Almost daily I find myself contemplating how Bitcoin and its underlying technology, the blockchain, will change the financial services industry as we know it. For me, it’s a practical question – I’m a commerce student preparing for a career somewhere in the banking sector, and I need to understand where the future opportunities may be greatest.
That’s why last year I participated in the digital currencies MOOC offered by the University of Nicosia, and it provided an excellent perspective on possible disruptions to the financial services landscape over the comings years. It was especially interesting to hear Antonis Polemitis describe the coming clash between two of the economy’s most important sectors: financial services and information technology. Since both sectors are quite profitable and filled with smart people, it could prove to be a contest of epic proportions.
Blockchain technology is allowing the IT sector (traditionally a supplier to financial services) to start encroaching on services traditionally provided by banks and other financial institutions. And there’s a lot at stake: financial services is the most profitable sector in the U.S. economy, representing just 8% of GDP but generating between 30%-40% of all US industry profits. So blockchain technology represents a huge opportunity for those able to penetrate this very profitable sector of the economy.
I keep referring back to one particular slide from the MOOC, showing the various business silos and specialty areas within financial services, and it serves as my roadmap whenever reading about a new Bitcoin venture, as I try to understand how it could potentially disrupt services being provided by today’s financial incumbents. I found this slide to be so helpful that I added it to my LinkedIn profile for easy reference.
We’re still at a very early stage of blockchain technology implementation, let alone adoption, however it’s already possible to speculate about where the greatest opportunities may lie for new challengers looking for a piece of the financial services pie. Both venture capitalists and institutional investors are already placing their bets, so someone considering financial services as a career may want to start monitoring these particular segments, since they could represent areas of both volatility and future contraction due to competition from the IT sector.
I have my own predictions about which areas of financial services may fare better than others as the coming battle heats up, however since we’re still at a very early stage (perhaps the bottom of the first inning), anything could happen. Here are my predictions:
Competition for Traditional Banking Niches
These areas will face competition from new business models that offer to do things better, faster, or cheaper:
- international payments (transaction costs are high, so an obvious target for competition)
- domestic payments (depends on the country and the transaction costs)
- remittances (seems like a natural niche for cryptocurrency, and a threat to intermediaries)
- lending (certainly for micro-lending, and maybe much larger amounts one day)
Potential New Business for Banks
If cryptocurrency becomes another asset class, it could create opportunities for growth in some of these areas:
- depository (the blockchain doesn’t pay interest – then again, some banks don’t either these days)
- exchanges (lots of investment in this area, but also potential acquisition targets for incumbents)
- wealth management (further diversification through Bitcoin)
- futures & options (as with all asset classes)
- investment banking (just guessing)
While it’s interesting to speculate about the future and how blockchain technology could impact financial services, someone might ask: “why do we even need Bitcoin?” (as a reader did in response to one of my recent posts). Well, that’s like asking why do we need VOIP when we already had the telephone, or why did we need the fax machine or email when we already had postal service? The answer – because someone found a better, faster, or cheaper way to help people do what they were already doing.
What does blockchain technology allow us to do better? If you’re using a distributed network, then trust is an issue, since you don’t have a central authority to validate transactions, and the potential for “double-spending” occurs. This problem isn’t confined to distributed computing networks, and the example often given is known as the “Byzantine General’s Problem”, which I won’t go into here (you can Google it).
Blockchain technology eliminates the trust issue when transacting across a distributed network (security is a separate issue, as we’ve seen with some Bitcoin exchanges). The technology itself replaces the role of the central authority. Ok, but “why do we even need Bitcoin?” Well, when you disintermediate an incumbent (even one charging a competitive fee, as opposed to a monopolist), you either create more competition (usually resulting in lower transaction costs for end users), or you potentially eliminate intermediaries entirely. Transaction costs won’t be eliminated completely (some critics point out that the regulation of Bitcoin will inevitably lead to additional costs – and they’re right), however new competition created by disruptors in various segments of financial services should lower transaction costs, resulting in savings for consumers like you and me, in the form of lower fees and lower commissions.
So it doesn’t really matter whether we “need” Bitcoin or blockchain technology – they’re already here, and a lot of the smart money is backing this growing segment because they see the value proposition that the technology offers as a challenge to the traditional way of doing business in the most lucrative sector of the economy. It’s only a matter of time until the disruptors start to chip away at existing business models, and some of those chips will be large indeed.
I’m still undecided about where the greatest opportunities may lie within the financial services sector, or where blockchain technology represents the greatest threat to traditional banking services. But one thing is clear – anyone preparing for a career in financial services should be thinking about the coming upheaval, which is bound to reshape the financial services landscape profoundly over the next 20 years.