I was interviewed by UBS's wealth management team a month ago, when the bitcoin bubble was in full bloom. The price had exploded, tripling in a month. Now that it has burst, the interview seems quite prescient so, here it is ...
Cryptocurrencies – digital currencies based on encryption – are in the midst of a bubble, but that should not overshadow the genuinely transformative change that is taking place within the financial services industry. That is the contention of Chris Skinner, Chairman of The Financial Services Club, author of finansernextjs.wpengine.com blog and one of Financial News’ ‘FinTech 40’ most influential people in financial technology. Chris Skinner spoke to Barry Corbett of the UBS Knowledge Network in London on 12 June.
Barry Corbett: So far this year, 85 new cryptocurrencies have been launched, bitcoin has traded within a whisper of $3,000, and the market capital of cryptocurrencies has surged to more than $100 bn, from $15 bn. What’s going on?
Chris Skinner: What’s happening at the moment is a tulip bubble. Everybody’s caught the craze of cryptocurrencies and wants some skin in the game. There is a craze over ICOs (Initial Coin Offerings) and the general public and the investment community have finally caught wind of bitcoins, zCash, ether, litecoin - all these altcoins - and decided they want to be involved. You can see there’s a bubble going on when your friends, your family and strangers are asking “Should I be buying these coins?” My answer is day-trade them. They’re very volatile. Don’t put your life savings in there.
BC: Some of this growth has been attributed to a rise in money laundering and state intervention. What other global themes should investors be aware of when dealing with the cryptocurrency market?
CS: The money laundering link is due to the association of bitcoins with the notorious Silk Road website. So yes, there’s an element of the underworld, but that’s there in the use of US dollars too. Uncertainty about some traditional currencies has been a factor behind the new interest too. For example, sterling weakness has meant that UK investors are looking for alternative places to put their money. Equally, the Japanese government gave bitcoin some credibility by stating that it is looking very carefully at making it part of the capabilities of institutional investors. Then you have events like Brexit, the surprise election of Donald Trump and people are potentially taking the view that “with all these uncertainties, maybe this is an area of certainty.”
BC: You mentioned Japan and the air of credibility that is creeping into the crypto space. Where do you see this going? At what point do the public start getting paid in cryptocurrency, and how would this even work?
CS: The majority of the general public probably does not know is going on, except that people want to buy some because they see the price going through the roof. What’s really happening is that cryptocurrencies are getting incorporated into mainstream capabilities. The Ethereum alliance, driven by Microsoft, is a good example of a collaboration of many banks and corporations to develop such a capability. You’ve also got Hyperledger driven by IBM. So heavyweight technology companies, big banks and corporations realize there is something tangible here to develop and use. Alongside this, the likes of the government of Dubai are saying they want all documentation to be on a distributed ledger by 2020, transforming paper-based processes and practices.
BC: China is dominant in Bitcoin mining. Why is this, and what are the implications?
CS: China’s had quite a rollercoaster ride with Bitcoin. The government has tried to outlaw it several times and failed. So it has decided to regulate the system at the same time as working with it, which has helped bitcoin grow very quickly in China. China is one of the countries that are very good at adopting complicated technologies. In addition, Chinese investors have very few places to put their money. So from a Chinese investment viewpoint, as individuals, it’s very appropriate to look at something like bitcoin. China has tried to stop outflows of money from the country. Yet Chinese citizens want to invest overseas, buy properties overseas. So how best to do so? Put it through cryptocurrency.
BC: Cryptocurrency is just one area of FinTech that has taken hold over the last couple years. How do you see FinTech changing the ecosystem of financial services and what are the implications for banks and investors?
CS: A hundred billion dollars has been invested in FinTech startups in the last four years, feeding into a multitude of sub sectors, where you have InsureTech, WealthTech, RegTech, artificial intelligence, machine learning, mobile wallets, payments, APIs, et cetera. The combination of all of those is what I call the open-sourcing of financial services, where the back, middle, and front office of institutions are changed into a world of plug-and-play. Front office becomes apps between devices and humans. Middle office becomes a smorgasbord of APIs that allow any part of the financial process to be easily lifted into any other part of processing online. The back office becomes completely automated in the cloud through Big Data, data analytics, artificial intelligence. What that means for the main players is that they have to become collaborative, co-creative, partnering, opening their capabilities to be part of that marketplace ecosystem. That’s quite difficult because an awful lot of the older institutions have legacy proprietary structures, and plug-and-play is very difficult when you have that legacy structure. When I talk to incumbent institutions, management typically resembles a bunch of old men who understand risk and compliance and finance, but don’t understand technology. You’ve got to have technology represented in the boardroom to achieve the transformation into a digital, open-source structure from a proprietary, physical structure.
BC: FinTech unicorns [private tech companies valued at >$1bn] have been slow to emerge, despite the significant investment. Venture capital has stalled somewhat in the US and Europe. Is FinTech dying in its infancy?
CS: No, I don’t think it is. I think there was a lot of hype in FinTech. I predicted that the noise would eventually plateau and decline. I think we reached that point in 2016, a pregnant pause to reflect on where we’re at. I liken it to the dot.com bubble bursting. Most of the internet investing in the late 1990s/early 2000s disappeared, and a lot of companies disappeared with it. But we still have the Amazons, Alibabas and Googles of the world.
BC: A key area of focus has been distributed ledger technologies, otherwise known as blockchain. They went through the hype cycle as you mentioned, particularly in 2016. Now they’re moving from the proof-of-concept stage to implementation in certain areas, and especially in finance. How will this affect the buy side, and how the sell side?
CS: I define blockchain as a method of recording transactions that’s completely immutable; it can never be changed once it’s on this chain of blocks. That’s effectively what was described by Satoshi Nakamoto (the elusive creator of bitcoin) in 2009 in his paper about peer-to-peer currencies. What has emerged from that as a second wave are distributed ledgers: it’s completely trustworthy because it’s immutable, because once recorded, transactions cannot be changed. We can build that into databases that are shared between people. They can trust each other because they know that these transactions are trustworthy, because they’re recorded on a blockchain. However, Blockchain and distributed ledgers are in the ‘trough of disillusionment’. They have gone through the media hype cycle and gotten something of a bad name. It got to the stage that everything from world hunger to child poverty to digital identities to clearing and settlement was getting ‘blockchained’. To be honest, a lot of these areas are not appropriate use cases for the technology. Clearing and settlement is a great example of an inappropriate use case. The issue here is not technology, but an industry issue where we have Central Banks and Central Counterparties and Central Securities Depositories, and trying to get them to put everything into a decentralized ledger is difficult to do in centralized structures. Half of that discussion is around interoperability and standards. A big debate when you’re dealing with custodian systems is “do we really need real-time clearing?”, because the whole reason for the collateralization of structures that we have today is to avoid real time. Maybe ‘near-time’ is better. If you don’t need real time, then you don’t need blockchain. The whole discussion became overhyped with use cases that were inappropriate. What’s coming out of that though are some areas where there really is low-hanging fruit for transformation, such as in the supply chain between corporate clients and commercial banks. Equally, there is great potential in things like digital identity. But I think it’s longer-term, because you have to work out how the structure of those operations can be agreed between different countries and corporations before you can deploy the technology. I think the biggest opportunity, longer term, is introducing decentralized structures and distributed ledgers, therefore avoiding the centralized single point that is vulnerable to a cyber-attack. So, from a cybersecurity viewpoint, having such a distributed ledger structure in place makes absolute sense, which is why Ripple has taken off as a counterparty clearing between banks. It could potentially become a replacement for SWIFT, or a SWIFT acquisition. The SWIFT network is at the moment based on what I view as being industrial-era physical structures and technologies that need to be replaced by 21st century digital internet-based technologies. If I get a check from a US bank as a UK citizen, it takes something like 28 days to clear if it’s a high value check, purely because of that whole SWIFT counterparty network. If I can transact through a distributed ledger in seconds for virtually no cost, then it obviously makes sense to replace systems that are antiquated.
BC: The general public and much of the financial services industry are unaware of Ripple. Could you explain how it would work and why it’s so appealing?
CS: Well, Ripple has two pieces, one of which doesn’t appeal to me so much in terms of the discussion, because it’s a cryptocurrency site, potentially like Ether and Bitcoin, and hence something that some people want to invest in simply because it has gained a lot of value recently. But more interestingly it’s a cryptocurrency that allows you to do counterparty messaging and clearing between banks with Ripple using a lot of banking expertise from the industry. The best example I got was from a conference I chaired in the Middle East, where a Middle East Central Bank gave the example that, if they want to move Dirham from Abu Dhabi to the capital of Oman, it has to go via SWIFT and takes at least three days. You can actually drive the money there in five hours. It just doesn’t make sense to have such a slow system. That’s why they’re using Ripple, because now they can move the money in seconds.
BC: Do you have indications around levels of adoption?
CS: There are over 100 banks now working with Ripple. They’re also getting into mainstream corridors of currency exchange, so we are starting to see this take off.
BC: The financial regulatory system is in flux. What role can you see FinTech playing in this changing environment?
CS: The regulators have struggled historically with their technology approach because again, like the bank’s leadership teams, they haven’t had technologists in the regulatory system. What’s been interesting recently is how that’s changed dramatically. Britain’s FCA was pushed by UK Treasury and the Bank of England to become far savvier on the FinTech capabilities of apps, APIs, analytics, distributed ledgers, cryptocurrencies, et cetera, and to see whether they’re threats or opportunities. That led to Project Innovate, which led to the FCA sandbox, which is a way of very quickly assessing a startup company’s capabilities, nurturing them and working with them to increase industry competition. This creates more choice for the consumer and corporate clients, and reduces inefficiencies in the banking structures. A great example is Know Your Client and money laundering. It’s estimated that only 2% of the $1.7 trillion that’s laundered through the financial system is tracked and traced today. I was sceptical about this number until I saw the documented evidence from different global regulators. The reason this occurs is that it’s really easy to print off a utility bill and make it look like that’s your address. It’s very easy to create false documentation that’s in a physical form. In a digital form, it’s much more difficult, especially if the data is on an immutable distributed ledger. That’s a very good use case, but a longer-term one, because you have to work out appropriate country and company standards. However, there is support from the regulators to help these companies get up to speed as fast as possible. The FCA sandbox can take a start-up to market within two months, which is incredible! A good example is ClearBank, which is a brand new FinTech clearing bank launched in February. It’s been three years in planning, actively supported by FCA, The Treasury and the Bank of England, and is led by Nick Ogden who was the founder of WorldPay. In the UK you can only get access to the clearing systems, like CHAPS and BACS and faster payments, through the big four banks thanks to historical consolidation. So if you want to build and start a credit union or FinTech startup, you can only go to these big four banks to get your payments and bank deposits paid and sorted, which obviously limits competition. ClearBank now has authorization to integrate into all the UK and global clearing systems, and all you need is the API and you can be up and running overnight. And that’s the world we live in today; an open source structure. No longer an old, proprietary, heavy-cost structure of a small group of banks, but a very open marketplace where anyone can plug and play.
BC: What impact is Brexit having on FinTech, both in the UK and in Europe?
CS: No city in the world has succeeded at being a FinTech hub without government support and involvement. That’s why the UK, specifically London, has been leading as a FinTech centre along with Singapore, Dubai and certain other cities. The Brexit implications are quite interesting in that, before the recent election there was a wait-and-see approach, with nervousness over a hard Brexit, losing access to the single market and the free movement of people. Free movement of people is a critical factor for London to be a FinTech centre. Without it, it’ll be very difficult to succeed, increasing the attractiveness of Dublin or Berlin or somewhere else. Now, thanks to the general election result, FinTech is actually in a very good position with regards to Brexit. The reason I say that is that no hard Brexit or forced decisions will be pushed through by a government that has no majority. They’re going to have to fudge everything and it’ll be much more of a “let’s try and support what Europe does” approach, particularly as most parliamentarians are Remainers.
BC: As a seasoned commentator on financial markets and FinTech, what attitude changes have you seen inside and outside the industry? What have you found most revealing?
CS: I’m often viewed as being a little bit too conservative in some of the things I say, when I’m actually quite provocative. For example, the libertarians in the bitcoin community think I’m a government agent trying to push everything back into the state system. My response is simple: if you understand that money purely exists to allow governments to use this as a control mechanism, then do you really think governments are going to let it go out into the wild and no longer be controlled? I just don’t see that happening. Equally, the FinTech community started out by saying, “we’ll destroy the banks.” I disagreed. You’ll change the banking model and collaborate with the banks, but you’ll never destroy the banks because they exist for a reason, which is that governments give them a licence to store value, and knowing that they have that license, you can trust them to store that value. If you put money into bitcoin and store it on Mt.Gox [a Bitcoin exchange], then you lose it, as I did! The most surprising thing to me is the naivety of a lot of people who believe that they can do things without government control and without regulation. What’s interesting right now is that you have a lot of FinTech companies that started out with the idea of disrupting and destroying the banks, look at them today and they are now partnering and collaborating with the banks. That’s because they eventually realized the complications and that global trade doesn’t take place overnight when you don’t trust each other. You have to create a system that enables that trust to be regulated and structured. Now, I’m not saying the global system is working well, because it’s not built for the internet age. That’s where FinTechs see their opportunity. That’s why they have to collaborate with banks.
BC: What will the financial services industry look like in five years’ time?
CS: The industry is being open-sourced into a structure of apps, APIs, and analytics from front, middle and back office, where an awful lot of technology is changing within the banks from being in proprietary, controlled systems that are on premise and internally developed, to being co-created and collaborative in a smorgasbord of apps and APIs and analytics. Culturally, it’s hard to incorporate that open, collaborative structure because incumbent institutions have never had to before. But in five to ten years, the institutions that resist this change are not going to survive. They’ll end up being acquired and merged with bigger players that embrace this change. I liken it to a dead fish on a beach. I was recently at a conference where I found a dead puffer fish on the beach. It wasn’t there when I walked up the beach. It was there when I came back. I just looked at the poor thing and thought obviously it’s been washed out of the water by a big wave and couldn’t get back in again. To me, that’s like a big bank. Big banks are getting hit by wave after wave of technology. If they can swim into the deeper water, away from the near shore and embrace this change, then they’ll survive. But if they resist it, they’ll very quickly get washed onto the shore and find that they can’t breathe anymore.
Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...