If you do not follow Matt Dooley on twitter then please do so immediately. I started a conversation with him several months ago in Hong Kong and every time we interact he makes me smarter. I recently wrote the first a series of 5 posts on distributed ledgers, see here, here, here, here and here. Matt commented on the first post in the series on LinkedIn thusly “Bitcoin will become the “Napster” for the financial industry. Music was never the same and nor will be financial services.”. I could not agree more and in fact had already started thinking and writing about the Napster analogy. Matt forced me to accelerate my thinking.
Regardless of my views on the factual limitations of BTC, the bitcoin blockchain and its limited applications to the financial services industry, the concept of distributed ledgers coupled with scripting protocols is going to forever change the industry. As such, I am arguing that Bitcoin is the equivalent of level 0 in the evolutionary journey of distributed ledgers. Bitcoin may survive in its current incarnation as the entire eco-system moves to level 1 and above or it may evolve by transitioning through various waypoints. Either way Bitcoin, in a limited capacity barring changes to the blockchain, or distributed ledgers based off of different technologies will profoundly change the industry.
To date I only thought and focused on non-Bitcoin platforms and protocols working in collaboration with financial services incumbents, regulators, current legal frameworks and other stakeholders. The reason being I believe this course of action to produce the most traction with the least friction.
Yet, there may be several other potential paths of development that may not include collaboration with existing paradigms, active or passive. Further, these paths, although leading the industry towards costly confrontation, may be as effective in changing current paradigms even though on the one hand applicability may not extend to core services or material market share in any corner of the industry and on the other hand the change may happen in indirect or diffuse ways.
Therefore, thinking about Napster and the music industry is a healthy exercise.
The music industry made an insane amount of money in a relatively short period of time thanks to three main factors: a) strong copyright laws, b) uni-directional mass media delivery channels and c) physical products (e.g. a cd).
Is that not reminiscent of banks for example? a) strong regulatory frameworks that act as defensive moats, b) uni-directional delivery channels, i.e. branches, c) thinking in terms of products rather than service and clients.
The music industry was not able or not willing to adapt and did not understand the technology threat of networks and torrent technology. This industry mishandled its Napster moment, used legal tools to crush it and… LOST. Napster lost too btw, as it had gone “rogue” in the eyes of the industry. Anyways, music today is being consumed in drastically different ways than prior to Napster. The music industry today makes much less money than it used to and the traditional part of the industry is dying.
The financial services industry is either a) transforming itself and adopting the strategic and operational thinking of technology firms, i.e. be technology, data and user experience focused (see my finserv = fintech post here) or b) is under unprecedented attack from startups and new tech and business models. This depends on your vantage point. As it applies to distributed ledger technologies in general and bitcoin in particular, the financial services industry may either learn from the music industry and co-opt new entrants, transforming the threat into an opportunity, or be slow to adapt and face extinction. How will the industry navigate its Napster moment? I personally believe more in the former than the latter path. I may be wrong though. To be clear the latter path does not necessarily mean an endorsement of the bitcoin blockchain per se, rather it may be an endorsement of its potential promise and how that promise will be leveraged and tweaked via different and more Darwinian-capable platforms.
For simplification purposes, I will now narrow my focus to securities trading, clearing and settlement for the remainder of this post and use this activity as a proxy for the financial services industry. By securities I mean equities, debt, derivatives and other esoteric financial contracts.
I have argued, as well as others, that the applicability of distributed ledgers or blockchains to the securities world is directly related to how well integrated these solutions will be with not only the eco-system of participants but also with the AML/KYC and legal frameworks in place. In other words crypto paradigms that do not play well with regulation and legal frameworks have no chance to be adopted. What if certain crypto actors were to go “rogue” – and by rogue I do not mean a la Mt Gox – and started to facilitate trading, clearing and settlement of securities via truly decentralized networks in an “illegitimate” way thereby bypassing legal and regulatory channels and bodies?
Offshore centers could reinvent themselves and add to their own legal frameworks to enable dark brokerage firms and dark securities trading – onshore regulatory pressure makes this difficult to fathom, so rather than dark these trading outfits may be gray. Further, any country with enough of a “structured” legal system that either operates on the fringes of the global financial services system or wants to elevate/differentiate itself and offer an alternative to current financial networks for economic, political or monetary reasons, could adopt new technology paradigms in hope of attracting trading volume, money and permanent capital. I do realize I am navigating the realm of true science fiction here, but stranger things have happened over short periods of time. Who would have predicted Craigslist would disrupt the classified business model of newspapers? Who would have predicted Google would disrupt the news media industry?
Offshore financial centers will always play a role in financial services. Certain nations will always want to build a different status for themselves in the industry’s pecking order. Neither can be avoided. What can be avoided or mitigated is how deep “illegitimate” or gray outcomes will take root. And the key to understanding this point lies with how easily, effectively and swiftly will all participants in securities trading, clearing and settlement develop commercial ties with the distributed ledger eco-system – by investing, partnering, contracting and becoming clients and adopters.
I wonder how Rick Deckard would hunt rogue blockchains and distributed ledgers?