In the 1990s, when the internet was undergoing rapid expansion and adoption, it was nearly impossible for the average person to anticipate what the internet might become* The technology was unlike anything we'd ever seen, and most of us had little idea how it might be used. If you had a crystal ball then that allowed you to see into the future, what might you have done differently? Would you have invested in Netscape, Cisco Systems, or some other dot.com?
What if you had a second chance to capitalize on the next wave of innovation? "The world's most valuable resource is no longer oil, but data." (1) Consequently, it is data management and related analytics tools that are receiving the lion's share of attention from innovators, financiers, and regulators, and therein lies great opportunity for investment as these industries grow.
Blockchain in Banking and Finance
In spite of the wild fluctuations associated with blockchain-issued virtual currencies, blockchain is now undergoing rapid adoption faster than any technology we have ever seen. Blockchain, at its heart, is really an innovative and interesting data management system, and it is what blockchain does with all that data that really matters. In particular, banking and financial services are experiencing dramatic change due to the impact of blockchain. Payment rails, or how to move money among people, businesses, or accounts, is the principal driver of evolving financial technology (FinTech), and for this reason, it has received the most regulatory attention, including from the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Financial Crimes Enforcement Network (FinCEN), the Internal Revenue Service (IRS), and related state agencies.
On January 3, 2009, the world's first blockchain was authenticated with the mining of the Bitcoin genesis block for a reward of 50 Bitcoins. (2) Not surprisingly, the launch of Bitcoin was met with little more than a whisper* Bitcoin was not the world's first decentralized payment system, nor would it be the last* Prior to Bitcoin, there were several digital cash technologies successfully created, but that developed into nothing. Ecash, (3) Hashcash, (4) B-money, (5) and Bit Gold (6) were all early forms of electronic cryptographic payment systems, and none of them ever proved a threat to traditional banking. So, what made Bitcoin different? Why did Bitcoin grow to such strength and magnitude where earlier systems had failed?
The collapse of the U.S. housing market in 2008 caused economic ripples throughout the world. (7) When top executives at big American banks were rewarded for financial mismanagement with $1.6 billion in bonus payments, (8) faith in the U.S. banking system took a dive. Meanwhile, worldwide access to high-speed, low-cost bandwidth expanded, and global human migration increased to unprecedented levels. (9) However, the cost of international money transfers via traditional bank SWIFT systems remained comparatively high. With the proliferation of smartphones and digital wallet applications, it became easier for the average person to learn about the new banking alternative called Bitcoin. This new tool allowed people to easily convert their money into a trusted digital currency and send it to their friends and family around the world where it could be converted into the local currency within minutes and for a fraction of what banks charged.
Western Union, the world's largest provider of cross-border payments, generates $4 billion in revenues from remittances each year, (10) and its business model is now under attack from new market entrants* Meanwhile, there is some argument over how much big banks make on money transfers. JP Morgan Chase, the world's second largest bank outside of China, (11) reports less than *5% of its consumer bank revenue comes from money transfers. (12) A recent internal memo reports Santander's money transfer revenue at 10% of their overall profits, and they charge six times more than their rival TransferWise, whose numbers have since been challenged. (13) Nevertheless, the traditional banking business model is built on cross-subsidies that impact fair competition and price discrimination, (14) but new entrants can attack profitable banking divisions by unbundling services, a strategy the United Kingdom's Financial Conduct Authority (FCA) has thoroughly explored.
In a recent article in Disruption magazine, Senior Staff Writer Laura Cox reports that "[i]n the last five years, FinTech startups like Monzo, Starling, N26, and Atom Bank have revolutionized the UK's banking sector." (15) These online-only banks increased pressure on existing industry giants while demand for innovative financial products grew. Recognizing the importance of supporting innovation for financial services and the challenges with the time and cost required to obtain a banking license, the UK FCA developed a solution called a "FinTech regulatory sandbox." Similar to a software development sandbox, a FinTech sandbox is a framework created by financial regulators to allow small-scale, live testing of new financial products using real customers with limited regulatory supervision and without requiring full regulatory licensure. (16)
The FCA sandbox model of financial innovation has proven remarkably successful, with 90% of participating companies going on to market. (17) Consequently, other nations have followed suit by implementing their own sandboxes, including Australia, Canada, the Netherlands, Hong Kong, Singapore, and South Korea. (18) Notably, the United States has not, but select states within the U.S. have implemented their own sandboxes, including Arizona and Wyoming, and several more are considering similar measures, including Florida. According to a recent study by the Inter-American Development Bank and Finnovista, Latin America and the Caribbean are part of the FinTech transformation with more than 700 platforms introduced throughout the region, with the majority located in Argentina, Brazil, Chile, Colombia, and Mexico. (19) Through a Regional Technical Cooperation, the governments of several Latin American nations are also developing policy frameworks for alternative finance and regulatory sandboxes. (20) In addition to payment solutions, FinTech companies throughout Latin America (LATAM) are also responding to gaps and asymmetries that continue to affect the allocation of credit, mainly to micro, small, and medium-sized enterprises. (21) As a result, the alternative finance market in LATAM saw triple growth in 2016 as compared to 2015, with business lending accounting for 71% of all loan origination activity. (22)
More recently, as an international initiative, the UK FCA and 11 additional financial regulators formed the Global Financial Innovation Network to create a universal FinTech sandbox. (23) With key themes centered around artificial...