I fear global bank regulators are about to make a decision that will unintentionally “obsolete” the banks, by prohibiting a coming tech pivot. Making this mistake would guarantee that the tech industry continues going around the banks, right as internet-native payment technologies are starting to scale.
The telecom sector offers a cautionary tale: When Voice-Over-Internet-Protocol (VOIP) was invented in 1995, most people disparaged it as a technology that couldn’t scale and wasn’t a threat to the telecom giants. Then, circa 2003, the technology to scale VOIP arrived – broadband – and within a flash, most of the telecom industry’s copper-wire networks became obsolete. Useless relics.
Bitcoin is a “Money Over Internet Protocol,” as is Ethereum, potentially. Just as VOIP moves voice data around the internet natively, Bitcoin and Ethereum move value data around the internet natively. Most people disparage Bitcoin, Ethereum, et al. as protocols that can’t scale and can’t possibly threaten the incumbent financial industry, just as they denigrated VOIP. But the scaling technology is now here – it’s called the Lightning Network, which is a Bitcoin layer 2 protocol. Its throughput capacity roughly equals that of Visa, and payments made over Lightning cost virtually zero. There are other scaling technologies, too. If I’m right and scaling technologies for internet-native money protocols have arrived, then many legacy systems operating in the financial system today will be obsolete within a handful of years.
As CEO of a new breed of bank – a dada-bank (“dollar and digital asset bank,” defined as a depository institution authorized to handle both and pronounced like “databank”) – my company lives with the problems inherent in the banking industry’s antiquated legacy systems every day. Culturally, banks have a history of building complex, “walled garden” IT systems. Fintechs sprang up in recent years to provide efficient front-ends that act as “middleware” between antiquated back-end systems and the user experience demanded by customers. Culturally, fintechs build the opposite of banks’ IT systems – fintechs generally build their systems to be as open and “low-walled” as possible to create network effects. Had banks done this, fintechs wouldn’t need to exist! But, until “Money Over Internet Protocols” came along, banks still had a role because fintechs still needed to partner with a legacy bank to settle their customers’ US dollar payments.
“Money Over Internet Protocols” at scale are truly a threat to traditional banking because they enable money to move outside the traditional, antiquated payment rails. To date, the US banking industry has lost roughly $600 billion, or 3% of its deposit base, to the crypto industry – and that happened before the “Money Over Internet Protocols” scaled! Despite all the legal, regulatory, accounting and tax problems faced by their products, and all the criminals and fraudsters running rampant (who should be in jail), the tech industry has proven its ability to go around the banks.
It will take Lightning a few years to lay down that proverbial broadband (scaling) infrastructure before the “Money Over Internet Protocols” hit their tipping point at scale. But make no mistake, it’s happening. The proverbial undersea cables that scaled VOIP are being laid before our very eyes.
But the “aha!” of these “Money Over Internet Protocols” isn’t cost or scale. There are two “ahas” that matter far more: integration speed/cost and developer communities.
- Integration speed/cost: Anyone in the world can become members of these emerging payment networks in the span of a few hours, using equipment that costs a few hundred dollars.
Banks’ IT systems will never be able to compete with that.
It’s not even a question whether legacy technology architectures can compete with these emerging protocols, for the simple reason that it’s fast, cheap and easy to join these networks. I recall a recent conversation with a B2B payments company, whose executive was very proud that his team whittled down to only 3 months the time required for its business customers to integrate with its system. In the legacy world, 3 months is impressive. But the paradigm has shifted: payment system integration time is now measured in hours, not in months or years – and in a few hundred dollars, not a few million dollars. It’s obvious which approach will win.
- Developer communities: Open, permissionless protocols have huge developer communities, which compounds the speed of their ecosystem development and network effects. Network effects are all about compounding. The code libraries and developer tooling available for Bitcoin and Ethereum are critical infrastructure that banks’ proprietary systems cannot replicate. Moreover, these developer communities organically create interoperability. Banks’ “walled garden” systems with closed groups of developers will never be able to keep up with their pace of innovation.
So, what could be the role of banks in the world I’m describing? Answer: banks become software application providers, providing access-controlled applications that run on top of the open, permissionless protocols and to make them accessible even to unsophisticated users, just as the telecom companies do with VOIP. I’ll bet very few of us use the command line interface to make a phone call – even though we could use it if we wanted to, most of us pay to use telecom providers instead because they make the user interface so easy.
That’s what banks will do, too: provide access-controlled applications to ease the use of “Money-Over-Internet-Protocols.” Huge, successful businesses have been built exactly this way – as access-controlled applications running on top of open, permissionless internet protocols. Auto companies are just one of many examples – they’re software companies now, albeit providing software that runs on a different type of hardware.
What about central banks? What would be their role in the world I’m describing? No different. They’ll become providers of a software application for issuing fiat currency that runs on top of open, permissionless protocols, too.
That brings me back to my fear that global bank regulators (specifically, the BIS) are about to make a decision that “obsoletes” the banks. Why? Because the BIS is proposing bank capital treatment that would effectively block banks from interacting with open, permissionless protocols. If they do that, they are guaranteeing that the tech industry will just keep going around the banking sector.
The biggest concern of global bank regulators with banks using open, permissionless protocols, I suspect, is compliance. But banks don’t need compliance to be built into the base layer of their IT systems. Compliance can be built into applications that run above the base layer, and which control access. In fact, that’s what banks are already doing today with TCP/IP. Every bank uses TCP/IP, and yet strictly controls access to their online banking platforms. Criminals and sanctioned countries use TCP/IP today too, but banks have the tools to block them from using banks’ applications. Same thing with Bitcoin and Ethereum – banks have the tools to block illicit finance from using their applications. It’s easier to police illicit activity on open blockchain systems than it is in legacy systems.
At its pivotal juncture telecom was a heavily regulated industry, just like banking is today at its pivotal juncture. How, then, did the telecom companies pivot to become software companies and avoid obsolescence? Answer: regulators enabled them to make that pivot.
That’s what banks will become, too – software companies – but only if bank regulators enable banks to make the same pivot. If they don’t, then it will be obvious, looking back 10 years from now, why the tech industry won.