Regulators across the globe are keen to regulate the new digital currencies, financial products and exchanges. The recent announcement by the US regulator CFTC (Commodities and Futures Trading Commission) is a recent example. All regulators say that they aim to provide market protection for consumers and reduce risks in the space. Interestingly the CEOs of many exchanges do not disagree .
To understand this let’s take a step back to look at the big picture.
Web 3.0 is the next incarnation of the Internet. The first version of the web (Web 1.0) was a collection of websites where most static were web pages and the vast majority of users consumed content and few produced it. In the early 2000s, the advent of Web 2.0 coincided with the Dotcom crash. It enabled the creation of web hubs and platforms where users could offer content and services that could be charged for.
Web 3.0 is based on the concept of a distributed control, incorporating concepts such as decentralisation and token-based economics. This means integrity is monitored by all users and not by “Big Tech” or an intermediary like a bank. This is very different from Web 2.0, where data and content are essentially centralised in a small group of companies.
An important aspect of Web 3.0 is that it enables the provision of financial services by a decentralisation network of organisations whose integrity is monitored and guaranteed by its users. This approach has significant implications for the banking sector as it effectively transforms the role that banks and institutions have on money, financial products and financial services. In many instances removing them entirely from the equation.
I bought my first cryptocurrency in 2014, so I do not consider myself a luddite, but I feel there may be too much optimism in the space. Let’s take a look at the building blocks of this new world to better understand where the opportunities but also the real challenges lie.
The Blockchain
Is the blockchain overhyped? No. Is it ready to replace existing centralised control mechanisms such as banks, corporations and governments? Also no.
The most well known blockchain is of course the distributed ledger governing Bitcoin, the cryptocurrency with the largest Market Cap. The Bitcoin Blockchain certifies the ownership and tracks all the change of hands experienced by every bitcoin ever created. It provides a decentralised and secure ledger of all bitcoin transactions. As the first of its kind, it now looks slow and less fit for purpose than newer blockchain technologies subsequently launched (think AOL versus yahoo and subsequent players). However, Bitcoin remains a leader due to its peerless security and its finite supply.
Why is there such excitement surrounding blockchain technology? Simply because the blockchain allows the creation of smart contracts that autoexecute when certain conditions are met, eliminating the need for all intermediaries that would normally be necessary to validate and execute transactions. This potentially huge disruption to the financial services industry has of course not gone unnoticed by the incumbents. Practically every financial institution is exploring how they can benefit from the security and efficiency of blockchains. Meanwhile, none of these institutions have abandoned their traditional modus operandi yet as blockchain technology still faces some serious real world challenges. This means that the vast majority of transactions still take place on traditional banking architecture.
On paper, the blockchain offers huge improvements on the current financial system. But the devil is in the details. Today many blockchains consume huge amounts of energy compared to centralised databases making a systematic use of the blockchain potentially expensive and very damaging to the environment (though there is a rapid trend towards the use of greener energy sources). They also have huge latency – so transactions can take longer than on traditional centralised databases. That makes them unsuitable for many payments transactions. It is estimated that the bitcoin blockchain can validate at 7 transactions a second – as compared to Visa which can process 24,000 transactions per second .
Lastly blockchains are considered risky in the sense that they can be prone to computer hacks though this is not a common occurrence. In reality the weakest link is their users. The blocks are hard to hack but the wallets are just as vulnerable as traditional banking interfaces as they are vulnerable to human error. But in traditional banking sometimes fraudulent transactions can be reversed. This is mostly not the case in the blockchain.
The real issue is that the financial services industry and their regulators have not developed the rules and practises needed to […]
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