The curious case of traditional finance weakness destabilizing a stablecoin

Circle Internet Financial is the US company which manages the stablecoin USDC. Stablecoins are a useful financial primitive because they provide the benefits of blockchain infrastructure but at the same time provide the price stability and acceptance of familiar fiat currencies. USDC maintains price stability because Circle redeems each USDC token for one US Dollar, 1:1. Circle can do this because it only creates as many USDC tokens as US Dollar reserves it holds. Circle holds these reserves with various traditional financial institutions (banks) as “cash” (which is immediately liquid) and, to a larger extent “short-dated US Treasuries” (which earns interest for Circle).

Circle, being prudent and managing their operational risk, diversifies their asset holdings at seven US-regulated banks. In January 2023, there were 42.28 billion USDC outstanding and USDb 42.34 in assets held across these banks.

Late last week, rumors of liquidity issues started circulating around Silicon Valley Bank (SVB), the 16th largest US bank servicing diverse clients, but with a large constituency of tech start-ups and venture capitalist firms. It is also one of the banks Circle uses to custody USDC assets.

By Friday evening March 10th, SVB had been placed in FDIC receivership, meaning that access to USDC’s reserve collateral held with SVB would be impacted. This of course meant that all USDC tokens were not backed 1:1 and this implication immediately caused the market price of USDC to “break its peg”, trading at one point at 0.8776 on 11.03.2023. For a “stablecoin” this is naturally catastrophic, not to mention the deep DeFi/oracle impacts on many protocols that rely on the USDC price and perform automated liquidations.

On Sunday March 11th, in order to stem possible bank-run contagion, the FDIC, US Treasury and the US Federal Reserve jointly communicated that depositors in SVB (and by now Signature Bank) would be granted protection including deposits exceeding the current limit of USD 250,000. This messaging had an immediate impact on markets and on the price of USDC, climbing to 0.9869 by Sunday evening before eventually reclaiming the peg on Monday.

Crypto skeptics claim crypto is bad and must be regulated. Circle is a legitimate, audited company backed by industry veterans and ample funding. It maintains an extremely professional operation with dedicated risk management and competent professionals. So how could this happen?

This crisis was not due to crypto, malicious hackers, defective smart contracts, new tech, nor to poor operational security.

This was due to a bank. A US-regulated bank. A KPMG-recently-audited bank. A bank rated “A1” by Moody’s. SVB’s management used depositor funds to buy long-dated treasuries in a low-interest environment, creating exposure to interest rate movements. It was also due to the Federal Reserve, who previously issued benign rate guidance, but in a surprise, all-hands-on-deck maneuver, the Federal Reserve devalued the instruments owned by many banks (not just SVB!) by dramatically raising interest rates over a very short period to combat inflation that it also caused! The dramatic rise devalued bank assets such that they no longer covered the value of deposits. This makes depositors very nervous, and they withdraw their funds. But not everyone can do this and human psychology trumps all: He who panics first, panics best.

Regulations (and by extension regulators) endeavor to keep traditional financial systems safe from different risks. They do this by mandating constraints on what an institution can do and what it can/cannot hold, and how it should hedge risks that it cannot/should not bear.

It is in this case bitterly ironic that all the costly, onerous regulation and auditing provided no meaningful consumer protection and may in fact have had the opposite effect. When was the last time you asked your bank about their duration mismatch and enquired which assets were purchased with your low-interest loan to them (aka your deposits)?

We understand the need for regulation and the resulting consumer protection. But when all the hard work and costs that go into running a regulated and compliant bank or business using banking services can vanish over a weekend in extinction event-level, spectacular fashion, pointed questions must be asked. What protections did those receive for the increased costs and effort? Was it all show?

Legacy players are already trying to place the blame with crypto, but simple observation leads to the nakedly obvious conclusion that crypto had nothing to do with the failings of these banks’ risk management, management or regulators’ rules and ineffective monitoring activities. As the dust settled, crypto and digital assets were nowhere to be found in these banks’ failings.

Demonization of crypto quickly followed to cover for failed interest rate policy, mismanaging interest expectations and blatant lapse in regulatory oversight. Crypto can show us a better path, better transparency and better regulation. Regulation that is immutably engrained in the code, the very fabric of its existence. Society, industry and government can greatly benefit, not by demonizing crypto, but by embracing the new tools of decentralization and trustless financial infrastructure.

The curious case of traditional finance weakness destabilizing a stablecoin was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

By John Orthwein
Head Engineering & Tech at i.AM Lab

Many people think of blockchains as dark and nefarious places where questionable actors come to transact ill-gotten gains. This can be true, but fundamentally blockchains are simply neutral, transparent and public accounting ledgers. You can think of Bitcoin or Ether as a two-column spreadsheet of addresses and quantities. If you possess the private key of an address that has a positive quantity, you have the power to change the public ledger reflecting a “transfer” of some quantity. Ethereum’s smart contracts gave rise to user-defined tokens, each with their own public ledger and similar rules for transfer.

Blockchain proponents spoke glowingly of pseudo-anonymity: a new paradigm, turning the traditional financial privacy model on its head. Instead of publicly opaque transactions and identities known only to sender, receiver and intermediary (bank), blockchain transactions showed all details of all transactions — but the public had no way of knowing the human identities that controlled the addresses.

This seems theoretically interesting at first glance. Practically, however, we quickly run into a problem. Let’s say I settle a bill with my friend using the blockchain, or I publicly associate an NFT with my Twitter/X profile. I’ve now irreversibly revealed my address, assets and entire transaction history to my friend or potentially to the world. Some may welcome such radical transparency, but many of us might desire a modicum of privacy. Everyone desires privacy to some degree. It is a fundamental right and an important part of a functioning society and economy. Privacy should be the default and people should be given that choice because that genie can’t be put back into the bottle.

There have been many solutions proposed to enable on-chain privacy, from dedicated privacy blockchains (Monero, ZCash) to clever, “moon-math” smart contracts that cryptographically break the link between a deposit address and a withdrawal address. The more deposits into the smart contract’s “anonymity set”, the more ambiguous (hence private) a withdrawal would be. Tornado Cash was one such protocol on Ethereum. Tornado Cash was so good at this that it drew the attention of OFAC (US Office of Foreign Assets Control) and the smart contract was placed on the SDN blacklist (Specially Designated Nationals and Blocked Persons List), normally reserved for dictators and terrorists. The Tornado Cash smart contract (and its developers) became criminalized overnight, even though much of the anonymization activity was legitimate transactions of users simply desiring robust financial privacy. Clearly there is a tension between legitimate user privacy and regulatory oversight/compliance. This tension was only exacerbated by the fact that nation states could not stop the activity but could only create the naughty list. (maintain a blacklist)

Last week Vitalik Buterin, Jacob Illum, Matthias Nadler, Fabian Schär and Ameen Soleimani released a paper entitled “Blockchain Privacy and Regulatory Compliance: Towards a practical Equilibrium”. The paper details a novel scheme that sets out to ease this tension and satisfy these conflicting perspectives.

Privacy Pools are an on-chain construct that use extremely powerful cryptographic tools called “zero-knowledge proofs” together with a set of addresses to obscure the exact source of funds. A person can use a zero-knowledge proof to prove a claim about some data without revealing what the data is. Now this is very abstract, so let’s try to understand it on a more practical level.

If we know that tokens held by an address are “clean” (not illicit), then we know that transfers from that address are also clean. If we have a large set of clean addresses, then all transfers from that group are clean too. The paper refers to such sets of addresses as “association sets”.

Remember the goal is to break any address relationship so that the sender–receiver link is sufficiently obfuscated. So, the larger the association set, the more obfuscated the link and the more private the withdrawal address becomes.

Imagine a smart contract that allows anyone to deposit tokens and hundreds of addresses do just that. Now I withdraw my deposited tokens to a fresh, new address, but I want to prove to an external party (the verifier) that the withdrawn tokens are from a clean address. The claim or assertion here would be that the tokens’ source is an address contained in a subset of all depositing addresses. The smart contract allows withdrawal only if I submit the correct proof. The proof is created with the publicly known association set data and the private data — the original deposit address.

If the deposit address is a member of the association set, I can withdraw the tokens to the new address and I have proven that the tokens originated from a member address of the association set. The verifier can check that addresses in the association set are not illicit or blacklisted (a service provider or government might offer such verification). This would create high confidence that withdrawn funds are not illicit and yet the source has not been revealed.

The logic presented here is sound and straightforward. It could provide workable solutions which satisfy honest, privacy-seeking users and compliance professionals/regulators. But with this solution, other nuanced questions arise. Should honest people with legitimate sources accept the onus of proving their own innocence? Does the pragmatism of the tradeoff merit the slippery slope of a “guilty until proven innocent” regime? Legal and philosophical discussions on the presumption of innocence and burden of proof is a long, deep topic far outside the scope of this article. The counterpoint to this is that Privacy Pools as described would be voluntary and opt-in, not a coerced change to a base-layer protocol. Crypto has always been about self-sovereignty, flexibility and alternatives. Privacy Pools represent exactly that: the free choice to use them or not, a choice to associate or disassociate. There is no doubt that further privacy solutions and ideas will develop in open permissionless systems and that many privacy alternatives will coexist on-chain and users will use those that fit their needs best.

Want to know more? Contact us at hello@iam-lab.ch

Privacy Pools: Balancing Blockchain Transparency with Individual Privacy was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

NFTs are dead. At least this is what you can read in most headlines nowadays, covering this topic. So why do we believe that it’s the perfect time to write about NFTs and their powerful effect on brands, individual people and communities?

Because we believe in the underlying technology and the digital ownership it enables. And because we believe in the numerous possibilities and long-term business opportunities this decentralized technology creates. In this article, you will find a recap of what happened in the past couple of years and our outlook for the coming years. But first, let’s check the current pulse.

What comes into your mind when you hear the word “NFTs”?

a) Overpriced JPEGs
b) Scams
c) Ripoffs
d) Ponzi schemes
e) all of the above

Yes, yes, we completely understand. NFTs have gone from all the rage in 2021 to the ugly duckling in Q3, 2022. Some would even equate the term NFT with credit default swaps or speculative pump & dump stocks like Gamestop. If you look at the current trading volume of Opensea, the largest NFT marketplace, it has dropped by 95% compared to the same time last year. Opensea has even laid off 20% of their workforce because market conditions were worsening. How exactly did this happen and why did the mood change so suddenly at the end of last year?

Are you completely new to NFTs? Then click here to watch our educational movie where we explain what NFTs are and check out our glossary of terms used in this article.

A little bit of NFT history…

The first mention of Non-Fungible Tokens happened in 2014, when Kevin McCoy’s “Quantum” NFT was minted on the Namecoin blockchain. A couple of years and NFT projects later, a collection called CryptoKitties, launching with the new ERC-721 standard for Ethereum, hit the nerve. It was the first time a collection got mainstream attention and traded for amounts up to 600 ETH (at that time USD 172K) on secondary markets.

Since then, there have been many successful NFT projects that have attracted stars and starlets like Gwyneth Paltrow, Paris Hilton, Justin Bieber and Jimmy Fallon. This led to even more absurd prices and even greater popularity of those little jpegs.

The art sector was the first to see a useful case in the adoption of non-fungible tokens, which certified that a unique physical or digital asset is the unforgeable original and that it belongs to one particular owner. This owner has full ownership and can decide upon his/her discretion whether to list it on the market or not. The biggest headlines were made by Beeple during a Christie’s auction in 2021, where his artwork collage “Everydays” achieved the incredible price of 69 million USD. Another example is the famous Bored Ape Yacht Club Collection, where a single monkey image was bought for 11.8 million USD.

This hype was created by a new kind of coolness and the urge to belong to this “cool kids” crowd. First, you have to be a bit of a nerd and understand what a blockchain is. Then you have to understand what a fungible token is. Then you have to know the difference between fungible and non-fungible ones. And most importantly: You have to be in the KNOW and have a feel for the latest market vibe.

Waking up at 4 in the morning to be one of the first hungry souls to mint an NFT is just what you did. Refreshing the minting page 200 times to see if your mint transaction went through really made your heart pump. Paying gas fees of 100 dollars and more is just what you did to be one of the first ones and making sure you would get a limited edition NFT. Everything is about scarcity and exclusivity — and the right to sell if the price is right.

NFTs went from being a technological innovation, which finally made it possible to own and transfer ownership of digital items, to a very powerful marketing tool, where individuals wanted to be part of a super exclusive club like the BAYC.

The crash

And then, last year in late 2022, the hype was suddenly over. Prices dropped and NFTs worth millions two years ago, were suddenly a fraction of their former value. What has happened?

Many factors played a role in the downturn of the NFT market. The global economy was heading into a recession and the crypto world slid along with it. The two largest cryptocurrencies Ethereum and Bitcoin lost over 60% of their value last year, which is one of the biggest dips ever recorded since their respective inception.

Bitcoin & Ethereum to USD

Liquidity has vanished into thin air, and on top of that, a number of scandals have taken place that shook the crypto world to its core: Terra/Luna, Celsius Network, 3AC and most recently, the FTX bankruptcy, to name a few, stripped people of their trust in cryptocurrency and anything related to it.

In addition to the financial crisis, another industry seemed to have turned their backs heavily on NFTs: The gaming industry. Gaming OGs on Twitter have slashed the benefit of incorporating NFTs in games and publicly made fun of large gaming companies like Ubisoft for using NFTs in one of their games called “Ghost Recon Breakpoint.”

There was also a lot of resistance towards the high amounts of energy which NFTs minted on the Ethereum blockchain consumed. One user on Twitter called NFTs a “planet-burning scam” and he was not completely wrong about that. But after the big merge which happened mid-September 2022, the energy consumed by minting NFTs on Ethereum has been reduced by over 99%. Other popular blockchains like Polygon have always had low minting costs, coming in at a fraction of a cent per transaction.

Web3: from high-risk speculation to community building and co-creation

So what else happened last year, amidst the financial market turmoil? Was everything doomed to fail? While most companies, institutions and private investors threw up their hands when they saw or heard the word NFT or anything related to blockchain, many established brands have quietly and intensively engaged with the underlying technology and launched extremely successful NFT projects last year. Just look at Nike, Tiffany’s, Reddit, Starbucks, Bulgari, Adidas, Gucci or Prada, who raised millions of dollars selling NFTs by engaging with their communities. All these brands have tapped into the potential of Web3. People are attracted to the idea of belonging to the nascent digital communities being built by these brands. Is that really so surprising considering people define their identities with those same brands?

If you haven’t heard about the term Web3 yet, you will soon encounter it if you are interested in the digital world. Web3 is “the decentralized internet designed to flip control of data and apps from centralized entities towards communities and individuals.”

This year, more brands like Porsche, Louis Vuitton and Hugo Boss are following. How does that go together, you may ask?

At the beginning of the article we said that we still believe in NFTs and Tokens in general. You may think to yourselves, “Wait, really? After everything that happened last year?”

Reason #1

We believe that NFTs went through the same bubble as the internet back in the day. New technologies need to be tested on a broad scale so that eventually you can see where they can really be best used. The trajectory becomes clear in hindsight. Just take a look at the Blockchain and Web3 Hype Cycle created by Gartner Research, who predict that “a tipping point in adoption will soon be reached, as risks are managed proactively.”

Reason #2

We truly believe that we won’t be even mentioning the term “NFT” in the future anymore but instead will be using the underlying technology seamlessly like we now use the internet. Does anybody know how the “Transport Control Protocol” (TCP) and “Internet Protocol” (IP) EXACTLY work? Thought so.

Reason #3

In 2022, there was this seismic shift from NFTs being regarded as “investments” and thus a vehicle of speculation, to NFTs regarded as digital collectibles and a tool for brands to build strong, engaged consumer communities.

Reason #4

Successful NFT projects all built very strong communities before launching their NFT. Through important social media channels like Twitter, Discord or Instagram, they have been explaining the holders’ benefits and how they might participate in the brand by holding the NFT in their digital wallet. Educational communities like myBFF have programmed many perks into their NFTs, so that holders could get other products and services for free or for a large discount. Community members were encouraged to participate in events in order to network, learn and support each other. With a strong purpose and message, brands are embarking on a new journey to build superfans and a new generation of followers.

“New technologies are building on the shift in behavior, enabling a new wave of community-first, product-later models that boost customers’ connection with a brand.”
Source: Accenture Life Trends 2023

The brands that do best will be those who shape their offering around the benefits and utility for customers, and let the technology sit quietly in the background.

Reason #5

It is up to the brands, which benefits they will create for their customers and how much creative power they are willing to give them. But it is more than just the power of co-creating and shaping products and experiences. It is also about ownership and future revenues, as the latest example from Bacardi is showing.

Bacardi launched a program for underrepresented female musicians who created mixtapes in the form of an NFT and listed them on a marketplace called Sturdy Exchange, a platform made by creatives for creatives. It differentiates itself by putting the artist in the driving seat and letting them control the whole process, from the creation to the listing of their NFTs. The buyers of collectibles, on the other hand, will become “fanvestors” who will earn a percentage of the streaming fee whenever their song gets played.

NFTs are dead… or aren’t they?

We all agree that last year was a very difficult year for the crypto world. Probably this year will also continue a certain reluctance and uncertainty towards everything related to crypto, blockchain and web3. Despite all this, we could see how a few companies might fearlessly plunge into the world of web3 and reap the first fruits of their ventures.

We also see great potential in tokens, be they non-fungible or fungible tokens (such as a currency, where tokens are indistinguishable and divisible.) The possibilities are truly endless when programming a token. Customers might become part owners through tokens of their favorite company and have a say in which direction the company will go. Or they can get exclusive access to events, products, bonus programs when they own and use a token. The way companies can now communicate with their customers is much more personal and targeted than ever before. The concept of “community-first, product-later” also helps companies develop products and services that really have an organic demand.

We are still at the beginning of this new paradigm shift, and mass adoption may still take a few years. But if you start building the foundation and forming a clear strategic vision now, you will be able to tap the full potential of this amazing new market in the coming years.

We appreciate the time you took to read this article and would like to hear your thoughts about it in the comments section below!

For more insights about us and what we do, check out our Website, LinkedIn and Twitter page.

If you want to know more about our NFT practice and what it can do for your business, click here.

Educational part:

Glossary:

Bored Ape Yacht Club:
Bored Ape Yacht Club, often colloquially called Bored Apes, Bored Ape or BAYC, is a non-fungible token collection built on the Ethereum blockchain. The collection features profile pictures of cartoon apes that are procedurally generated by an algorithm. The parent company of Bored Ape Yacht Club is Yuga Labs.

Blockchain:
A blockchain is a distributed database that is shared among the nodes of a computer network. Blockchains store a continuously growing historical ledger of information (e.g. accounts and transactions) into blocks which are all cryptographically linked.

Credit Default Swaps:
A credit default swap (CDS) is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse them if the borrower defaults.CDSs played a key role in the credit crisis that eventually led to the Great Recession. Credit default swaps were issued by American International Group (AIG), Bear Sterns, and Lehman Brothers to investors to protect against losses if the mortgages that were securitized into mortgage-backed securities (MBS) defaulted.

CryptoKitties:
CryptoKitties is a blockchain game on Ethereum developed by Canadian studio Dapper Labs, a company spun-off from Axiom Zen, that allows players to purchase, collect, breed and sell virtual cats.

Decentralized:
Decentralization is the process by which the activities of an organization, particularly those regarding planning and decision making, are distributed or delegated away from a central, authoritative location or group.

Fungible Token:
A representation of an asset on a blockchain that is interchangeable. Cryptocurrencies are the prime example of fungible tokens because each coin has the same value as any other coin of the same type at any given moment.

Gas Fees:
A gas fee is the payment individuals make to complete a transaction on a blockchain. These fees are used to compensate blockchain miners for the computing power they have to use to verify blockchain transactions, and they are typically paid in the blockchain’s native cryptocurrency. The price fluctuates based on network congestion. As a result, the more people using the network, the higher the gas fee.

Minting:
Minting an NFT, or non-fungible token, is publishing a unique digital asset on a blockchain so that it can be bought, sold, and traded.

NFTs (Non fungible token):
NFTs (non-fungible tokens) are unique cryptographic tokens that exist on a blockchain and cannot be replicated. NFTs can represent real-world items like artwork and real estate. “Tokenizing” these real-world tangible assets makes buying, selling, and trading them more efficient while reducing the probability of fraud.

Opensea:
OpenSea is a non-fungible token (NFT) marketplace that offers users the ability to buy, sell, create, and trade NFTs. It is the largest NFT trading platform, with more than 2.4 million active users and a daily trading volume of $6.03 million, as of November 2022.

Ponzi Scheme:
A fraudulent scheme that involves paying existing investors in a nonexistent enterprise with the funds collected from new investors.

Proof-of Stake:
With proof-of-stake (POS), cryptocurrency owners validate block transactions based on the number of staked coins. Proof-of-stake (POS) was created as an alternative to Proof-of-work (POW), the original consensus mechanism used to validate a blockchain and add new blocks.

Pump & Dump:
Pump and dump (P&D) is a form of securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price.

The Merge:
The Merge was the joining of the original execution layer of Ethereum (the Mainnet that has existed since genesis) with its new proof-of-stake consensus layer, the Beacon Chain. It eliminated the need for energy-intensive mining and instead enabled the network to be secured using staked ETH.

Token:
Tokens, generally speaking, are non-mineable digital units of value that exist as registry entries in blockchains. Tokens come in many different forms — they can be used as currencies for specific ecosystems or encode unique data. Additionally, some tokens might be redeemable for off-chain assets (i.e., gold, property, stocks).

Web3:
Web 3.0, sometimes known as Web 3, is the concept of the next generation of the web, in which most users will be connected via a decentralized network and have access to their own data.

5 Reasons why we believe NFTs are not dead was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

This article looks at the major challenges facing asset managers and what they need to do to stay relevant.

Most asset managers will contend that the environment in which they are operating is changing rapidly, and that they need to adapt. It is true that technology is evolving and that they need to keep abreast of how it impacts the industry, however, having the latest technology will not be enough. To be successful, asset managers need to better manage their corporate cultures, have a rigorous focus on clients, and update their business models.

i.AM Innovation Lab June 2020

1. Introduction

The asset management industry has undergone very little change, if at all, over the past 40 years. And, it has not felt the need to change. It is a necessity of modern life, since most people lack the necessary expertise needed to manage their own wealth, and hence delegate these duties to established players. Economies of scale and high legal and regulatory obligations have also helped keep new entrants at bay. Protected by a relatively stable environment, asset managers have tended to focus primarily on optimizing their existing business models and developing products that met increasingly tightening regulatory requirements and slightly changing client needs. And while doing so, they earned a lot of money. And since the status quo is working quite fine, innovation was not deemed very important.

But different factors may cause a change in this attitude.

2. Factors Forcing Change in the Asset Management Industry

2.1 Macro-economic and industry trends

In an environment of global quantitative easing and increasingly correlated markets, alpha is becoming hard to generate. And, automated passive investing products offer simpler and lower cost alternatives to arduous research and product selection. The trend of switching from active to passive products will gain even greater momentum, leading to compressed margins and increasing cost pressures. This cost pressure is further exacerbated by the fact that asset managers are suddenly faced with a completely new type of client, with different needs and expectations.

2.2 Demographic shifts

In 2020, millennials will account for the largest adult segment in the U.S. And they are on the cusp of their best earning years. They will benefit from a monumental wealth transfer from their baby boomer parents, the largest wealth transfer in history. Estimates assume that up to U.S. $70 trillion will be passed between these two generations in the next decades. Millennials will not only become increasingly more relevant as investors, but also as agents for investment decisions. Millennials are relationship managers for clients of wealth managers, investment committee members of pension funds, or chief investment officers for family offices. In these positions, too, they will be strongly guided by the values of their generation:

• As investors, they are demanding greater transparency and reduced costs. Mounting financial scandals, perceptions of increased inequality, and spiralling complexity have led to eroding trust in traditional financial institutions. Return on investment is less important for them than sustainability and emotionality when investing becomes more important than pure facts.

• As users or clients, millennials are different because they are digital natives. This generation has never owned an investment product or had a financial planner, but they happily rely on their smartphone for all manner of services and prefer consulting an app or their social network to personal contact with an investment professional or financial institution. They grew up with technology baked into their lives. And they will never accept investment solutions and services that do not come with a large portion of digital services.

2.3 Technology

Technology is evolving as well. Advances in robotization are helping asset managers handle their existing processes more efficiently, and the increased use of cloud solutions promises a more cost-effective IT setup. Additionally, ever decreasing computation costs and ever larger data volumes mean that “big data” will become an important factor in the investment process. However, the truly disrupting technologies are blockchain and new technical possibilities to revolutionize customer interaction.

2.3.1 Blockchain and DLT
Blockchain and distributed ledger technology have the power to turn the antiquated methods and processes in the fund industry upside down. Although the industry moves vast sums of money every day, it still uses the methods of the last millennium for processing transactions. Thousands upon thousands of transactions are processed via fax every day and spreadsheets are used to painfully consolidate and reconcile the many disjoined ledgers.

Public blockchain networks have the power to legitimately solve many of the issues of the industry with thoroughly novel constructions. At the heart of finance is the question of how we trade and record its history. Many counterparties and processes, which were previously required to build a web of trust, become superfluous in the context of a blockchainpowered financial infrastructure.

Blockchain-based identity could make compliance and fund subscription vastly more efficient, with passported know your customer (KYC) procedures where investors prove their identity once, instead of multiple times for multiple institutions. Fund shares as tokens could advance entire new models and markets for distribution. Asset pricing and net asset value (NAV) calculations can be handled on-chain, transparently and in real-time. Risk management and portfolio guidelines may be implemented as code, bringing new levels of confidence and control to asset positions, while significantly reducing monitoring effort as a side effect. Near-instant trade settlement between counter parties that happens directly and with deterministic certainty. Even custody of assets can be managed not by independent third parties, but by smart contracts that simultaneously allow discretionary trade and cryptographic security.

The technology, therefore, has the potential to not only improve the existing model of the asset management industry by minimizing costs and risks, but it can also open up completely new opportunities for asset managers to manage and distribute products. Combined with new technologies for customer interaction, it can form the basis for a new fund ecosystem.

2.3.2 Customer Interaction
The technology for greatly simplified and improved customer interaction has also made great strides in recent years. In addition to the online touch points, the areas of (video) chat and email have also developed greatly. But asset managers have not fully embraced these media, relying instead on printed reports sent by mail. Moreover, new communication channels such as social media have been added, which make it easier for asset managers to contact their potential end-investors directly.

Innovation is mostly a product of technical progress that makes new ideas possible and the willingness to use new technology. The financial services sector has largely been able to ignore technological progress because core financial infrastructure has not been forced to adapt. It has been sustained by powerful incumbents, captured regulators, and complacent central banks. Even celebrated fintech companies with shiny apps and slick user experience (UX) designs still use the rusty rails of legacy financial infrastructure.

But with the new, potent emerging user groups — who combine complete openness towards new technologies with shrinking trust in established financial institutions — a major change for the financial industry is ahead of us.

So, the question is: what is the impact on the financial services industry?

Everyone remembers Bill Gates’ famous words that “Banking is necessary, banks are not”. But the prediction of the decline of the banks has not materialized as yet — despite a severe financial crisis. Why should anything change now?

The big change is the combination of new technologies, which facilitate a change in the ecosystem, and a user group that is much more open to change. Banks will still be around in 10 years, but clients will increasingly consume financial services from specialists, large tech companies, and fintech platforms.

As a result, however, the traditional sales channels of asset managers will become less important. But that is not necessarily a danger for asset managers. It can also be a great opportunity.

The existing distribution channel simply has some big problems, such as:

• It is not very transparent: the asset manager normally does not know which end-investor is invested in their products. And the customer lacks product transparency, for example, regarding the breakdown of the exact costs.

• It is extremely expensive: up to 70 percent of the total product costs are spent on distribution.

• It is highly inefficient: banks and insurance companies tend to sell products that help them achieve their business objectives. These products are not necessarily the best to satisfy the end-investor’s needs.

As the existing distribution channel becomes less important, direct sales (B2B or B2C) and sales via platforms such as Revolut, N26, Amazon, WeChat, or Netflix can offer completely new opportunities. Those platforms are very much clientfocused, strong in designing great user experience, and they know how to work with data. They are also not asking for 70 percent distribution premium.

3. How Can Technology Help to Address the Challenges of the New Reality?

A key point to remember is that these new platforms are often not banks. They do not have expertise in anti-money laundering (AML), they are poor in fulfilling regulatory obligations, and they have little experience in selling or reporting financial products. This is where the asset managers can help. Asset managers distributing through tech platforms will need to cover certain functions that are currently covered by the distribution partner in the traditional setup with banks. This will not only involve classic business functions; many tech platforms will also demand technical solutions from the product provider (e.g., sophisticated portfolio reporting).

In return, digital platforms can provide what they know best: they know their customers inside-out. KYC, a discipline often perceived by banks as an operational- and compliance- driven function, is the core function for digital platforms. And it is the first important step to unlock a great client experience. Asset managers need to win back client relationships. As mentioned before, asset managers currently do not know their customers well enough. If managers do not even know their customers’ names, how can they know their pains, wishes, or personal goals? And this is exactly what they can get from digital platforms in return for their investment expertise.

The bottom line is that the combination of excellence in investment expertise combined with great regulatory knowhow from asset managers and fast, client-focused delivery capabilities with great client experience from digital platforms can be very powerful.

Asset managers want to get closer to their clients, despite increased regulatory duty and costs. However, numerous counter-parties and intermediaries stand between them — an artefact of rules and regulations long past their “sell by” date. However, with the introduction of new distribution channels, the acquisition of additional customer information becomes easier.

But technology can do much more. It can help asset managers build great digital touchpoints, which can create a substantially differentiated customer value and experience, such as client portals, which allow direct interactions, options to conveniently buy products directly, sophisticated reporting, powerful investment insights, and interaction capabilities. For business-to-consumer (B2C), the technology enables solutions that can connect the asset manager directly with the end-investor. For example, asset managers can develop direct investment applications that allow investors to save and invest money seamlessly.

With an app alone, the work is, of course, not done. Marketing in the retail segment is known to be enormously complex and expensive. But good marketing is a necessity if you move closer to your client. If their trusted banking party is no longer their counterpart for investing, they need to know their asset manager, their skills and capabilities, and they need to trust them. Social media can play a major role in building that trust as a channel to spread the word. But, ultimately, the message itself is what matters. If an asset manager manages to build trust in their work and company through good brand marketing and good product marketing, they will also be able to attract direct clients.

However, as the ease with which asset managers can be compared increases with the elimination of the distribution partner, it will become even more important for asset managers to achieve even better performance results in the future. This is why big data and artificial intelligence (AI) might become more relevant in the investment process. Portfolio managers will be provided with much more powerful tools to make even better investment decisions.

In summary, technology can help asset managers build and strengthen their client relationships, create better investment products, and lower production costs and risks. But is it that simple?

4. What Else Matters Beyond Tech?

The new distribution models are a great opportunity for asset managers, as it allows them to get immediate and full access to the investor. They will even get access to new client segments. Imagine the huge potential of all non-banked segments they can target through apps or platforms. User groups who do not currently have bank accounts, but who use social media and other online platforms intensively have huge potential. Distributing their products directly or through platforms will substantially lower distribution costs, allowing a more aggressive pricing of the investment product.

But the new models will require asset managers to cover topics they have never covered before, which will have a major impact on the organization.

They will need new skills, such as marketing, sales, and distribution, which collaborate with tech platforms, rather than banks or call center agents, for direct client requests.

The culture and values of the organization also need changing. The new asset manager needs to become more agile (e.g., reporting in real-time, faster product lifecycles, faster technology cycles), leaner (end-to-end integration, cost focus), smarter (better able to analyze client data and understand client needs), and more client-centric (instead of product-centric).

The quality of the investment product is important and will stay important (e.g., transparency will help investors to better
compare performance), but this is not where asset managers win the race. This is where the race is lost. If their performance is poor, they will lose clients.

The difference can be made with client experience. That is where you win new clients. To offer the best client experience, they will need to fully understand the investor. They must understand the client’s needs, pains, feelings, and wishes. Only then, will they will be able to offer

• Great products

• With a great user experience

• And a great service

We still do not know whether or when the big disruption in the financial industry will finally happen. But even if nothing changes at all — an asset manager who puts client experience first, can make the difference.

Conclusion: Client Experience Is Key

Why was Uber successful? Not because they painted their taxis black instead of yellow. But because ordering an Uber is extremely convenient. You are still in the bar, you open your app, you order your Uber and you even get a quote before the ride starts plus a well-estimated arrival time. The client experience is simply better with Uber than it is with a normal taxi.

Why was Apple iTunes so successful? Not because they were cheaper. Definitely not because of the more beautiful CD covers. Because it was more convenient. You can sit at home and buy the one single you want. You do not have to buy a full CD. The client experience is simply better with iTunes than at a CD shop.

Even if the industry does not change dramatically, an asset manager can make a difference with better client experience. But for that they need to have a client relationship, they need to understand their client, their pains and fears, their needs and desires. If they understand their clients, their investors down to the last detail, they will be able to offer outstanding investment products their clients will love and service that will keep them coming back. Not only because of great performance, because they have outperformed the benchmark for 15 years, for example. They will love it because they get what they want. Client experience is key! Not technology.

The Future of Asset Management — a Technological Perspective was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

Since i.AM Innovation Lab’s inception, it has been our conviction that tokenization of assets will play an important part in our society and economy. Earlier this year, we decided to take this idea from vision to reality. If we want the industry to capture this potential, maybe we should take the first steps.

And so we did. We decided to “walk the tokenization talk” and convert the equity shares of i.AM Innovation Lab AG into tokens. This means that each share of our company is represented by a transferrable token on the Ethereum public blockchain that can be held or transferred by the tokenholder. The Ethereum blockchain and the smart contract defining our token is fundamentally the maintainer and shareholder registry for the Lab’s shares.

We did this exercise so that we could experience first-hand how the tokenization process works, from the current legal landscape to the choice of token standard to the technical implementation and final deployment of the live token.

Through share tokenization on the public Ethereum blockchain you can:

→ Enable easy, digital Peer-2-Peer transferability of your shares (End-2-End)

→ Empower 24/7 liquidity for your shareholders for unconstrained trading

→ Automate and secure a transparent share register

→ Develop and run a rule engine that governs corporate actions, voting, compliance

→ Enable programmability and interoperability of your securities by using existing infrastructure

→ Create a strong global community and gain access to new investors and funding

Let’s talk about what’s in it for you


What you see here is the culmination of careful thought and research into the clearest legal situation, and the most flexible, open technical solution for a Swiss company. Our solution complies technically with the most popular token wallets, dapps and blockchain infrastructure, while also complying with legal standards set forth by the CMTA, Switzerland’s leading association promoting the issuing, distributing and trading of securities in the form of tokens using distributed ledger technology.

No really, what is this?

Private individual shareholders of i.AM Innovation Lab AG have placed their tokenized shares on the decentralized exchange Uniswap. Here you can trade an array of popular ERC20 cyrpto tokens, like ETH, DAI, USDC, XCHF or even wrapped Bitcoin, for the shares in our company.

This means you can own shares in a Swiss company by swapping crypto tokens for the iAM token here or any other peer-to-peer platform where they may be available.

You will need a crypto wallet like metamask or other dapp wallet that can interact with our website or Uniswap directly.

Become an owner of the i.AM Innovation Lab here

How we tokenized our shares on the blockchain and what we learned in the process. was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

The Coronavirus Pandemic is causing us to rethink a lot of things. Physical cash is extremely beneficial for convenience, privacy and personal liberty. However, bank notes and coins are susceptible to transmitting pathogens among society as the physical money circulates. China has taken the step to quarantine physical cash for 14 days before allowing continued circulation, in hopes of rendering residual pathogens not viable.

At the same time, major central banks of the world are thinking about how a Central Bank Digital Currency (CBDC) could function. Many of the central banks are considering some kind of blockchain or distributed ledger design solution.

We’ve written before about “stablecoins” and their economic and technology-stack usefulness. Stablecoins endeavor to maintain a parity-peg with a target fiat currency, through various mechanisms. In doing so, they can be used economically to price and purchase items and can also be natively integrated into novel smart contract-based products and services. That is powerful, but their link to the underlying fiat is not guaranteed and relies on various things which could become compromised, such as third-party trust or oracle manipulation.

When we speak of “fiat” currency, we are really talking about sovereign nation issued currency. The translation of the Latin word “fiat” is “by authoritative decree”, or basically, “because I said so”. Sovereign nations have given themselves the ability to issue currency in this way, since all nations have removed gold-backed currency regimes.

So, would a CBDC be considered a stablecoin?

We don’t think so and here is our rationale: Stablecoins are issued by companies (e.g. USDC is issued by Circle Internet Financial, Inc.) or by groups (e.g. DAI is issued by MakerDAO), with the goal of maintaining price stability relative to the target currency. CBDCs will not be considered stablecoins because there is no peg relative to a benchmark, they are, in fact, the digital version of the national currency, accruing directly to a nation’s base money supply. In this sense, the idea of stablecoins seems an intermediate step in the progression towards blockchain technology legitimacy on the part of central banks.

Smart contracts, the technology upon which CBDCs would be based, enable incredible ideas to be natively embedded into the act of value transfer. However, they could also enable ideas that run counter to personal privacy and liberty to be directly implemented at the level of individual accounts, such as freezing, confiscation or even negative interest rates.

Today, many countries are acting with direct monetary stimulus to businesses and citizens to ease the impact of the current crisis. The US will mail checks to all households to be deposited in bank accounts. The resources and time spent in this effort alone will be considerable. CBDCs could achieve similar goals with far greater expediency, efficiency and directed impact. But: with great power comes great responsibility, and this is where the technology remains silent and our institutions must prove themselves on merit.

Asset Managers investigating tokenized assets must also be aware of the significance of currency tokens because assets are, after all, mostly traded against currencies. The payment leg of a trade is half of the equation in the “delivery versus payment” scheme. Funds will likely be hesitant to hold stablecoins issued by companies or groups and will strongly prefer CBDC tokens considered legal tender.

We believe the benefits of national CBDCs — direct, government-sanctioned fiat value — and their ability to use the rails of blockchain-enabled infrastructure will be immense. But there will be tradeoffs between these benefits and the privacy, liberty and individual sovereign custody that stablecoins can offer.

Differentiating Central Bank Digital Currencies and Stablecoins was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

i.AM Innovation Lab March 2020
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Stablecoins represent an evolutionary step in the digitalization of commerce. Software developers rely on modular abstractions to create solutions. Blockchain technology has produced a number of innovative building blocks known as open finance “primitives”. They are critical building components in the developing crypto-financial ecosystem and move the space forward, enabling new and exciting crypto systems to move in-step with the non-crypto economy.

These components form psychological and technical bridges from the physical, legacy financial system to crypto, digital systems. Market price stability is a fundamental core financial primitive that many other use cases will build upon, such as payments, lending, collateralization, hedging and insurance, to name a few.

What are Stablecoins?

A physical coin is a representation of physical scarcity and authenticity. It also embodies a type of security: if you have the coin, I don’t have it anymore. This is the primordial sacrifice of exchange. The coin is a token which enforces physical-world accounting rules.

Representing balances digitally presents a dilemma because we do not have the physical scarcity to enforce these accounting rules. Moving from atoms to bits has many advantages, but we lose the convenience and simplicity of physical scarcity as accounting enforcement.

A solution to the digital double-spend problem is one of the major benefits of blockchain technology. But cryptocurrency tokens or coins currently have developed a different market-oriented problem. Because they are poorly understood, regulation is shifting and inconsistent, adoption is nascent, markets are thinly traded, and large holders can potentially manipulate prices — they exhibit volatility which acts as a hinderance to use. A seller of goods or services cannot justify the costs of updating prices or of bearing the risks of not doing so.

So how can we create a medium of exchange that can take advantage of the digital infrastructure and significant practical benefits of blockchain technology, but without the market price volatility associated with non-sovereign cryptocurrencies?

Stablecoins seek to accomplish just that. They seek to closely target the tradable value of a specific sovereign currency, e.g. 1 USDC = 1 USD. That sounds easy enough on the surface, but the FED or SNB is not (yet) the issuer of these stablecoins and the market is a harsh mistress.

“The goal of stablecoins is to get the blockchain medium of exchange benefits without the cryptocurrency store of value drawbacks.”

Fiat Collateral Stablecoins

Sometimes troubled sovereign states seek stability in their currency relative to a dominant, larger currency through the use of a currency “peg”. The most common peg mechanism is where a country’s central bank establishes a fixed exchange rate by promising to freely exchange their currency for the peg target currency at the fixed rate. This means, however, that the central bank in question must have a sufficient supply of the peg target currency to satisfy exchange demand, at least until confidence is established: the success and longevity of any peg rises and falls with the confidence of this promise.

Predictable redeemability is a straightforward (if not primitive) mechanism to achieve market price stability in a stablecoin. An issuer of such a stable coin must provide some credible proof that the redeemable collateral exists to garner the confidence required to sustain a stable value.

Here is where issues arise. The real-world fiat collateral must be safely held. An independent custodian is the obvious choice but is accompanied by costs. Also, transparency is only vaguely offered periodically and auditors (further costs) attest the balances. Intra-period, one must simply hope that the funds exist. These stablecoins are centralized due not only to the fact that a centralized counterparty holds the collateral, but also in the fact that regulators require certain superpowers be embedded in the token contract code and granted to the issuer. This means the issuer will have some ability to seize/confiscate/freeze/reverse/censor funds or transactions should they choose or be compelled to. Here is an example of the centralized permissions in the USDC code:

Or here in TUSD:

Or here in USDT:

Commodity Collateral Stablecoins

Another caveat to the fiat-collateralized stablecoins is the current environment of negative interest rates. Swiss Crypto Tokens (Bitcoin Suisse), the issuer of XCHF, a Swiss Franc stablecoin creates a rolling, one-month bond and uses vault cash to avoid negative rates imposed by the Swiss National Bank.

Another category of stablecoin uses the physical commodity as the underlying collateral. The company Digix Global has created a similar setup for the stablecoin (DGX) representing one gram of gold. Again, physical gold is stored at a 1:1 ratio, backing the tokens minted (a common term for token creation which increments the token supply). They maintain a sophisticated process for minting, storing and documenting the gold in their vaults. The tokens are redeemable for physical gold (101 DGX minimum for a certified 100-gram ingot).

Crypto Collateral Stablecoins

A third category of stablecoin tries to create stable market price valuation by collateralizing cryptocurrency. But the underlying collateral is not the value being pegged. Because the underlying cryptocurrency value is different and volatile, the stablecoin’s collateral value must be overcollateralized to ensure reliable backing of value even when the collateral value experiences significant price swings.

The most prominent example is the Maker Foundation’s DAI, which is collateralized by a basket of underlying cryptocurrencies. It is as known as Multi-collateral DAI and targets price parity with USD.

DAI Mechanics

In contrast with fiat- or commodity-collateralized stablecoins, cryptocurrency collateralized stablecoins hold the collateral on the blockchain in smart contracts. This is a significant change and benefit over the latter. It means that anyone can inspect and verify the real-time state of the collateral account, enabling ad-hoc audit of the entire system. It also means that custodial counterparty risk and costs are obviated.

The Maker smart contract system creates stability by securing collateral, enabling different participants with tools and economic incentives.

As the market shifts the DAI demand curve due to external factors like expectations, confidence or adoption, the price will vary from 1.0 DAI/USD. The DAI smart contract system strives to move the equilibrium price back to 1.0 by adjusting the DAI supply through various mechanisms.

Normal users of DAI will usually buy these tokens on an exchange. But users can also create their own DAI, by locking ETH or other designated Ethereum-based tokens in a smart contract called a Vault. The current minimum collateralization ratio is 150%, meaning that ETH in the value of USD 150 locked in a Vault will create DAI 100 from which the user can draw. The user can transfer and spend these DAI tokens arbitrarily, but their ETH remains locked in the Vault as collateral. Only the return of 100 DAI can fully free the ETH in their Vault.

In this example where the collateralization ratio is at the minimum, any price decline in ETH will trigger liquidation of the Vault. When a Vault is liquidated, the Maker smart contract system autonomously initiates a Collateral Auction where Vault’s ETH is auctioned off for DAI to the point where the minimum collateralization ratio is again achieved. Vault owners can increase the safety of their Vaults by returning DAI to the Vault or conversely, adding more ETH. For example, generating only 50 DAI from the Vault above would leave it with a collateralization ratio of 300%. The market price of ETH could drop 50% before the Vault is in danger of liquidation.

Vault creators must pay a Stability Fee. This is currently 6% p.a. and is paid automatically when the Vault is extinguished. Should a liquidation be triggered by falling ETH price, a liquidation penalty of 13% is paid out of any ETH remaining post-liquidation.

Returning the same amount of DAI that was minted allows the Vault creator to release all ETH collateral. The DAI are burned (a common term for destroying tokens and provably removing them from supply) by the Maker smart contract system, reducing the total DAI supply.

Essentially, the DAI maintains USD price parity through an intricate system composed of collateral (Vault Positions), autonomous smart contract feedback mechanisms and economically incentivized external participants.

DAI Savings Rate

A further lever on DAI total supply recently introduced to the Maker smart contract system is the DAI Savings Rate or DSR. This is an interest rate which is earned when users send DAI to the DSR contract, locking the DAI and effectively removing it from circulation. The DSR is a mechanism which can also impact DAI total supply and circulation. Higher interest rates will incentivize DAI to be locked, but also DAI creation and increased collateral levels. Currently the DSR is 6%, which is the same rate as the Stability Fee.

Price Oracles

Blockchain systems have no native means to interface with the real world and cannot know about exogenous events or data on their own. As such, they must rely on “Oracles” to inject the external data that smart contracts might require.

To facilitate stability, the Maker smart contract system must have information on the current market prices of the different collateral types fed to it. Clearly, this is an extremely sensitive area for the system as it will autonomously react and trigger events and actors depending on the price data delivered by the Oracles. The Maker smart contract system mitigates Oracle risk by specifying multiple addresses that are whitelisted for each collateral type. The median price across all Oracles is selected (to prevent outlier skew) and the price is effective with a 1-hour delay to grant the Maker governance community a reaction window.

Decentralized

There are no restrictions on how DAI is used or integrated. DAI endeavors to be decentralized and has no pause, freeze or blacklist capabilities. An Emergency Shutdown Module does, however exist. The consequences of an Emergency Shutdown are a global system freeze and the ability to redeem collateral at respective market prices at the time of shutdown by DAI holders. The Emergency Shutdown is intended to mitigate malicious governance and prevent exploits of critical vulnerabilities.

The Maker system configuration is steered through the MKR token used in governance votes. These votes impact certain key configuration parameters in the Maker system such as collateral ceiling or the DSR. Governance votes are taken here and all MKR token holders can participate:

vote.makerdao.com

These changes affect the Maker system immediately. The votes and parameters can be transparently verified. These independent websites offer a view into the on-chain state of the Maker system:

makerburn.com

daistats.com

Conclusion

Stablecoins help participants in the digital economy transition to cryptographically secure money with all the benefits of blockchain technology, but without the uncertainty about the future value of their tokens. Systems and applications can freely integrate digital money without restrictions or volatility, benefitting from the transparent, open, real-time and verifiable nature of these decentralized digital currencies.

Price Stability: Building crypto-finance innovation with Stablecoins was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

i.AM Innovation Lab August 2019
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This essay contains our insights about millennials, the generation of mid-twenties to mid-thirties, who also became known as the Digital Natives. We engaged in in-depth discussions with millennials that described themselves as financially literate and such that saw themselves as financial illiterates. Moreover, all interviewed millennials held a university degree and expected themselves to have a high future income. This group is particularly interesting because although it will make up a rather small part of the population, their share of wealth will likely be relatively large by comparison.

In short, the most important findings of this essay are that a paradigm shift is taking place. A change from striving for more money to fulfil a purpose towards searching for a purpose within the usage of money. At the same time, it is secondary to the millennials how much their investment grows. They want more than just bringing their money to the bank and hoping that it will increase.

Another crucial finding is that the millennials we talked to don’t seem to have an actual financial goal. They either don’t want to deal with money in the future or picture themselves not having to deal with money. The financing of present and future consumption is what counts instead. Moreover, the usage of things is more important to them than to whom the things they’re using belong to.

This lays the foundation for capturing the current situation and sketching how products, business models, and distribution channels could change. This essay is both meant to provide an overview of this new customer group as well as to spark ideas for actions to optimally serve them.

How Millennials think

The generation born between 1983 and 1993 has many names. Digital Natives, Millennials or Generation Y are some. It is a generation that grew up in a world of fast and radical societal and technological change. This, among other things, entailed the formation of the European Union, the usage of a common new currency and being able to work visa-free within Europe. The same generation also witnessed the commercialization of the internet, the emergence of smartphones and the spread of massive digital social networks. All this change has left its mark.

While prior generations wanted to increase production and thereby welfare at any cost or maybe didn’t know the whole extent of these costs, the millennials have a different approach. Now that the true costs are known, it feels growingly difficult to look away. Many millennials are strong advocates of socially and ecologically sustainable products, which is reflected in how the offering in the food and clothing sector changed. And now it seems that the same change is underway in financial matters.

We had exciting conversations with representatives of this generation. In those interviews, we found that they are likely to fundamentally change not only the products, but as well the business models, and distribution channels of the financial industry.

The ‘No’-Goal Goal

The hedonism of the millennial exponents we talked to, showed itself in their consumption behaviour. Although many of them just entered the job market and their high ridge is not overflowing with money many reported to have travelled the world (and wanting to see more) and to live a lifestyle in which they can’t think of anything they want, but can’t currently afford. At the same time many were repaying some kind of debt or faced large initial expenses such as furniture for their own flat.

The needed money for these expenses that exceeded their income was often taken from a saving account their parents set up when they were still kids. This means that instead of limiting their consumption, millennials ‘borrowed’ money from themselves to be able to facilitate their lifestyle. This behavior is commonly known under the economic concept of ‘consumption smoothing’ that many millennials adhered to either knowingly or unknowingly. This concept states that there is an optimal quantity of consumption which translates into a maximized utility: too little or too much results in suboptimally low utility, hence, it should be optimal to strive for the same amount of consumption all the time.

Interestingly, the interviewed millennials reported that while they don’t expect their personal and future family consumption to grow significantly, they expect their household income to grow considerably. When asked whether they pursued any financial goal, the response of both financially literate and illiterate millennials was essentially the same: not having to deal with money. However, the motivation was different. While the literate group wanted to have enough not to think about it anymore, the illiterate counterpart showed such an aversion towards financial topics that they didn’t want to be bothered with it.

In the case where their income exceeds their consumption needs, most millennials except for some reported to put it on the savings account because they didn’t know what else to do with it. Investments were scarce. The financially literate among the interviewed either conservatively invested their money because of the prevailing exceptionally low interest rates, which can easily result in a negative return due to inflation. The illiterates, in turn, often felt like investing equates to gambling, which they didn’t approve. However, a common factor was that both felt that they weren’t presented with the ‘right thing to invest in’ yet.

I don’t save because I like it, but more because I don’t know what to do with it.

Laurent, 27

This finding stands in contrast with the current prominence of goal-based investing in the industry. For this discrepancy we see three possible explanations. Firstly, it could be that we happened to only talk to a nonrepresentative subgroup of millennials. Secondly, goal-based investments could be something particularly appealing to older generations, but not to millennials or thirdly, it could be that the notion of goals is broader for millennials and to some extent latent. Regardless, we will engage in further research to clarify this.

Meaningful > Optimized Investments

Both millennial groups stated that they will likely turn to increased investment activity with growing income even if they didn’t enjoy dealing with money. However, we noted a fundamental and clear paradigm shift in both groups.

Instead of striving for increased wealth and looking later how this could fulfill a purpose, both groups exhibited a strong desire to first search for a purpose that they can serve their money with. Whether and by how much that money grew through the investment was secondary, especially for the financially illiterate group. This is in line with the prior finding of not having a specific financial goal other than being able to comfortably secure their only slightly increasing consumption.

It would be contradictory for me to pay attention to sustainability when it comes to food, but not when it comes to money.

Dario, 29

Many of the interviewed millennials reported that it is crucial for them to know where their money is flowing exactly. Equally important was to be transparently informed about which services they pay for, how much and why. Moreover, both the financially literate and illiterate millennials reported that they felt a strong informational asymmetry between them and the ‘financial world’. They also stated that the most important quality to bridge that asymmetry was trust.

The place where trust is most present for both millennial groups is in the family. Unsurprisingly, this is also the place where millennials currently are receiving — and in the future reported so seek — their financial advice from. This trust is built upon the best interest of the parent for their child. Associating a particular experience further strengthens this trust. Whether the parent, which was often explicitly mentioned as the father, was literate in financial matters or not was at best secondary.

Ease of use vs. Morality

At the same time, scepticism is what both millennials groups have when it comes to banks and their employees. Moreover, the financially illiterate group said that they didn’t really understand what a bank does and that they often didn’t feel fully informed by banks. By how much this picture is shaped through news or the recent financial crisis remained unclear.

These feelings and views are clearly reflected in the attitude of millennials towards banks. Every interviewed millennial reported that it is more a ‘having to use’ rather than ‘wanting to use’ a bank and the majority of both groups stated that their last bank visit was either some years ago or so long ago that they couldn’t even remember. Most of the millennials are still with the bank where they had their first account. However, this connection is very fragile and according to both millennial groups, only existent because of the high switching costs and the lack of alternatives. All of the interviewed claimed that the banks in the market didn’t offer anything distinguishable.

However, when asked whether they would feel comfortable entrusting their money one of the GAFAA (Google, Apple, Facebook, Amazon and Alibaba) tech giants, many of the financially literate and illiterate millennials alike faced a conflict that is indicative for this generation. They distrust the GAFAAs because of their ‘business model with personal data’ and their ‘recent privacy issues’ that were covered in the media.

However, contrary to the banks, the tech giants offer a certain convenience that creates a moral conflict for the millennials. Both the financially literate and the illiterate group voiced the concern that although they are sceptical and would rather not use the GAFAAs for financial matters, they fear that the offered services will become so convenient, easy, and widely adopted that they can’t evade using them. This is in line with a lot of moral conflicts millennials face, such as with traveling, textiles, and food.

“I would NOT use GAFAA-services if I can prevent it. They already have far too much power and information. However, perhaps at some point, aspects of daily life will outweigh the urge not to sell yourself.”

Dario, 29

In our opinion, these findings form a fertile ground for new players with new products and business models to serve these pain points and moral conflicts. Looking at recent developments in the financial industry, one can see neo banks such as N26 or Revolut already heavily challenging the incumbents in some fields.

Regardless of whether challengers or incumbents will address those needs, we are certain that this new generation will profoundly impact not only the future of offered products and services, but also how they are distributed and how providers of these services earn money.

Off to new shores

Based on what we found through our discussions with the interviewed millennials, we set up the following hypotheses, which we’re keen to further explore in our research:

Products:
Information — Customization — Transparency

Hypothesis №1

Future financial products will be characterized by extensive and very granular background information that is smartly aggregated. All products and fees must be presented and explained transparently, and each customer will receive a tailored product.

Talking to millennials showed that they attach more value to profound and extensive information provision than to the nature of the investment product (i.e., whether it’s equity, fixed income, etc.). It seems very important for them to precisely know in what projects, regions, and topics they would — and in the future could — be investing in and that this is in line with their moral compass. The information provision is expected to be very granular when requested, but at the same time aggregated to an easily understandable level.

So far, only customers at the higher end of wealth received genuinely customized service. We expect this to change as future generations will demand the same customized experience they are currently already receiving from the entertainment industry (e.g. Spotify or Netflix). We expect the investment universe to grow considerably due to the tokenization of assets, which makes it possible in currently non-bankable assets. Moreover, we expect the investment universe to become very granular in nature. However, we expect each individual to receive a dynamically adjusted personalized portfolio that goes well beyond risk/return personalization down to incorporate preferences at a very granular level.

Moreover, all products and services should be offered with an easily understandable and transparent fee. Millennials want to know precisely which part of the product and/or service they are paying how much for and why.

Business Models:
Advisory — Joint Goals — Performance

Hypothesis №2

‘The business model will change from a fixed-fee transaction model towards a flexible-fee advisory model with joint goal setting.‘

Currently, an investor mostly pays for an active or a passive managed portfolio, which essentially translates to a fixed, charged fee for transactions conducted in his or her name. This fee structure is something many interviewed millennials expressed discontent over. We expect these ‘transaction fees’ to drop considerably and transactions to be simplified and/or automated in a way that individuals can easily execute their trades.

At the same time, we expect the investment universe to grow to an extent where it becomes challenging to keep track of everything. In this setup, we expect tailored, meaningful advisory to become very valuable while leaving the execution option to the client. Talking to the millennials showed that they didn’t want to pay management fees, which they translated to ‘doing nothing’. However, millennials at the same time exhibited a high willingness to pay for tailored services where they saw the direct value (e.g., personalized financial planning).

If millennials decide to embark on a journey with a bank, it will be essential to form a trustful relationship, which in our opinion could be characterized by personalized advisory and a joint goal setting at a very low fixed fee and higher flexible fees. This means that the client and the bank could sign an agreement in which they would record joint goals and decide on actions with both outcomes in which these goals are achieved, but also on outcomes in which the jointly set goals could not be achieved. This way, we think that one can foster loyal, successful, and long-lasting client relationships.

This could translate to a flexible pay-for-performance fee in which the bank would earn a share in the case of achieved goals and would provide some form of a discount when goals are not achieved. Of course, the basis for such a model is that the joint goals are realistically set and that both parties are equally informed about all opportunities. Some banks already offer models where a performance fee is charged. However, they reserve this right only for positive outcomes.

Distribution Channels:
Omnichannel — Online — Flexible

Hypothesis №3

Products and services will be distributed almost exclusively online to the customer. This includes external apps and whenever the customer pleases.

Our talks have shown that millennials want to be able to invest through multiple and simple channels. However, they want to decide when and where. This is because not only have lifestyles grown to be very distinct, but also time and the decision on how to spend it, has become among the most valuable things. Moreover, we believe that everything that can be done online will be done online. Millennials want to be able to individually execute simple operations such as transactions or investments easily through an app: anywhere, anytime.

We think that a system similar to omnichannel online shopping could be established where an investor could theoretically decide at 2 am to invest in a cool project that he/she just read an article on or watched a documentary on — directly at the end of the article or the documentary, respectively.

However, for more complex matters such as the planning of their finances, millennials want to be able to request assistance or advice when needed. In doing so, they want to have multiple options. Either they are approached in a personalized way online, or they are given the opportunity to walk in and talk to specialized advisors or to be able to schedule an appointment for when it suits them — somewhat similar to an Apple store.

The ‘NO’ Financial Goal Generation was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.

Our job as an innovation lab is to be on the bleeding edge, where technology meets society. Many times, new technologies feel like hype, leaving us scratching our heads. “What’s that good for?” or “Who could possibly need that?” are often heard among the smiles and laughter. It’s true, we often don’t need new technologies for our current, everyday life. But that’s exactly the point, because new technologies that prove beneficial to humans change our everyday life that makes the new technology indispensable going forward!

Well, i.AM Innovation Lab just set up a device in our downtown Zürich office that bundles two hypes in one device. The first is “Internet of Things (IoT)” technology: the idea of millions of tiny devices and sensors that connect to the internet to enable capabilities or report data. The second is “blockchain” technology: the idea that a network can form consensus around the state of certain data. About now you’re probably rolling your eyes, thinking which VC firm dreamed up this scheme. We wanted to dig deeper on this, so we decided to try it our ourselves.

The device is a Helium Hotspot, about the size of a small book. These are actually nodes forming the Helium blockchain network. The set-up was very easy — plug it in, screw in the antenna and connect it to our own local wi-fi network with the help of an app. The device even gave itself a name, “Little Mint Alligator”. Now we waited for a few hours while Little Mint Alligator downloaded the entire Helium blockchain. Our hotspot didn’t even tell us it was finished when it got to work mining.

Mining on the Helium blockchain is different from other Proof of Work blockchains. Helium uses a consensus mechanism called Proof of Coverage. The hotspot can detect signals and receive data packets from over 10 Km using LoRaWAN, a low-power radio frequency. Nodes in close geographic proximity issue challenges to each other or witness challenges. Through challenges, witnessing and forwarding IoT data, nodes earn the native token, HNT. This is a crucial part for all public, open blockchains — people are incentivized to obtain a node, set it up and operate it because of this reward.

Now any IoT-enabled device in the Zürich area can transmit data to our node which will then forward on to a destination on the internet, like temperature sensor data or the location of my lost dog.

You can track Little Mint Alligator’s mining and data-forwarding progress here and enjoy this experiment by following along with us! Even better

See all 9,271 Helium Hotspots here:

network.helium.com

Two Hypes, One Device? was originally published in i.AM Lab on Medium, where people are continuing the conversation by highlighting and responding to this story.