The Evolution of Financial Services

Financial Services Evolution: Cryptocurrency

The Financial Services industry has been under attack for the last decade. After the financial crisis, changes in government regulation and innovative technology have had the biggest impact. According to the New York Office of the Comptroller, New York’s securities industry lost 28,300 jobs during the financial crisis, and has only gained back around 8,000.

Software and the Internet are bringing the power of data, automation, and scalable new business models into each segment of Finance:

• Savings/Investments
• Lending
• Capital Markets
• Payments

Technology has always been a disruptor to old ways of doing business. The best examples being how the industrial revolution changed the way goods were manufactured, or how Henry Ford implemented Adam Smith’s idea of assembly-lines as described in Wealth of Nations, or most recently the rise of telecommunications in the 1990s with VOiP.

The difference today in financial services are technological advances occurring alongside government regulation. After the Great Recession of 2008, Federal Regulators quickly stepped in to stop the bleeding of wealth destruction by lowering interest rates to a level not seen since the Treasury Accord of 1950. Legislators followed by passing laws that would prevent future wealth destruction and impose further regulation on the financial services industry that “created the problem” leading to the housing crisis. Some of those regulations (Dodd-Frank, DOL, JOBS Act) either hampered the profitability of certain areas of financial services, or opened doors for innovation.

Savings / Investments — Wealth Management

In the area of Wealth Management we’ve seen small technology firms (RoboAdvisors) like FutureAdvisor and WealthFront raise more assets under management in a matter of months than many wirehouses raise across thousands of Financial Advisors. The reason is twofold.

1. The DOL has made it difficult for Financial Advisors to make a profit servicing smaller accounts
2. Millennials no longer trust their parent’s Financial Advisors.

Additionally, we’ve seen a growth of high net worth women moving away from male-dominated financial advisors and into platforms created for women, by women, such as Ellevest.

Lending & Consumer Banking

We’ve seen startups like SoFi and LendingClub create scalable online businesses that lend to more customers than many large banks. Banks have to hire armies of brokers to underwrite loans of various types (many of whom became unemployed in 2008 and 2009). Banks are not willing to hire these people back in scale, and, to my previous point, regulation makes it difficult for these banks to make a risk-adjusted profit in lending. They risk incurring fines and lawsuits for errors in lending docs, etc. The online lending approach scales easier, and the savings in expenses makes the business profitable enough to weather the potential liabilities.

Capital Markets — Decentralization of Investment Banking

Crowdfunding 1.0 thad the promise of disrupting traditional Investment Banking and Venture Capital as a solution to fund small business directly. This segment has taken longer to take off because 1) the small business segment is fragmented 2) Raising capital is largely relationship-driven, both access to deal flow and to investors and 2) prior to the JOBS Act, there has been a high barrier to entry

The Sotoshi Whitepaper was written around the same time The JOBS Act was passed. Both of these documents were created due to frustration stemming from the Great Recession and the centralized financial system. Both were generated independently, but the technology and the legislation would later converge to support and allow the current blockchain marketplace. Digital assets have lowered the barriers of entry and democratized capital raises for companies. As a result, Crowdfunding 2.0 began as a wave of ICOs came to market in 2017. Individuals and Institutions were able to see investment opportunities and judge for themselves whether they want to participate without going through the middle-man of a banker or VC.

Payments — The Future of Money

High monetary transaction costs have led to further developments in digital assets (aka cryptocurrencies). Small countries are searching for ways to reduce friction and barriers for remittances. Economies that experience volatile inflation and currencies are utilizing Bitcoin and other existing digital currencies as stabilizers. Non-governmental entities are even developing digital currencies backed by fiat currencies or derivatives of those currencies.

We are already making payments to Starbucks and other retailers using our phones by electronically loading fiat currencies to our accounts. It won’t be long before we are transferring other digital currencies for purchases alongside fiat from our own countries.

Banks Reject Risk, Tech Embraces It

When it comes to early stage FinTech, there is significant risk inherent in building and operating the core product itself. Before PayPal there were no peer-to-peer payment options for use over the Internet. Logically, you might think that large existing banks would recognize this giant market opportunity for consumer payments over the web and leverage their existing infrastructure to be first to market. However, banks did not seize this huge market opportunity. Through the lens of their traditional banking and payments businesses, this was a minefield of potential fraud and other compliance issues. The risks were far too great.

Not surprisingly, it took an ambitions group of technophiles from Silicon Valley to see the opportunity and take on the risks of building such a product with PayPal. An incredible group of young founders came together including Elon Musk, Peter Thiel, Reid Hoffman, Ken Howery to tackle the problem and won.

Today’s leading banks aren’t building tomorrow’s financial services. Smart, risk-taking entrepreneurs will build it with their passion and determination to change how the business of banking is done, and do it online at scale.

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