This is Part 2 of 10 of our series on [Banks] of the Future. Part 1 provides the overall context for this series and explores the technologies and consumer needs that are driving the natural evolution of money towards a system that is frictionless and universally accessible. Open systems are an integral part of this evolution.
Money is the world’s oldest and most popular value transfer system, and no analysis of a system is complete without considering the concept of open and closed systems. As is the case with many other technologies, we believe that truly open financial systems are likely to be one of the key pillars of the [Banks] of the Future.
So, what are ‘open’ systems?
In short, open systems are systems and standards anyone can use without permission, often decentralised (i.e. not controlled by a single entity), and which typically result in common standards that lead to interoperability. The most popular example of this is the internet: it is open and free to use for anyone (often referred to as ‘open loop’), whereas closed systems (‘closed loop’) like company intranets can only be used by company employees or approved customers.
When the internet as we know today started it was just one of many options to access information ‘online’; most of the other options were types of intranets owned by corporates where they effectively acted as gatekeepers and charged a toll for people to use it. Most people believed that these closed loop systems were superior because they were centrally planned and co-ordinated with resources and incentives to both build and maintain them. Why would anyone build and maintain an open system for no salary? And if no-one could control the system, what kind of bad things would come about?
Well as it turns out, the open internet we know today was pretty popular. At the risk of upsetting internet historians, we’ll over-simplify by saying it was to a large extent because this system allowed for permissionless innovation: anyone could use it, and that incentivised many people to do just that — for fun but also for profit.
And of course the fact that anyone could contribute to this innovation meant it could move much faster than closed systems that required all kinds of internal company checks and balances. And the more people used it, the more powerful and valuable the entire system became, leading to more people wanting to use it — a concept commonly known as ‘network effects’ — which means that it quickly overtook the closed loop systems. While these open systems didn’t eliminate all the closed systems, they certainly displaced them for a vast amount of use cases.
Why is an open financial system likely to succeed?
The popular narrative is that open systems are generally better than closed ones, however, it should also be acknowledged that this is not always the case. Research suggests that like with many things in life the relative value of these types of systems will depend on a number of specific factors. A good example of this are loyalty schemes that act as a form of currency but might not function optimally if it was completely open.
So while we shouldn’t assume that open systems are always better, we would argue that in the specific case of money, and in particularly in context of money used in electronic format on the internet, open systems are fundamentally superior. Why?
Firstly, because the internet has helped shift the power to the consumer and they, as individuals and collectively as society, demand it. They want everything, not just money, to be faster, cheaper and more transparent, and where the technology exists to make this happen it will naturally follow the path of least resistance to this outcome. Open financial systems represent this path of least resistance.
When one looks back in time to how trade and barter systems originated, the concept of value transfer was always fundamentally between two parties with no intermediaries or restrictions. These facilitators can of course play a useful role in facilitating usability, trust and scalability, but at its core both the means of exchange and parties to the transaction was without restriction, so the concept of an ‘open financial system’ is certainly not new. And somewhat ironically, technology is now allowing these systems to go back to the way it was a very long time ago.
Another driver is that the trust in financial systems and currencies that are controlled by companies or governments are at and all-time low, with very little signs that this will change soon. Not only is trust low, but value is being eroded on a grand scale — ask any of our customers in emerging markets about what has happened to the value of their hard-earned cash over the past few years. The reasons for all of these things is diverse and complex, but the impact is that we’re moving into a world where people are seeking change, and where they can’t get this change or the change doesn’t happen fast enough, they will seek alternatives.
Lastly, at a more philosophical level, there is also absolutely no reason why the basic value transfer between two parties should be governed by an intermediary as part of a ‘closed loop’ system; in fact one could even go as far as arguing that access to free and zero-cost financial services should be a basic human right. Did someone say bank the unbanked? In our view using an open financial system is the only way to do this at scale.
Now of course in the context of money things can get a bit more complicated: we can refer to the instruments themselves being ‘open’ or not (i.e. government-issued fiat vs. other instruments like gold) or the ‘openness’ of service providers (e.g. pretty much anyone can use cash, but there are restrictions on who can use bank accounts). Given we’re not able to invite all of our readers over to ‘discuss this over a glass of wine’, let’s just summarise by saying we would argue that this natural evolution of money to an open system will likely be applicable to both. And this is not wishful thinking, we can already see it happening in front of our very eyes:
The migration has started.
In terms of the instruments themselves, we are already seeing consolidation and standardisation of financial instruments and other means of exchange like gaming credits across the board. And the service providers are also following this trend: this includes initiatives like the UK government and the EU trying to get banks to open standardised API’s, similar initiatives in India and Singapore, and of course also an increasing trends of companies ‘partnering’ to make their systems more interoperable, for example the recent partnership between Moneygram and Safaricom.
But as was the case with the ‘intranets’ of past, these efforts require a lot of co-ordination, negotiation and compromise, never mind endless amounts of red tape. Progress is and will continue to be painfully slow, and in line with our arguments around the broader fintech industry in general, in the bigger scheme of things the impact of all these initiatives will likely be marginal.
In the meantime the world now has access to open financial systems like Bitcoin and Ethereum, and despite what many people might believe, these are growing fast across pretty much all metrics (more data and details on this in another part of this series).
Underlying consumer needs and wants, open technologies that enable permission innovation and create network effects, the subsequent speed at which things change — we’ve seen this story before.
Looking at these trends we can also see a clear shift towards the popular narrative that the banks of the future will be ‘platforms’. While this is very likely, this thinking misses the more important fundamental shift: that money itself will likely be the primary open platform upon which these banks of the future will be built. Open platforms built upon open platforms is the future of finance.
Open systems, interoperability; yeah we get it, so what?
Sometimes when we discuss open systems and interoperability we see a lot of nods in the room, but the reality of it doesn’t always seem to really hit home. Here’s a very small but ‘real life’ example of why this really is a big deal.
The BitX Smart Wallet is one of the world’s most popular Bitcoin wallets. It allows you to do many things including buying or selling Bitcoin, sending it to friends or family anywhere in the word via email or text, and so on. But very importantly, it also allows you to buy things online at almost 150 000 merchants (excluding payment platforms, which makes the actual number much higher).
The inability to build large merchant acceptance networks is one of the main reasons why many wallets or similar financial products fail — it takes a lot of work to build this distribution and is often prohibitively expensive. But what was the time taken and merchant acquisition cost of getting access to all those merchants for BitX? Virtually zero, in both cases.
We don’t know them, made no agreements with them or another intermediate service provider, but we can completely trust each other. Not only that, but this global merchant base is growing fast everyday, with no additional effort for us. That’s pretty powerful when we live in a world where speed and scale matters.
But wait, there’s more! This is something we always considered obvious, but have realised that for many people outside the industry it’s not always the case. Any other company with a Bitcoin wallet can also pay at all those merchants — and people can also move ‘money’ in between all these various wallets without needing any agreements or co-ordination — it’s all truly and totally interoperable.
On top of all of this, most of the companies building these new services on top of an open money protocol are also inclined to open up their platforms with API’s that gives access to various Bitcoin-related products services. This means other companies can and already do build and integrate on top of all of us — a payroll company on Uphold, remittance providers and many others on BitX, and according to Coinbase, thousands of applications on their platform.
These second derivative open platforms are causing an additional explosion of innovation, and the best part: all of these new applications and businesses are potentially interoperable with all our products and services, those same merchants, and all the other companies in the industry. These feed each other in a virtuous cycle that creates enormous network effects that fuels adoption and growth.
What is effectively happening here is that there is a completely new and parallel financial system being built at rapid speed, connecting millions of people and thousands of companies around the world. This is the real power of a truly open financial system; and this one is on steroids.
If one takes a step back to think about what this actually means for how people are able to use money and how it changes existing business models, it’s quite overwhelming.
Open financial systems are here to stay.
We firmly believe that open and interoperable financial systems are not only inevitable, but that they are a crucial component in the architecture of the [Banks] of the Future.
Consultants and investors are going to be scratching their heads about where exactly the value will lie in the overall value chain and which companies will be the winners and losers in this market. But the consumer doesn’t care; one way or another they will reap the benefits.
This series was first published on the BitX Blog.