Author: Chris Skinner
ValueWeb: How Fintech Firms are Using Bitcoin Blockchain and Mobile Technologies to Create the Internet of Value Chris Skinner 2016
About the book valueweb
We are entering the era of the next generation Internet (ValueWeb), in which the exchange of value occurs globally, free of charge and instantly. However, ValueWeb is impossible without updating the financial system, which means the entry of new players into the market and a significant transformation of the old ones.
A book for managers and specialists in banking, fintech and investment. And also for everyone who is interested in the future of the financial system and money.
about the author Chris Skinner
Chris Skinner is an independent financial commentator, author of thefinanser.com blog, and a sought-after speaker in the field of fintech and banking.
- Ranked second in The Financial Brand’s list of the most influential people in banking (2015), as well as top 5 in information security (BankInfoSecurity, 2016) and top 40 in fintech in Europe (Wall Street Journal’s Financial News). , 2015).
- Chairman of the European forums Financial Services Club and Nordic Finance Innovation.
- Winner of “Financial Consultant of the Year” and Game Changer (Finance Monthly), “Best Fintech Speaker” (TMT Global), “CEO of the Year” (CV Magazine). Member of the jury of awards in the banking sector.
- Member of the advisory board of companies: B-Hive, Innovate Finance, Life.SREDA, Moven, Meniga and others.
- He is the author of more than ten books, the key ones being Digital Bank (2014), ValueWeb (2016) and Digital Man (2018).
The third generation Internet expands the concept of value. A new system of value exchange requires the development of a new financial system, which will be based on two technologies – mobile phones and digital currencies.
The transformation of the financial system is inevitable, but this does not mean that the old giant companies will die out like dinosaurs, or take on a modest role of intermediaries, and fintech startups will come in their place. Traditional banks still have time: firstly, there are serious regulatory requirements in this area, and secondly, the role of the brand and trust in the company is important. Banks that cannot abandon their old structure based on the physical distribution of paper in the local world will indeed sink into oblivion. In general, the banking system is on the path of integrating the old and the new. In addition, new financial instruments and services are emerging.Today, banks must actively engage not only in the digitalization of their infrastructure, but also to look for new values that they can offer customers when transactions become free.
The financial services market is highly differentiated and it is difficult to compete in each category with new companies that specialize in a particular service. Therefore, one of the ways for the bank to develop is to become a reliable aggregator, focus on processing and offer customers a range of services relevant to them.
Bitcoin and blockchain have made a lot of noise in the press. And while bitcoin remains a currency for geeks and venture investors, many companies have become interested in blockchain as a technology for a secure global ledger, banks and fintech startups are gradually implementing it.
According to the libertarian position, peer-to-peer exchange of values (without intermediaries and without state control) will take over and society will self-regulate. However, a society cannot exist without guarantees from the state and without a reliable third party in the form of banks. Digital currencies are the future, but they need to be institutionalized.
The existing value storage system was created for physical tokens (units) of value – money. However, these days, value tokens can be digital and, in addition, any asset can be tokenized: likes on social networks, the number of subscribers, airline air miles, and much more. Therefore, ValueWeb needs a new system for exchanging and storing value tokens.
A new form of attracting investments has appeared – ICO (Initial coin offering). The company tokenizes its assets and sells tokens in the form of a new cryptocurrency.
ValueWeb (Internet of Values) is the next generation Internet, Web 3.0. The key difference between this generation and the previous one is the establishment of connections between people and machines, that is, the Internet of things. ValueWeb needs a global, instant, and free exchange of value , which in turn requires changes to the current value exchange system. The two key technologies of the Internet of Value are:
• mobile phone; allows you to include more people in the network and make it truly global (due to the network effect, each new connection increases the value of the network more and more); peer-to-peer value exchange (P2P, peer-to-peer) became possible with the help of mobile phones;
• digital currency; provides an instant exchange of value, while practically free (for example, one bitcoin transaction for 81 million dollars had a cost of 4 cents).
The coverage of the population with smartphones in some countries reaches 100% (Japan, Korea), in Europe and the USA – about 80%. The time spent on smartphones is increasing year by year, especially among the younger generation, who spend most of their time on instant messengers and social networks. At the end of 2016, the share of mobile Internet traffic exceeded that of PCs. As a result, the number of payments made from a mobile phone is increasing. There is a battle for mobile wallets among IT giants (Apple Pay, Samsung Pay, Google Pay), although the share of mobile wallet users is still low– on average, no more than 10% of all smartphone users. More payments are made by PayPal users, but Chinese companies, Alibaba and Tencent (Chinese Facebook), have had the biggest success: they have not only opened their e-wallets, but also started to provide other banking services such as money transfers and microfinance.
However, all these wallets cannot be called new digital money – this is an add-on to the existing banking system. It’s just that banks and payment systems are wrapped in several layers of processing, invisible to the wallet user. Technology companies, in turn, require banks to reduce transaction fees. The real breakthrough in the financial system will be associated with cryptocurrencies and blockchain technology.
The combination of mobile technology and digital currency is especially needed in developing countries, where a large part of the population does not have credit cards and access to banking services.
In Kenya, mobile operator Vodafone has launched the M-Pesa payment system, which links e-wallets to a mobile phone number. Thanks to M-Pesa, Kenyans got access to fast money transfers, but it should be noted that the success of this project is due, among other things, to government support and the operator’s developed agent network.
What you need to know about bitcoin
Bitcoin is an ecosystem that includes cryptocurrency, blockchain technology, protocol, contracting system, and more.
1. There are more than a thousand cryptocurrencies, and their number is constantly growing. Nevertheless, they are all different variations of the first digital currency – bitcoin. At the moment, bitcoin is considered the most popular and liquid cryptocurrency.
This is not entirely true. If the early cryptocurrencies were copies of bitcoin, then the currencies based on new technologies – Ethereum (the second largest cryptocurrency by capitalization), Ripple – have significant differences with it.
2. Bitcoin is based on blockchain technology – a distributed ledger of data, consisting of linked blocks . A new block in the ledger and new bitcoins are created every time miners manage to find a solution to a particular mathematical problem. The new block contains information about transactions with bitcoins made during the solution of the problem.
3. Blockchain solves the problem of double spending (re-selling the same assets) and makes peer-to-peer exchange of value possible, that is, transactions without a regulatory third party (payment system or bank).
4. Bitcoin is a decentralized self-regulating currency . There is no central authority that could influence the issuance of bitcoins, and anyone can become a miner. Each miner’s node stores a copy of the entire ledger. Cryptographic algorithms guarantee the immutability and security of transactions.
Security is guaranteed to the extent that a person keeps their digital wallet and private key secure.
5. The registry is not completely anonymous, as it is possible to trace from which IP address the transaction was sent. Bitcoin has been criticized as a currency for criminals and terrorists, but the problem is not with the currency itself, but with the Tor network, which allows you to anonymize IP addresses.
In 2014, researchers at Carnegie Mellon University hacked into the Tor network.
6. The maximum number of bitcoins is limited – 21 million (since 2009 more than 17 million have already been created), while generating new bitcoins every year is becoming increasingly difficult. One bitcoin is made up of 100 million satoshis.
The current block reward and the number of created bitcoins can be viewed, for example, on the website https://bitinfocharts.com/ru/bitcoin/ .
7. Bitcoin can be considered both as money (a means of payment), and as an investment instrument, and as a commodity. There are more and more companies accepting bitcoin for payment, including Apple, Microsoft and Amazon.
8. Due to the high entry threshold and a large number of risks (rate volatility, hacker attacks), bitcoin is still a currency for a narrow audience, and its share in the global financial market is still insignificant. Bitcoin at this stage is often compared to the early years of the Internet – it still takes time for the technology to become accessible and secure for a wide range of people.
9. While there is a debate around the Bitcoin currency, many companies have become interested in blockchain technology and are developing based on it.
Bitcoin and government
States are gradually starting to introduce legal regulation for cryptocurrencies, so the status of bitcoin depends on the specific country.
• In Japan, bitcoin is recognized as legal tender.
• In Germany, bitcoin has the status of private money.
• In China, transactions with bitcoins are allowed only to individuals.
• In the US, the government is trying to institutionalize bitcoin: the State of New York issues BitLicenses to companies that work with virtual currencies; in terms of the composition of the requirements, this license strongly resembles a banking one. • In Ecuador, all cryptocurrencies are banned because the country is developing its own national digital currency.
Bitcoin exists outside the banking system, and governments do not like the fact that financial flows pass without their knowledge. One of the reasons is criminal transactions and financing of terrorism. Although, as mentioned above, bitcoin is not a completely anonymous currency. Another reason is tax evasion, more precisely, tax avoidance, which, in turn, is not an inherent defect of bitcoin, but only signals that the tax system also needs to be transformed.
Libertarians are supporters of bitcoin and believe that ValueWeb should function without government intervention, because society will be able to regulate itself. However, bitcoins are not yet full-fledged money, they are a commodity or a store of value, because there is no free exchange of bitcoins yet. For the normal functioning of the economy (and for control over society), money is needed, provided with a reliable side in the form of the state and banks.
old financial system
A revolution in which intermediaries are excluded from the industry has already occurred, for example, in the field of tourism and music. When we pay for goods on the Internet, our transaction goes through at least three intermediaries: the issuing bank, the acquiring bank and the payment system (Visa or MasterCard). If we use ApplePay or Paypal, then the number of intermediaries, each of which takes its own commission, increases. In other words, 1) banks have already failed to cooperate for Internet payments and mobile wallets, 2) the global network transformation of the banking industry is yet to come.
In most countries there is little to no banking competition and only a few major players, some of which are over 100 years old. The fact is that the entry of new companies into the banking services market is hindered by a regulatory barrier, as well as high requirements for the volume of reserve capital. In addition, banks are a political tool. These circumstances give banks a slight head start in time, but do not guarantee a stable future.
The current banking system is designed around physical values and the physical distribution of documents on a physical network. Because of this, by modern standards, it is slow, expensive and local. Banks are obsessed with control and centralization, so they build their own data centers and develop their own software – these days, these are huge transaction costs. At the same time, having a large amount of data, banks do not use them to their full potential.
The slowness of the banking system is especially evident in international payments due to government measures to combat money laundering and tax evasion. The centralized management model focused on the national economy is already outdated. Blockchain technology can make transactions completely global and practically free. As a trusted party, the bank performs three functions: confirms the authenticity of the value token, guarantees the irreversibility of the transaction, and stores information about it. Blockchain copes with all these functions.
Banks will not be able to quickly do away with the old legacy (physical infrastructure), at least because they need to support old customers. More than 50% of customers still want to have a local bank branch. However, this legacy needs to be digitalized as soon as possible and new systems need to be created to attract new customers. Perhaps it would be more efficient to open a new bank.
New financial system
When a disruptive technology enters the market, the entire market turns into a wild west for a while, but over time, order is born out of chaos. This happened, for example, with the film industry, which survived the heyday of digital piracy, and now companies have learned to offer users additional value.
The key players in the new financial system are digital banks (banks that have switched to digital infrastructure) and fintech companies (companies that combine traditional elements of the financial system: deposits, insurance, payments) with new technologies: mobile Internet, social networks, cryptocurrencies, etc. d.). Banks and other traditional financial institutions cannot move quickly to the new footing because it comes with high transaction costs. In turn, without partnership with banks, fintech companies will not be able to fully function in the market. Therefore, a new financial system is born in the collaboration of traditional banks and fintech companies.
Characteristic features of the modern financial system:
1. Leading financial institutions (such as the New York Stock Exchange) are investing in fintech startups.2. The largest banks (for example, JP Morgan and Goldman Sachs) are implementing blockchain technologies.3. Tech giants (Apple, Google, Amazon) enter the financial market.4. The market is becoming more specialized: competition is on specific banking products.
5. New financial services appear (peer-to-peer lending).
Although high technology has long begun to penetrate the financial industry, especially in the field of investment, companies that use it (for example, high-frequency trading) still operate within the old business model. However, in recent years, so many fintech startups have emerged and so much venture capital has poured into them that experts are talking about a new Silicon Valley. These companies can be divided into three types:
1. Adders: they rely on the existing financial market and close problem areas in it. For example, payment systems and electronic wallets: PayPal, Apple Pay.
2. Substitutes: replace banking services with programs and servers. For example, peer-to-peer lending: Zopa, Lending Club. The essence of peer-to-peer lending: customers deposit money into a deposit account, the processor (replacing the physical bank) assesses the risks and uses this money to make loans to others. In this model, the deposit rate will be higher, while the lending rate and server commission will be lower. In addition, the process takes place online and instantly.
The model is somewhat simplified, and you should not take the words “processor” and “server” in their hardware sense.
3. Reformers: using mobile technologies, cryptocurrencies and blockchain, they are transforming the entire industry and creating new financial services. For example, the Ripple global payment system forms a common banking registry using blockchain, which speeds up the exchange between banks and makes intermediaries in the form of SWIFT and clearing systems unnecessary.
As for the investment industry, there are three markets that are most interesting here: social trading (beginners can learn from the actions of more experienced traders), market data services (complement trading strategies) and market financing platforms – crowdfunding companies.
It is important to note that at this stage, we are not talking about crowding out banks by fintech startups, because:
• new companies use the services of traditional banks, and banks, in turn, invest in fintech companies; • some startups work with new tools and new markets, that is, they create an alternative financial system;
• Regulators are forcing fintech startups to partner with organizations that have a license.
An example of a collaboration between a bank and a fintech startup: Goldman Sachs has established a partnership with peer-to-peer lending platform Aztec Money — the bank transfers to the platform a company whose credit history does not meet the requirements of the bank. Another example in peer-to-peer lending is Metro Bank and Zopa, where the bank offers P2P lending to its customers as an asset class for deposits.
Bank as an aggregator of services
The classic bank model is vertically integrated and includes three areas: customers (service experience), channels (processing) and products (production of innovative products). In addition, banks strive for universality and provide a wide range of services: commercial banking, investments, insurance, etc. Business growth occurs through mergers and acquisitions. Regulators are aware of the danger of such universality and are trying to distinguish between types of services for different actors.
The technological shift has brought specialized financial services companies to the market. The bank will not be able to compete with everyone at once. The new role of the bank is to aggregate these services and help the client find the products that are relevant to him. Thus, the bank should become an integrator of value systems.
To switch to this model, banks will need:
1. Move the back office to the cloud and learn how to use big data. Thanks to cloud technologies, products will be available anytime, anywhere. And the analysis of the digital footprint of the client will allow you to select personalized products for him.
2. Use discovery processing: real-time APIs will allow you to integrate bank products with others. This increases the number of points of contact with customers. It is open source, including for mobile devices, that PayPal owes its success to.
3. Improve user experience through mobile phones, social media and gamification. Banks need to focus not only on their profits, but also on customer experience.
In other words, the industry is reengineering the financial supply chain. You can draw a parallel with the automotive industry: car manufacturers do not have to produce all its components themselves, dealer and service centers also exist separately.
With market differentiation, regulators should also be component-oriented and regulate financial services separately.
A digital bank is a bank that has made the transition from a physical structure based on buildings and people to programs and servers. Some banks consider Internet banking and mobile banking as another channel of interaction with the client, but this is fundamentally wrong, there are no isolated digital channels, there is a single digital ecosystem.
Digital banking today
1. Society is not yet ready for 100% digital banks. Direct contact is important for brand and trust, so banks should maintain a two-tier system.
2. To reduce risks, banks should study the social data of customers . Based on them, a so-called “passport of trust” is formed, which will help to make a decision.
Klarna is a European online payment company that was valued at 2 billion euros in 2016. The value of Klarna for the client is the simplification and security of online shopping. In fact, Klarna pays for the purchase instead of the client, and the client transfers the money to Klarna when he receives the goods, if he suits him. The company’s core competency is a risk calculation algorithm that processes data in seconds based on a customer’s name, date of birth, postal address, and purchase circumstances.
3. A digital bank should build a relevant (depending on the location and needs of the user) and trusting dialogue with the client and go where it is convenient for its clients to communicate – in social networks.
4. The bank can become a store of value in the global sense of the word . From World of Warcraft gold to memories. Our memories, along with photos, likes and posts, can be easily lost if a social network, for example, decides to change its business model.
5. If transactions become free, then banks will have to look for new ways to make a profit, that is, look for additional value that they can offer customers. Such value can be consulting on cost issues or the creation of applications related not to banking, but to banking products.
Banco Original, the first Brazilian digital bank, analyzes the personal goals of its customers. If a large number of customers indicate, for example, a certain brand of car as a personal goal, the bank can make a wholesale purchase of cars at a discount and then offer customers to make a purchase or take out a loan. It turns out a kind of social crowdfunding.
Korean Shinhan Bank has created a restaurant app that collects reviews and ratings of restaurants, allows you to book a table, and also simplifies the process of paying by invoice. The app has become number one in its category, and the bank’s competitors pay a fee to Shinhan Bank to connect to the wallet.
Banks and blockchain
Blockchain technology can be used to register any transactions and contracts. The cryptographic secure protocol guarantees the irreversibility of transactions and eliminates the need for a trusted third party.
Uber, Airbnb, Amazon have made a breakthrough in their industries due to the fact that they have become convenient intermediaries in the exchange of value. In the same logic, banks need to focus on processing, and the best technology for processing is blockchain.
In order for blockchain transactions to pass regulatory reviews, a global ledger of digital identity is required.
Now technology companies are actively developing biometric authentication devices: for example, Nymi bracelets with heartbeat identification, DeepFace recognition system from Facebook. However, in the Internet of Things, communication is M2M (between machines). In this case, blockchain and smart contracts can be used for authentication.
10 key ideas of the book
1. ValueWeb needs a global, free and instant value exchange system. At the same time, anything can act as a value: from bitcoin to likes.
2. Key technologies of ValueWeb: mobile phones (provide globality) and digital currency (ensure free and instantaneous transactions). With the help of these two technologies, a peer-to-peer exchange of value is possible – from person to person, without the mediation of a third trusted party.
3. Bitcoin remains a currency for a small number of users for now due to its volatility and barriers to entry, but over time the ecosystem will become more accessible.
4. Of particular interest is blockchain, the technology behind bitcoin. A decentralized registry that ensures the security and irreversibility of transactions is the basis of many fintech startups.
5. Libertarians believe that society is capable of self-regulation and Bitcoin does not need to be institutionalized. The author of the book takes a different point of view: currency is an important political tool, and it is necessary to control society, otherwise the economy will not be able to function normally.
6. Processes in traditional banks are based on physical infrastructure, they need to completely move to a digital core. Operationally, this is a costly process. So much so that it’s easier to create a new bank. But there is still time for banks to transition because the financial industry is highly regulated, which is holding back new businesses.
7. Fintech companies do not always aim to completely replace traditional banks and payment systems, they can work in new markets, with new financial instruments or in cooperation with old banks.
8. The banking services market is differentiated. In this case, it is difficult for banks to compete with specialized startups in all banking components. One of the development options is to become a service aggregator. This is similar to the platform model that Uber, Airbnb, and Amazon operate on.
9. To become a financial services aggregator, banks need to: move to the cloud, learn how to use big data and social data, use open APIs, build an ecosystem around the client.
10. Thanks to the blockchain, transactions can become free, and peer-to-peer lending and fintech companies will take away some of the customers from banks. Then banks need to look for other ways to create value for the customer. It can be consulting, storage of digital values, social crowdfunding, creation of relevant service packages.