How Frontier Tech is shaking up banking
We live in exciting times. Traditional banks, not always known for their forward-thinking on technology, are now starting to explore and take seriously a host of concurrent technology trends. The growth of Decentralised Finance (DeFi), the rise of Central Bank Digital Currencies (CBDCs) and the growing popularity of the metaverse are all having an impact on the future of finance and are opening up new ways of doing business.
Most central banks around the world are now exploring CBDCs in one way or another. The Bank for International Settlements (BiS) is also driving this exploration through its global innovation hubs. All of these pilots and exploration are starting to come to fruition creating a time of upheaval and new challenges for the banking industry.
One of the key elements being investigated is how to use CBDCs in the wholesale space between commercial banks, as well as in central banks themselves. As a result of their exploration, central banks have encountered a very painful and important use case to solve — the need for cross border currencies.
The proposed launch of Facebook’s Libra (which then became Diem and has now folded) combined with interest in — and concern about — China’s Digital Yuan (e-CNY) experiment really gave the impetus for central banks to start actively probing what they could do. Facebook’s original announcement opened up the prospect that practically overnight, you would have the potential to connect 2 billion people and to be able to transact between them across the world. It sparked imaginations and all of a sudden would national borders dissolve as we opened up a whole new way of exchanging money?
Central banks are primarily interested in the stability of the financial system as a whole but they are also focused on consumer protection so Facebook’s project sparked concerns over how consumers would be affected and whether banks needed to offer their own alternatives to Libra. Consequently, the retail impact of CBDCs for the consumer is also being accelerated by projects like the Bahamas sand dollar, which was one of the first CBDCs to launch around the world. In Europe we also see exploration of a digital Euro and the Bank of England talking seriously about the introduction of a digital Pound. However, it is not yet clear whether wholesale CBDC will get off the ground first or a functional, retail CBDC, or indeed how the two will interrelate.
Meanwhile, the whole idea of decentralised finance (DeFi) is challenging what it even means to be a bank. Right now our economies still operate primarily in a world of centralised finance where everything moves through third party intermediaries and commercial banks. All of a sudden the advent of DeFi has presented this opportunity where you no longer need that intermediary anymore because you can transact peer to peer. In the regulated financial industry, at the same time, that trust element presents itself because of banks’ regulatory status and typically strong balance sheets with corresponding insurance to weather dangers in a storm. Even in a decentralised finance environment, there will be those large players who seek that element of trust given their fiduciary responsibilities.
Banks are now being challenged to think about what their appropriate role is within the decentralised finance world. They may have to change or reimagine what their role is and where they are really going to add value. If you can settle transactions without them, then where do banks add value? Banks’ role might shift to adding value in different ways such as by giving people advice, in terms of wealth management, or advice in terms of supply chains and sustainability to meet Environmental, Social and Governance criteria. They can also supply a trusted record of activity because of their regulated status. Banks are still trusted to give advice that can protect wealth and secure assets for transacting, trading, and investing activities.
Going even further into the future scenarios, we have recently seen JP Morgan’s engagement with the metaverse as they have opened a lounge in Decentraland and HSBC also bought a plot of land in the Sandbox gaming platform. While this may seem like just a good bit of zeitgeisty short-term marketing on behalf of banks, it is perhaps more interesting to ask what could be the role for banks in the metaverse longer-term?
The metaverse has been around for a long time but we are now finally getting to the point where it is becoming much more of a reality. Banks again have an opportunity to bring in that trust element in providing advice and helping clients to navigate a complex space and perhaps bring greater financial inclusion and engagement.
Is there a way to use the metaverse to reach out to people to help them manage their money better? If so, that could be a very positive development. How do you pay for things in the metaverse? Is it based on using fiat currency in a digital wallet, for example, using a CBDC or stablecoin? Or is a new cryptocurrency or crypto asset required? How do those different digital assets play together? Whatever happens, there is no doubt that this is a very interesting period for banking. We are seeing a whole reimagination of the financial system and how it can be better designed and purposed, whether that is in the virtual world or in the real world. Banks may never be the same again.
To learn more, listen to our podcast series, The Gage Episode 3 — How Frontier Tech impacts on Banking.