The Banking Sector Evolution Geared Towards Blockchain-Based Financial Services
As Goldman Sachs says Bitcoin is officially a new asset class, a growing number of companies are accepting Bitcoin and other digital assets as means of payment. Against this backdrop, the banking sector is adapting to the emerging paradigm with new financial institutions approaching blockchain technology to enable blockchain-based transactions. The following post focuses on payment services and provides an overview of the industry evolution.
This article relies on the analysis and the results achieved in “New Banks in the 4th Industrial Revolution: A Review and Typology” (Buchi et al., 2019) presented within the 22nd Excellence in Services International Conference.
The high volatility of digital assets (a.k.a. cryptocurrencies) has been often publicized as the main reason to be wary of such instruments. Despite criticism of digital assets regarding their riskiness and lack of real underlying value, an increasing number of companies have started accepting Bitcoin and other digital assets as an official payment option.
Even though Tesla, after Elon Musk’s announcement, has attracted most of the attention (despite the recent retraction for environmental concerns), many other companies, belonging to different industries, now accept digital assets as valid forms of payment. Fast food (e.g., Burger King Venezuela), Big tech (e.g., PayPal), and Drink (e.g., Coca-Cola Amatil) companies are three instances of industries now involved in this business [1]. Other prominent examples, helpful in getting an idea of the scope of this phenomenon, are Microsoft (software sector), Expedia (travel sector), and Lush (shopping sector).
This phenomenon can be traced back to a dynamic of network effects that may not be related to the payment service as such. As a matter of fact, because of the tendency of these tools to fluctuate, it is difficult to think of cryptocurrencies as widespread means of payment, which is why it is better to define them as digital assets [2]. Figure 1 below traces out the trend of these network effects by showing the evolution in the usage of ATMs to purchase digital assets from 2016 to 2021 worldwide.
In such a context, we should ask ourselves why more and more companies are approaching digital assets as a valid payment option. Is it reasonable to believe that there are other rationales behind this choice, besides simply expanding payment options? A plausible explanation could be that of an advertising release to attract the attention of new potential customers, as well as the possibility that it is a marketing move to show themselves on the market as innovation-oriented companies.
However, despite these considerations, the growing trend for companies to accept digital assets as a viable payment option requires the operational support of financial institutions (private banks or other entities that have access to banking licenses) capable of developing/activating tools to enable such transactions in a regulated environment. As a consequence, this adoption phenomenon puts pressure not only on other companies belonging to a wide variety of industries to enter follow suit but also on financial intermediaries to provide enabling tools for transactions involving digital assets.
At the same time, the Decentralized Finance (DeFi) ecosystem represents a growing environment composed of dApps that goes well beyond the simple payment services, including lending services, exchange and trading, direct asset management, and stablecoin issuance. In this framework, we can expect that digital assets will soon be replaced or complemented by so-called stablecoins to perform B2C transactions, guaranteeing price stability over time due to their peg to fiat currency or other (stable) digital assets, e.g., USDC and USDT [3].
Nevertheless, it is logical to think that the growing network effects generated by activities that accept such digital instruments as means of payment are in turn caused by the ever-increasing global interest in the world of digital assets. As evidence of this, looking at the market capitalization of the principal blockchain-based digital assets (i.e., those with at least 1 billion USD of market capitalization), the ecosystem has achieved an amount of about 2000 billion US dollars, with respect to the 300 billion of April 2020 [4].
In such a context, how will the FinTech environment and the DeFi ecosystem evolve in order to enhance the efficiency of their interaction, as requested by the market?
In this post, we focus on the connection between the banking sector and the payment services blockchain-enabled. Starting from a typology of the FinTech context able to identify the main categories of players and, with the help of some use cases, it is possible to trace a potential path of the evolution of the traditional financial sector and FinTech in reaction to recent developments in the blockchain landscape.
Digital Native Banks
Considering the Fintech and Banking state of the art, technological evolution and growing predisposition of users to approach banking services through the digital channels have led to the birth of a new generation of digital-native banking entities.
According to a recent study conducted by LINKS Foundation in collaboration with the University of Turin [5], Digital Native Banks (see Figure 2 below). are recently established organizations offering banking services mainly through digital channels. Such ventures leverage lean technological architectures specifically designed to exploit the latest innovations on data management, in order to offer a superior user experience.
Among these organizations, it is possible to notice a growing availability of services that aim at the management and transfer of cryptocurrencies, primarily for customer’s investment purposes as well as means of payment.
Within the Digital Native Banks (DNB) landscape, by looking at the group core business, it is possible to identify two clusters: entities belonging to corporate groups mainly focused on the banking industry (Banking First) and entities belonging to corporate groups mainly focused on other industrial sectors, such as technological or retail sectors (Non-Banking First)(see the first feature of DNB in Figure 2 above).
Banking First
Considering the Banking First entities that approach the crypto world, Neobanks represent the most experimental and innovative organizations, being new financial actors that provide early banking services — like payments — without owning a full banking license. Although this category includes a multitude of organizations mainly of small and medium size, among these we can also mention very developed and established ones. An example is Coinbase, one of the most known realities, born simply for the management and exchange of cryptocurrencies.
Today, Coinbase is a listed giant with almost 100 billion dollars in capitalization, even if still not equipped with a full banking license (in the US it owns the license as Money Transmitter, similarly in Europe it is authorized as Electronic-money institution for the Execution of payment transactions and credit transfers). In this regard, Figure 3 shows the European legal framework for financial services, differentiating among Banking, E-Money and E-Payment licences.
- The Banking License is the legal requirement that authorizes the institute to carry out all types of banking activities, such as taking deposits from the general public but implies strict compliance and capital constraints.
- The E-Money License allows all Payment Institution services. In addition, E-Money Institutions (EMI) can issue electronic money and are allowed to provide IBAN accounts, payment cards and e-wallets.
- The E-Payment License (Payment Institutions) allows offering payment services, including credit transfers and direct debits, issuing or acquiring payment instruments, and similar.
Another example is the Neobank Wirex, a British fintech company that aims at connecting the world of crypto with traditional currencies through a platform based on a prepaid card. By making cryptocurrency management accessible to everyone, since 2014 Wirex has established itself on the Fintech landscape: today it has an international presence of 2 million active users and a transactions volume of over 2 billion US dollars.
In recent years, the company has created the first prepaid credit card based on cryptocurrencies, the first rewards program with Bitcoin, as well as a real cryptocurrency in collaboration with Stellar. The Wirex’s solution provides a multi-currency account that gives access to 9 cryptocurrencies along with traditional fiat currency like Euro, Pound, Us Dollar and others. The service allows customers to store, exchange and spend crypto along with traditional currency to the e-wallet.
Although the first Neobank realities in the cryptocurrency field were born mainly to offer services to individuals, today there is a great variety of operators able to meet the needs of businesses, thus facilitating their adoption as a tool of payment.
This is the case of the Neobank Bankera, Lithuanian fintech born in 2017 that offers a range of crypto-friendly financial services integrated with the traditional financial ecosystem. Bankera’s vision is to become “the bank of the blockchain era”, focused on fulfilling the needs of digital and innovative businesses, including e-commerce stores and tech companies. Through the collaboration with Spectrocoin, Bankera’s customers are able to obtain a loan by using a cryptocurrency as collateral, thus supporting the diffusion of cryptocurrency as a payment system for companies.
Remaining within the Banking First entities, the hype about cryptocurrencies has recently captured the interest of several Challengers banks, Digital native fully-licensed banks that, in addition to basic banking services like payments and cards, aim at offering a full range of financial services (mortgage, saving, trading) and operates with a challenging approach to existing incumbents.
Since 2015, the Challenger bank Fidor Bank (later acquired by the Groupe BPCE banking group) has provided a European bank account and foresaw the possibility to buy Bitcoin directly using its online banking platform. In 2017, Revolut, a Neobank that has recently obtained a full banking license becoming Challenger Bank, cleared the introduction of cryptocurrency transfer in its range of financial services. In 2021 Revolut further strengthened its crypto offering by adding eleven coins to its custodian and management services, including the most traded Cardano, Uniswap, and Filecoin.
Revolut has partnered with major and trusted players on the market such as GDAX, Coinbase, and Bitstamp to provide brokerage with high liquidity, market-low rates, and lightning-fast execution. Revolut’s interface also includes appealing features, such as the possibility to round up daily payments and convert them to a cryptocurrency.
The last group of Banking First entities, Beta Banks, refers to digital spin-offs of incumbent banks, that thus have a consolidated knowledge in the field and represent incumbents’ defensive reaction to protect their share of the digital banking market. Usually, these entities rely on the license of the group to which they belong to.
In March 2020, Hype, the Beta banks of Italian Banca Sella group, made headlines in the country presenting Hype Bitcoin, a bitcoin trading service. Hype was created in collaboration with the Italian fintech startup Conio and represents one of the first crypto trading services offered by a Beta Banks through a wallet fully integrated into the customer’s account, which gives full custody and ownership of the currency, offering the final user a higher level of control (and responsibility) on the digital assets.
Non-Banking First
Moving on to the Non-Banking First entities, the only concrete examples of Bigtechs’ Bank (DNBs made up by technology giants) are from China, where Bigtech giants Alibaba (through AliPay) and Tencent have respectively founded the DNBs MYbank and WeBank. Although in western countries several Bigtechs are winking the financial market, there still does not exist an example of Bigtechs’ Bank: the closest example is represented by Paypal.
PayPal was born in 1999 as a Fintech startup and reached the status of Bigtech since its market capitalization is huge (about 286 Billions $), bases its business model on technology and is without doubts the market leader (PayPal is the largest online payment system, being present on 54% of websites). Currently, it appears as one of the most involved Bigtech in the financial industry, also considering that it holds a full banking license in Europe since 2007.
At the end of 2020 PayPal has introduced a new functionality allowing customers to exchange and manage cryptocurrencies, favoring the possibility of using them as a means of payment (or/and as an investment), thus representing the first major opening by a strong financial player towards the crypto world. In fact, until this point, we mainly talked about startups, even if unicorns: PayPal represents a very different player, with 21.45 billion dollars of Revenues in 2020, 377 million global customers and 26 million served merchants all over the world.
PayPal’s innovative driving force is something that the financial market watches carefully as a precursor of future trends. PayPal is feared as the real Bigtech player that banking incumbents need to worry about, also given its growing presence in the loan market for small business that in 2020 reached $10 billion in cumulative volume. Through its subsidiary Venmo, the mobile payment app, it allows its users to buy, hold and sell bitcoins and other digital tokens, as well as invest in them in a democratic way with a minimum spending requirement of only $ 1.
Overtime path and next steps
According to the authors, although the examples cited are not exhaustive, they highlight a convergence trend towards the world of digital assets that affects most of the digital operators in the banking and financial sector. Figure 4 shows the overtime trend of FinTech actors in entering the blockchain environment emphasizing how Neobanks have been the first ones, followed by Challengers banks, Beta banks and, finally, Bigtech banks.
What has been analyzed so far highlights a growing trend that sees an increasing number of financial institutions (more or less equipped with their own banking licenses) approaching the world of digital assets and, more generally, blockchain technology. Although digital assets such as BTC and ETH do not represent the most suitable instruments to be used as payment options, the global interest in these new realities has opened up new market segments for the FinTech ecosystem.
Neobanks and Challengers banks, i.e., the most innovative players in this field, represent the categories of players that have most experimented with new solutions for blockchain-based services, both in terms of the number of companies and of the “complexity” of the payment services themselves.
The two worlds of DeFi and FinTech seem destined to intersect. This strand of research will continue with new posts focusing on different aspects of this phenomenon. We will focus on the converging trend of these two ecosystems from the perspective of the market’s main financial services and the role incumbents play in this fast-moving context.
[1] Insider (2021), “More companies, including PayPal and Starbucks, are accepting bitcoin and other cryptocurrencies as payment, despite volatility warnings”, Retrievable at link.
[2] Moncada R., Ferro E., Favenza A. and Freni P. (2020), “Next Generation Blockchain-Based Financial Services”, In: Future Perspectives of Decentralized Applications (FPDAPP) 2020.
[3] Moncada R., Ferro E., Freni P. (2020), “Decentralized finance ecosystem: a cross-chain study”, Overtheblock Innovation Observatory, Retrievable at link.
[4] https://coinmarketcap.com/ — accessed 13/04/2021.
[5] Buchi G., Cugno M., Fasolo L., Zerbetto A., Castagnoli R. (2019), “New Banks in the 4th Industrial Revolution: A Review and Typology”, 22nd Excellence in Services International Conference.
Please cite as:
Zerbetto A., Cigna G., Moncada R., Ferro E. (2021), “The Banking Sector Evolution Geared Towards Blockchain-Based Financial Services”, Overtheblock Innovation Observatory, link
OverTheBlock is a LINKS Foundation’s initiative carried out by a team of innovation researchers under the directorship of Enrico Ferro. The aim is to promote a wider awareness of the opportunities offered by the advent of exponential technologies in reshaping the way business is conducted, and society is governed.
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