There is a battle going on for the future of digital finance. It involves banks, fintechs, big tech, and governments – plus something called decentralized finance (DeFi). There are a number of trends already emerging that will start to redefine the way we view this topic.

The tectonic plates are shifting
First, the move to offer a comprehensive range of financial services on a single platform. Banks and fintechs will continue to acquire start-ups to increase their range of services and develop a ‘destination platform’, which consumers will rarely need to leave. This is encouraged by the rise of financial services that are embedded in digital activities, such as shopping. Ant Financial and Tencent developed ‘super apps’ for a wide range of business, although they are now heavily regulated by the Chinese authorities.

Second, as cash usage declines, central banks are developing digital money or Central Bank Digital Currencies (CBDCs). But this is a radical shift for governments and will take time for other countries to follow. However, China, the leader in this space, recently launched its CBDC wallet app on Android and Apple app stores as it gears up for the Winter Olympics in February 2022. 21 million digital wallets have already been created to hold digital currency.

Third, internet economics are being changed by DeFi. This centres on blockchain applications, that store and verify lines of code and provide security without the need for intermediaries. Since 2020, many of the functions of the financial system have been re-created on the Ethereum blockchain (launched in 2015), such as wallets, lending and deposit applications and payment systems. It settled around $120 billion of transactions in early 2020, but that rose to $2.5 trillion by the second quarter of 2021. These decentralized networks, which underpin crypto currencies, allow ownership to be distributed through tokens, based on their contribution to the network, and sometimes confer governance rights. This means that participants are rewarded for their activity.

An extension of this is the rise of non-fungible tokens (NFTs), blockchain-based records that represent digital assets – not just financial assets, but music, art, games and video, for example. This means that the original creator can be paid for them and also receive royalties on subsequent sales. One digital artist, Beeple, sold an NFT to Christies for $69 million in March 2021. Other ‘Web3’ examples include Braintrust, a talent management business that incentivizes via tokens, and various music platforms, such as Audius and Royal, that will develop new revenue streams that bypass the record companies. Such services have the potential to redistribute revenue (and control) from Big Tech and deliver it to content creators, technologists and small businesses. This is the equivalent of Facebook or Twitter paying you for your content on their social media platforms. Currently, content creators get very little from the major platforms and talk about ‘21st century serfdom.’

• There are low barriers to entry into the DeFi arena and payments are cheap and almost instant.
• Cross-border payments are still very expensive. Small businesses typically struggle to get access to capital. These are major targets for such initiatives.
• Competition will erode the huge margins of incumbents – Visa and Mastercard make gross margins of 65-80%. Big Tech power will also be eroded by the rise of DeFi, particularly as such businesses share revenue from content creation with the owners.
• Banks are slowly getting used to the idea that crypto currency can be used for payments. They need to accelerate this approach and include DeFi in their thinking.

• We have yet to see the regulatory response to such initiatives – no doubt this will emerge in the coming year.
• New financial products are always open to scams and it is not clear how this will be dealt with in a decentralized world.
• Decentralized communities will enhance security and privacy, but this has a knock-on effect on how anti-money laundering is monitored, especially given the recent spate of significant bank fines in this area.
• Being a front-runner has its disadvantages. Facebook invested in Diem, a blockchain-based payment system, but progress slowed after initial criticism from a number of global banking authorities. The sponsor, David Marcus, recently left the company.

Banks should be developing strategic scenarios as well as pragmatic, short-term actions, given the speed of change in this market. It will be extremely interesting to see how these trends play out in the digital finance arena over the coming 12 months.

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