Is Banking Ready to Answer Tomorrow’s Questions?
By Bradley Leimer, Co-Founder, Unconventional Ventures
The best of times and the worst of times rarely happen simultaneously—yet, here we are.
With the ongoing tragedy of the Ukraine invasion still unfolding—coupled with a global pandemic not quite in our rear-view mirror—the financial-services industry faces a significantly displaced landscape across every minutia of its business model. If we add in inflationary headwinds, unbalanced workforces and sustained supply-chain issues impacting nearly everything, the longer-term prognostication of the banking industry is murky at best. But it’s been like this for a while, hasn’t it, as the banking industry is challenged almost daily now?
Beyond consideration of the fiscal constraints of this lingering pandemic, there is the toll of external fintech disruption and ongoing challenges to the efficacy of the existing model. The fact that these more modern banking-as-a-service (BaaS) offsprings have bolted into the sector just as truly open-data standards have emerged has proven to be incredibly disruptive for incumbents. Multiply new business-model creation through neobanks, data aggregators and technology-infrastructure players to that of super-apps, embedded finance and new credit schemes such as buy now, pay later (BNPL), and the argument can be made that banking is now more open, active, innovative and accessible than ever before.
This makes traditional finance (TradFi) feel less relevant—at least to those working within fintech, cryptocurrency and decentralized finance (DeFi). The seeds of even greater disruption are just being sewn, and incumbents have even more about which to be concerned as these new seedlings start to take hold. There are, indeed, many parallels with the impact of fintech on the business model as we start to see the forest through the trees.
Don’t say some of us didn’t try to warn you.
The fintech forest and the roots of Web3
Right before the Great Recession, a very different set of seeds were being planted—and this landscape set up the fertile ground for where things are headed next today. The year 2007 was the starting point for a more decentralized future. Fintech (financial technology) wouldn’t be here without the influence and success of iterative initiatives such as M-Pesa in Kenya, the microfinancing platform from Safaricom, launched in March 2007, which showed that micro-payments and credit could be delivered across non-financial networks, all while improving access for millions of the unbanked across Eastern Africa.
Fintech also needed a scalable delivery vehicle. In June 2007, the introduction of the iPhone by Steve Jobs (chief executive of Apple) and the subsequent app economy drove fresh user experiences, new communities, connectivity and eventual explosions of business models across social networks, e-commerce and mobile payments. This fundamentally shifted our customer relationships and changed how we began to equate money with a device we hold in our hands or wear on our wrists. Banking went from being a tethered place to something you could do anywhere on an app.
Hearts and minds also changed in 2007. In November, the very first Finovate conference in New York mirrored the initial push of venture capital (VC) into financial services, which opened more eyes and capital toward disrupting banking than ever before. While technologists and VCs dominated early shows, the seats were soon filled with people from the banking industry—none of them have forgotten the first time they consumed the firehose of information that two days of startup demos delivered. This initial conference led to an entire industry of global conversations driven by entities such as Sibos Innotribe (2008), Money20/20 (2012) and so many others as the mystery of banking’s technology stack became more transparent.
The regulatory impact of the Great Recession also created opportunities—from changes in customer sentiment toward banks to new regulations that benefited nascent fintechs, such as the data standards and controls, protections and interoperability promises of PSD1 (Payment Services Directive 1) (November 2007) and the subsequent regulations of PSD2 (Revised Payment Services Directive) and GDPR (General Data Protection Regulation) that have led to open-banking standards and more open business models. As additional controls were placed on top of the banking system, the U.S. Durbin Amendment (2010) included changes to the interchange-rate structure, making it economically feasible for banks with under $10 billion in assets to provide card services as an infrastructure business model (cards as a service). This helped launch neobanks through startups such as Marqeta, Synapsefi, Productfy and others to provide prepaid, debit and credit cards with partner banks such as Cross River. Beyond this, global economic policies drove a decade-long dance of low rates that benefited credit, savings and wealth-focused startups and related business-model iterations and helped ramp up the venture-capital-infused explosion of fintech pioneers across every possible banking segment.
One could say that the past 15 years have been a perfect storm to create the next generation of banking. Everything has become connected to everything else—payments, credit, investments, everyday transactional banking, capital markets and corporate banking—nothing has been immune to the changed expectations driven by these initial sparks. Without these early touchstones as a catalyst, where would fintech be today? Yet incumbents were still caught flat-footed as the global economy stammered, and the fintech revolution grew from small seeds to the forests we see now. And it’s happening again, but this time even more rapidly.
While thousands of fintech founders—many of whom came from the banking industry itself—spent a decade challenging the establishment by thinking about everyday problems differently, these early embers of innovation became forest fires in the minds of nascent Web3 founders (for example, decentralized information, technology and commerce, which could include elements of cryptocurrency, decentralized finance, non-fungible tokens [NFTs] and metaverse/community-related startups). They seemingly have even less respect for what fintech has accomplished as they look to build an entirely new system of money—and they have earnest plans to capitalize on ongoing neglect toward innovation, despite banks’ slowly mobilizing over the past decade to plant their own gardens of innovative change. Will it be too little, too late for incumbents, or will economic slowdowns and rising rates rescue them this time around?
Follow the money (to the future)
The financial-services ecosystem has always been changing, of course. That is nothing new. Consumers and businesses continue to redefine what they want from banks and are creating anew what the word banking really means. Banking is now the most dynamic and innovative sector globally, as more money has poured into fintech technology and crypto-related startups than any other economic sector. It is simultaneously the most exciting and terrifying time to be in banking, especially if you are trying to compete against well-funded startups.
Venture investment has simply transformed banking’s innovation agenda. Just this past year saw a record $132 billion committed to funding fintech startups ($63 billion in the United States alone, an all-time high). In 2021, fintech accounted for 20 percent of all global venture investment—represented through 343 global mega-rounds ($100 million invested or more)1. At the end of the first quarter of 2022, there were a total of 267 fintech unicorns (companies valued at more than $100 million), doubling over just the past year. By the fourth quarter of 2021, there were 10,755 fintech startups in the Americas, 9,323 in the EMEA region (Europe, the Middle East and Africa) and 6,268 in the Asia-Pacific region2. Back in 2007, banks couldn’t even imagine these numbers or the impact. While fintech has disrupted the financial-services business model in countless positive ways—efficiency, transparency, user experience, value propositions, increased access and adoption of digital experiences—has it been enough to change banking for the better? Could something on the horizon be even more disruptive to banking as we know it today? Or will fintech experience a dot-com-like boom-and-bust cycle as the current post-pandemic economy stutters?
While the pace of fintech funding has indeed slowed some in the first quarter of 2022 (down 18 percent quarter-over-quarter to $28.8 billion raised)3, it’s partly a reaction to sorrowing business conditions, not an insatiable appetite for disruption. And while the amount of funding was down in the first quarter, the amount raised still made it the fourth-best quarter ever. But it’s also a reflection of the fact that venture capital has long been looking at a shiny new disruptive object of late as it shifts some of its fintech investment into the rails of Web3.
Just how thirsty is global venture capital for Web3? Very much, it appears.
Blockchain and crypto-related startups garnered an additional $25.2 billion in venture-backed funding in 2021, up 713 percent from $3.1 billion in 2020. There were 1,247 deals (up 88 percent year-on-year), $15.5 billion in mega-round funding across 59 deals, and 40 new unicorns were born in 2021 (now 47 in total). The U.S. represented 56 percent of the global share, with New York the leading metro for these activities. Coinbase Ventures was the top blockchain investor in 2021, with investments in 68 companies, followed by China-based AU21 Capital with 51 and Andreessen Horowitz (a16z) with 48. Of the venture volume invested in Web3 startups, a quarter ($6.4 billion) went into crypto-exchanges, $4.8 billion into NFTs and related activities in gaming, marketplaces such as OpenSea and infrastructure players. The last major category for investment was in decentralized finance, in which DeFi deals garnered $3.4 billion, an 851-percent year-on-year growth4. While this is significant, what could that future look like? And what is all the fuss about this third iteration of the web?
Is the third time a charm?
The internet’s early history could be defined as two versions of the World Wide Web (WWW). Web1 started off with the idea of an open and decentralized internet to facilitate research, data sharing and communication between universities. As the connected web grew, the scope broadened to anyone with access to a modem and appropriate telecom capabilities. This first generation, a more read-only version of the web, spanned from the early 1990s to the early 2000s and was characterized by open-source protocols developed between the 1960s and 1980s and based on technologies such as TCP (Transmission Control Protocol), IP (Internet Protocol), SMTP (Simple Mail Transfer Protocol) and HTTP (Hypertext Transfer Protocol).
Web2—the internet we have today—was meant to address the shortcomings of Web1. It developed a more interactive and collaborative set of “read and write” content. It also saw the expanded use of images, audio and video, as internet speed and infrastructure provided. Web2’s business model quickly became dependent on building proprietary, closed protocols accessed by the open-source code of Web1, and has led to the creation of many of the world’s most valuable companies, from Amazon to Facebook to Google, which control much of what we see on the web today, as well as the predominant business model of leveraging, storing and manipulating personal data for commerce-related activities and subsequent advertisement revenue.
The term Web3 was coined5 in 2014 by Gavin Wood, one of the co-founders of the decentralized, open-source blockchain/cryptocurrency Ethereum, while laying out his vision of the future of the internet (it’s also been heavily propagated by several well-known VCs, such as a16z’s Chris Dixon6). According to Wood, Web3 is a truly decentralized and more democratic version of the current internet—one that is not dominated by a handful of large social, technology and commerce platforms and infrastructure as it is today. Web3 leverages open-source protocols but is collectively owned by distributed communities. Leveraging blockchain (distributed ledgers)—the key technology behind cryptocurrencies and now Web3—theoretically provides users with the ability to read-write and own their personal data and share it as they see fit. While this hasn’t disrupted the Web2 model quite yet, it does feel like there is momentum.
As people throw business models against the wall to see what sticks, Web3 has been called a lot of things: the future of a decentralized web, the money layer for the internet, the identity layer for the internet, a reaction to Web2 personal-data monetization. Some see Web3 as a new patron model for the internet—a way for artists and creators to get compensated for their work through new communities and cooperative ownership, as well as the sale, trading and ownership of NFTs and other digital goods. Much of the gaming economy is centered around these types of communities, as are the half dozen or more versions of the metaverse, in which avatar-led facilitators act as the primary-user experiences, and digital goods can be acquired and communities formed. As Web3 evolves, will a more decentralized internet also lead to more decentralized finance and more competition for the banking system beyond the decade-plus-long onslaught of fintech and cryptocurrency startups? Yes is the most likely answer to both.
The central role of decentralized finance
If the traditional-finance (TradFi) business model begat fintech, then cryptocurrency’s decentralized nature of ownership and control will drive Web3 and the components of decentralized finance (DeFi). The benefits7 of decentralized systems are very important for a more decentralized financial system to emerge and provide real challenges to the existing models. With its decentralized distributed ledger, blockchains ensure that no one central figure can own or control the data in its system, and consensus provides for security that makes the system harder to manipulate or exploit. Blockchains record immutable transactions with date, time and location stamps, which provides transparency across the network and creates open-record traceability that can be audited to prove a transaction’s origin. Blockchain removes third-party mediation (creating a permissionless network across applications), which creates (in theory) greater efficiency and speed. Finally, the use of smart contracts can automatically trigger the next steps in a transaction when specific prerequisites are met, increasing automation, reducing unnecessary interventions and decreasing errors.
As more of the infrastructure of decentralized finance is built, the strength of the underlying blockchain technology and the experience of leveraging cryptocurrencies will prove disruptive. After the anonymous Satoshi Nakamoto whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System” was published on October 31, 2008, and the first bitcoin (BTC) was mined on January 3, 2009, many people were introduced to blockchain technology for the first time, but the underlying principles of distributed ledgers had been around for decades prior. Built primarily on the ethereum cryptocurrency, decentralized applications (DApps) are now creating alternatives to traditional banking.
DApps have many practical uses, such as providing the ability to send money instantaneously (direct, immediate transactions), stream money (continuous payments over time through smart contracts), open-source lending and borrowing (where users can act as the bank and/or the customer)—including peer-to-peer and pool-based lending and borrowing, currency exchange via decentralized exchanges across cryptocurrencies, fiat currency or tokenized assets, and derivatives to enable advanced trading across an open market of assets that are available to trade 24 hours a day, seven days a week. These DeFi apps are also free from traditional governing authorities such as banks, brokerages or exchanges and are open to all. But just as it has been with fintech, it will take a while for the average bank customer to take the leap of trust into this alternative system. There has been progress here as well.
The total crypto-market is valued8 at $1.693 trillion (as of April 29, 2022, down from a high of $2.9 trillion seen on November 9, 2021). This still puts crypto-assets valued at near the size of those of the 15th largest bank in the world. Consider the following statistics9 around crypto and DeFi. While nearly 11,000 different cryptocurrencies are traded across more than 200 crypto-exchanges, the top 10 cryptocurrencies account for 88 percent of the total market value. Currently, 300 million people use crypto globally, and the largest crypto-exchange (Binance) traded a 24-hour volume of $76 billion on the first day of May 2022 alone. There are now more than 15,000 businesses accepting10 BTC globally. The number of crypto-enthused and crypto-curious consumers grew exponentially during the pandemic.
User growth continues to match the rise of investment into the DeFi space, where we continue to see record funding. Companies such as Consensys, which bagged a $450-million mega-round investment11 in mid-March and is now valued at more than $7 billion, are typical, having built out applications such as MetaMask, which now has more than 30 million active users, providing them ways to mint and collect NFTs and other DeFi products. Other companies with recent big rounds include Alchemy ($200 million in February), Fireblocks ($550 million in January) and Blockdaemon ($207 million). According to CB Insights12, the top 50 most valuable blockchain companies have raised more than $17.17 billion in venture capital. At this stage, venture money is being invested at a faster rate than in fintech, and many banks, such as JPMorgan Chase, Citibank and Santander, are deploying their investments alongside it.
Like fintech before it, decentralized finance isn’t going to go away. As the Web3 business evolution takes hold and the fintech revolution of the past 15 years evolves toward further decentralization, what then? Who benefits? These are tomorrow’s questions for financial incumbents across the business model who’ve already been impacted by market changes since the Great Recession, if not before.
Answering tomorrow’s questions today
From within (and increasingly outside) the industry, there is this ongoing debate about what the future will hold, where the opportunities are, and what form banking will take next. While the combination of fintech and banking has resulted in more than 600 million more people coming into the formal financial system over the past decade, access is only the starting point for financial inclusion. I would argue that we have increased the percentage of the population who are underbanked and underoptimized as we have increased the number of choices and the complexity of the ways in which people and businesses complete their banking activities. Will Web3, with crypto-wallets, NFTs, tokenization and financial transactions in the metaverse, make banking any easier? Many people said this about fintech a decade ago, so getting informed and involved is critical.
A Web3-driven future isn’t likely to result in deeper inclusion levels just because it is based on decentralized technology. What will be needed is real inclusive leadership at these companies that are building the infrastructure of these new forms of finance to focus on understanding and meeting the financial needs of the communities they are privileged to serve. Just like with fintech before it, we must question who benefits from the investments in these startups and spaces, who makes the decisions around product and service design, and how truly inclusive these technologies are when they are so focused on avoiding existing rails and regulations under the guise of better value propositions. Who is collectively validating any of this in the end? Based on the way the crypto-community acts—especially toward those working within banking and even fintech—time will tell if their hearts, motivations and value propositions are in the right places.
Given the unforeseen path for financial services, how can we even begin to answer tomorrow’s questions, where the past and present meet in context to form a very different future? While the acceleration of the banking business model toward a more comprehensive Web3-focused decentralized model is unprecedented—even when compared to the early growth of fintech—what are we to make of Web3? Will these new models be resilient enough to drive the industry toward an inevitable irrelevant future, or will incumbents leverage this time to adjust and transform themselves as they have during the onslaught of fintech—if only by being better prepared for this latest wave of disruption?
Atonement of purpose
To truly gauge the success of the influence of fintech over the last decade within the financial-services business model, we must move beyond access. Are the individuals and communities that the entire industry serves better off than a decade ago? Is there more transparency? Are there fewer forms of extraction? And are profits in line with the purpose of banking? Is banking better able to deliver the basics—the food, water and shelter equivalents—of our global monetary system? How much has really changed? This is a big reason why I co-authored Beyond Good: How Technology Is Leading a Purpose-driven Business Revolution13 (Kogan Page, 2021)—to ask and answer these questions through the diverse lens of the founders and business leaders who are making banking better.
The banking industry can and must do more. Let’s go back to the foundation of Web1 and the first principles of financial services and remember for whom we are building. Yes, let’s build, but not the future that venture capitalist Marc Andreesen pined for14 two years ago in his epic yet somewhat misguided post about the future. Let’s build a future that is truly to the benefit of every part of our society, lifts up each community and deserves to be the thrust of a new chapter of a more inclusive humanity.
References
1 CB Insights: “State of Blockchain 2021 Report,” February 1, 2022.
2 Statista: “Number of fintech startups worldwide from 2018 to November 2021, by region,” F. Norrestad, January 11, 2022.
3 CB Insights: “State of Blockchain 2021 Report,” February 1, 2022.
4 Ibid.
5 CNBC: “What is ‘Web3’? Here’s the vision for the future of the internet from the man who coined the phrase,” Arjun Kharpal, April 19, 2022.
6 The Verge: “Chris Dixon Thinks Web3 Is the Future of the Internet—Is It? Plus, why a16z has spent $3 billion on web3 startups,” Nilay Patel, April 12, 2022.
7 The Inner Detail: “Blockchain Explained.”
8 CoinMarketCap: “Global Cryptocurrency Charts; Total Cryptocurrency Market Cap.”
9 Earthweb: “Cryptocurrency Statistics 2022: How Many People Use Crypto?” Thomas McGovern, March 22, 2022.
10 Zippia: “How Many Businesses Accept Bitcoin? (2022): 21 Important Bitcoin Statistics,” Jack Flynn, January 17, 2021.
11 Insider Intelligence: “ConsenSys bags $450M in megaround as investors flock to back blockchain,” Will Paige, March 17, 2022.
12 CB Insights: “The Blockchain 50: The top blockchain companies of 2022,” March 1, 2022.
13 Amazon: Beyond Good: How Technology Is Leading a Purpose-driven Business Revolution (Kogan Page Inspire), Theodora Lau and Bradley Leimer, March 30, 2021.
14 Future from a16z: Andreessen Horowitz: “It’s Time to Build,” Marc Andreessen, April 18, 2020.
ABOUT THE AUTHOR
Bradley Leimer is the co-author of Beyond Good: How Technology is Leading a Purpose-driven Business Revolution, Co-Founder of Unconventional Ventures and Co-host of One Vision, a podcast on fintech, technology and innovation. As the former Head of Innovation at Santander Group, he and his team connected the bank to the fintech ecosystem and served as the global organisation’s observatory for trends originating in the United States.