusive yet independent governance framework.
Now, picture a universe of Sandboxes, some like the FCA, some independent not-for-profit organizations. Some focused on one country, others focused on a group of countries. A US Sandbox, a LATAM Sandbox, a Brazil Sandbox, the UK Sandbox, a EU Sandbox, a Western Africa Sandbox, an Eastern Africa Sandbox, a South East Asia Sandbox, a China Sandbox&8230;
Further, picture Sandbox cooperation, bilateral, multilateral, thereby creating a bottoms up #network that would foster innovation, market structure optimization and financial inclusion by taking account of grass root technology and business models advances from startups, developers and incumbents. I know I am dreaming but, playing the FCA chess game several moves ahead I do not think such a vision is that far fetched, although the details when implemented may vary from my current crude vision.
Do remember that we do have top down multilateral cooperation around financial services regulation either at the State/Government level or international organization level. Why not multilateral cooperation from the bottoms up too, via Sandboxes, as powerful tools to augment the interplay between innovation and regulation?
ps: I enjoyed using as &8220;props&8221; both Shakespeare&8217;s Macbeth and an allusion to a movie about Mark Zuckerberg and Facebook. The supernatural phenomena that is Regulation and the omnipotent traits shared by a regulator and Zuckerberg will not have escaped readers.
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Black Swan Events and Fintech
If you have not read The Black Swan by Nassim Nicholas Taleb, I recommend you do post haste. For a brief description of #Black #Swan Theory without reading the book, see here.
Taleb makes a distinction between two types of Black Swan #events: a) “…those that are present in the current discourse&8230;” and b) &8220;&8230;those nobody talks about, since they escape models&8230;&8221; He goes on to state that, due to natural human behaviors, the incidence of the first type of Black Swan event may end up being overestimated while the incidence of the second type of Black Swan event is usually underestimated. Further, needless to say that whatever the type, Black Swans are notoriously difficult for human beings to identify and analyze correctly. Our brains are so hardwired to focus on the immediate past or future that we naturally occlude data residing in the long tails.
Re-reading Taleb’s work recently got me to ask myself several questions. Which are the Black Swan events already well documented in the #fintech/finserv ecosystem? Which are the ones few talk about that one systematically underrated? I include both Black Swans that can be directly linked to fintech and those that would have an indirect influence on fintech to my musings.
I can think of the following Black Swan events of the first type that are overestimated:
– Fintech startups will fundamentally disrupt finserv incumbents
&8211; #Bitcoin will revolutionize the financial services industry.
&8211; Bitcoin will eliminate the need for financial institutions as intermediary agents.
&8211; The Uberization of Financial Services has arrived.
&8211; New technologies will disrupt financial services
&8211; Roboadvisors are the future of wealth management
&8211; Crowdfunding/Crowdlending is the future for financing individuals/companies
&8211; Regulatory rules (Basel IV or others) become even more draconian and are applied as is, further hampering the finserv industry by reducing profitability, adversely impacting liquidity and increasing volatility.
Are there any other Black Swan events every one is talking about in fintech/finserv?
What about Black Swan events that few people are talking about, i.e. those that are underestimated. Does the threat of GAFA (Google, Amazon, Facebook, Apple) and Ali Baba competing against financial services incumbents fall in that second category? The narrative most mined at all fintech conferences I attend seems to revolve around &8220;fintech startups vs finserv incumbents&8221; where the questions asked are should there be competition or cooperation and who will be the ultimate winner. Seldom do I hear about potential GAFA threats although I know savvy bankers and insurers take the threat seriously. Does this mean this Black Swan threat is underestimated as it does not fit most participants&8217; models?
Here are other Black Swan events I think may be underestimated in the industry:
&8211; Any action from central #banks that would eliminate fractional reserve banking &8211; and implications thereof for the role of banks in money creation and lending intermediation
&8211; A repeat of the economic crisis of 2007-2008 &8211; or even worse another great depression &8211; which would further weaken financial services firms and make them even more vulnerable to fintech startup competition or GAFA competition
&8211; Large financial services conglomerate breakup by legislative fiat or due to market forces, thereby reducing incumbent size to a point where fintech and finserv blend into one thereby redefining the rules of engagement and competition and probably favoring large non-bank competitors. I have Robert Sams to thank for pointing this one.
&8211; A string of natural disasters clustered in time &8211; thereby weakening insurance companies and banks&8217; balance sheets due to resulting losses. Would such losses weaken incumbents to the benefit of startups?
&8211; Long term and secular deflation with continued negative interest rates. How would bank react? How would asset managers be impacted? How would consumers react vis a vis their savings strategies? How would lending be impacted? I have Jan-Maarten Mulder to thank for this one.
&8211; Quantum computing ushers a new era of financial services, making many existing offerings obsolete
&8211; Oil prices crash and remain low, thereby inducing strings of bankruptcies in the industry, followed by heavy losses with large banks, forcing regulators to step in and further crippling said incumbents to the benefit of their non-bank competitors and fintech startups
&8211; Cybertheft takes on a new meaning and as digital identities become central to our lives, an entire country&8217;s worth of identities is hacked and stolen, thereby chilling digital adoption in material ways. I have Michael Meyer to thank for this one.
Can you think of any other Black Swan events of the second type that would have an incidence on the world of fintech/finserv?
Let the brainstorming begin.
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Technology Arms Race & Financial Services
We now hold these truths to be self-evident, that #fintech startups (especially of the d2c variety) do not pose an existential threat to finserv incumbents, that finserv incumbents are endowed by their regulators with certain unassailable defensible rights and duties embodied by licenses and are saddled by history with obsolete technologies that hinder their effectiveness in a changing world, thereby creating material barriers to a stable Life, Liberty and the pursuit of #Financial Stability.
We are still exploring whether the following are also truths, that the existential threat to finserv incumbents lies with GAFAA, that fintech startups can help finserv incumbents counter such existential threat.
Some do not believe #technology giants are a real threat, arguing none of the GAFAA (Google, Amazon, Facebook, Apple, Alibaba and their smaller brethren) are interested in obtaining licenses and directly competing against #banks or insurers. Although I do not know with certainty that Apple or Amazon are thinking of owning and operating a bank, I do know the real question we should ask ourselves is “Can and how would GAFAA or other similar companies cripple financial #services firms?”
It is evident we, individually or as businesses, engage with the world via our smartphones and tablets. We spend time on these devices interacting with a variety of apps (social messaging for example) or platforms (Facebook for example), reading, creating, sharing, consuming, purchasing. The more time we spend on these devices, with these apps and platforms, the less time we engage directly with the manufacturers of the products or services we ultimately consume. This state of affairs may not pose an existential threat with a brand like Nike for example. It is easy to engage emotionally and mentally with simple concepts whether physical or digital, ones where we have a meaningful bond that helps define who we are. It is not so easy for a provider of a checking account, a loan or an insurance policy. We do engage with money in completely different ways.
To me, this means there is a potential catastrophic scenario in the making whereby financial services providers would be relegated to being &8220;dumb&8221; providers of products and services without having any meaningful control or tie to the end user – retail or enterprise even though it is arguably more difficult to visualize for the latter.
Finserv incumbents are now fully engaged, having woken up to the initial threat of fintech startups and realizing they do need to reform the way they do business. Innovation is the name of the game &8211; a dual mandate to be sure where both technology and culture need to be upgraded. For the purposes of this post, I only focus on the technology part of the innovation equation.
The technology part of the innovation drive is multifaceted. Legacy rails, core systems, market infrastructures need to be upgraded. These &8220;basic&8221; upgrades a necessary but not sufficient. New technologies also need to be acquired. I view Artificial Intelligence (AI), Augmented Reality (AR), #Blockchain/Consensus Ledgers, Quantum Computing (QC), Internet of Things (IoT) to be the main enabling technologies the financial services industry needs to acquire in order to close the gap and compete effectively.
One does not acquire technologies in a vacuum and there is a competitive battle in the marketplace for the hottest assets. As this post from CB Insights shows, tech companies are hard at work acquiring the best AI startups. Try as I might, I could not find any finserv incumbents on the list of acquirers, nor could I find finserv service providers.
How does a bank or insurer close to gap in AI if tech giants have first dib at the best assets? I do not know how things are developing in QC or AR but I would not be surprised if the same narrative were to be present. To be fair, the insurance industry is present and active in the IoT field and the banking industry is very active in the blockchain/consensus ledger field which shows a bank or insurance company can take the lead in a strategic technology field. Gaps are indeed being addressed, but not systemically.
To be fair, there are many ways to bridge a technology gap other than through acquiring.
&8211; Finserv incumbents could partner with tech giants, indeed such examples exist. Some tech giants are better at partnering than others. The risk of losing direct ownership of the customer still exists though.
&8211; Finserv incumbents could develop their own technology solutions via internal R&D (such a strategy has not paid hefty dividends in the past, even if one is able to attract top talent)
&8211; Finserv incumbents could develop partnerships and commercial agreements with independent startups. There will be AI, QC or AR startups that will decline selling to tech giants and pursue their own destiny. Let’s assume some of these startups will be up to par with what giant tech companies are concocting within their walls, the question therefore is which type of independent startups are most appropriate to partner with. The AI, QC or AR startups specialized in the financial services, or those that have a horizontal &8220;go to market strategy&8221; approach. Startup xyz that only sells to banks or IBM Watson? Which will be most optimal?
With every #arms #race one needs to play to one&8217;s strengths. A finserv incumbent&8217;s strength is twofold in my opinion: a) deep knowledge and mastery of arcane work flows and processes specific to money/data flows, b) mastery of licensing and AML/KYC peculiarities.
Extending these strengths to enabling technologies (AI, AR, QC, blockchain, IoT) thereby ensuring optimal customization and applicability is therefore key. Choosing the right strategy, best fitted to this goal while at the same time ensuring one does not lose the arms race is paramount.
Regulators should play a role in facilitating their wards technology arms race battle. We know banks now have a difficult time making equity investments, and rightly so if these equity investments are made with a speculative and casino-like financial bent, from a proprietary trading point of view. Could strategic and technology based investments be viewed differently? Especially as the industry wakes up to the fact that financial services incumbents need and have to behave more like technology companies? After all, it is not too far fetched to picture an insurance company acquiring a cybersecurity consultant or service provider to hone its skills at underwriting cybersecurity risk. From the same token, a bank could (or should?) operate via a mix of acquisition/build a data analytics or AI startup. Such a move may actually be central to a strategy of delivering superior products or managing a client&8217;s identity or data.
Building resiliency into a bank or insurer business model will require different approaches, and competing effectively in the technology arms race we are currently witnessing will have to play a part in a portfolio approach.
Finally and clearly, a rising interest rate environment would greatly help finserv incumbents. Fire power in the form of an increase in operating earnings has a tendency to solve many a problem. This leads me to fire a parting question: What if the next 20 years will deliver continued low interest rates environments across the world? In this environment, financial services firms, and their regulators, will have to come up with drastically different approaches, else the technology arms race may be lost permanently.
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