The Trouble With Fintech (Or Why 'Now' is the Time for DLT)

A critical look at the reasons behind the change in dialogue surrounding blockchain and distributed ledger tech.

AccessTimeIconMar 5, 2017 at 1:15 p.m. UTC
Updated Mar 6, 2023 at 3:38 p.m. UTC

Chris DeRose is a software developer, bitcoin evangelist and the controversial co-host of the podcast Bitcoin Uncensored.

In this opinion piece, DeRose looks at the promotion of blockchain and distributed ledger solutions, arguing that, in many cases, they're simply a smokescreen for the shallow repurposing of existing ideas. 

In 2013, 'fintech' gained serious steam.

With the rise of the 'bitcoin bubble', Silicon Valley began paying attention to finance technology in a new way. An army of talking heads and oracles quickly declared the state of finance technology to be a world of 'broken' business models and antiquated ideas 'ripe for innovation'.

What followed next should come as no surprise: venture capitalists began their plans for 'disruption' through the dot-com model of funding aggressive development teams with esoteric company names, and they went full steam for projects such as 'Ripple' and 'Digital Asset Holdings' – all of which were designed to lubricate the wheels of interbank financial systems.

Two years in, what have we got to show for this exuberance? I would argue not much.

Finance is a difficult industry to disrupt. For one, it's a highly regulated, and some of the world's best and brightest minds are working hard to keep the wheels of our world's financial systems humming along as is.

Unlike the small- and medium-sized business industries that we typically see Silicon Valley tackling, fintech 'customers' have generally included a comparatively small number of large institutions with long sales cycles and few incentives to aggressively pursue new technology.

Why the hold up?

The Silicon Valley formula is supposed to work like this: 'runway' capital is allocated to a venture for the purpose of maintaining operations and with the hopes that the venture 'takes off'. The venture burns that capital while acquiring customers, and as the company grows, either more cash is raised, or the company switches fully to customer-funded operational support.

But, that model doesn't apply well for products for whom customer purchase life cycles are inordinately long, and where regulatory encumbrances are high.

The runway period becomes too long, and the risks grow commensurately larger. So, in the case of today's fintech startups, something unusual has started to happen.

Without many exceptions, as the fintech customers have failed to arrive, startups have begun to abandon much of the pretense of customer acquisition, and have instead focused heavily on winning investors.

As traditional VC's have begun to abandon these startups, the companies have instead designed their marketing initiatives to cater toward a more diverse range of unspecialized investors. As such, in 2015 'buzzword compliance' became the new modus operandi for many of these companies as they pivoted toward a nebulous pursuit of 'blockchain'. (Whatever that word may mean.)

At the start of 2017, it would appear that blockchain compliance is out, and having still not attracted capital inflow from paying customers, these companies are now ready to solicit a new round of investors under the newest buzzword: 'distributed ledger technology' (DLT).

So, what's the new pitch?

Well, much like with the term 'blockchain', the answers are… vague.

'DLT' appears to be rooted in the notion that 'the technology behind bitcoin' (still the biggest success in the fintech sector, at least as measured by market cap) is seemingly found in the process of 'ledger reconciliation'. But, is now really the time to revisit this age-old function?

With distributed ledger technology, the pitch appears to be that transactions will be sent to all parties on the network, instead of just the involved banking institutions. By using cryptography to automate and increase the sharing of data, it is argued we will find increased reconciliation accuracy and cost reduction from regulatory compliance.

How is this different than blockchain? Well, the 'blocks' (folders of transactions) of blockchain are no longer in vogue, and thus we're back to sending transactions 'unbatched'.

For some, DLTs are a triple-ledger accounting system, whereby debits are accounted from individual deposit transactions, in lieu of accounts. For others, DLTs are merely the syndication of data between all parties in the system, instead of the direct participants of a transaction.

But for most, DLTs merely exists to represent and facilitate 'The Next Big Thing' in the previously uninteresting world of financial ledger and accounting technology.

The problem with DLT

Rarely found in any discussion of a new technology is the examination of their opportunity costs. And, in the case of DLT, these costs aren't terribly different than the costs preventing 'blockchain' uptake.

Chiefly, sharing data with one's competitors is a tough pitch – it removes the proprietary 'edge' that banks use to form the basis of their competitive advantage. Further, requiring cooperation amongst these institutions is a tougher pitch still, when even trusting their own employees is difficult.

But concerns over sharing aren't the only thorn in the DLT pitch: most of the supposed advantages for these platform can only come to fruition if all vendors and customers of an institution (and in turn, their customers and vendors) use the same software.

This all-or-nothing proposition isn't an easy hurdle to surmount.

In an attempt at tackling these roadblocks, distributed ledger and blockchain startups have taken to the aggressive pursuit of acquiring high-profile talent to lead their ventures. This comes at stark contrast to the usual Silicon Valley playbook, which is more often defined by previously-unknown whizz-kids at the helm of their technology.

This conspicuous hire phenomenon was very evident for the case of bitcoin wallet firm Blockchain's acquisition of ex-Barclay's CEO 'Antony Jenkins', and Digital Asset Holdings's acquisition of the 'credit default swap' progenitor 'Blythe Masters'.

In all cases, the companies' history of press releases would suggest that the acquisition of a strong 'brand' was more important than any announcement of actual growth or traction.

Though the relationship between these hires and prospective clients may very well help with the sales processes for these endeavors, it may simply be that the purpose of these hires has more to do with securing additional funding from investors – particularly since these hires generally have very little to do with the actual specialization of message-passing architectures which these systems seek to replace.

Where will messaging innovation come from?

The last notable and successful modern renovation in financial-message passing may very well be Swift's transition away from directly connected data lines to the public TCP/IP network.

This transition was performed in the early part of the 21st century over a four year period ending in 2005. During this migration, the upgrade was made by incumbent institutions at a slow and prudent pace, involving all existing members of an incumbent interbank messaging standard.

Standards bodies and committees were formed within Swift, and all institutions ratified proposed changes with a prolonged discussion.

It's worth noting that such changes in interbank message routing, though rare, are well precedented. And have never been defined by the quick and risky paths typically taken via venture capital investment programs.

Banks are necessarily incrementalist institutions. And 'disruption' in incremental institutions is nothing more than a representation of risk.

As such, these changes are ill-suited for a non-incumbent intermediary to tackle. The non-regulatory costs of moving data is already very low – and often 'free'. This leaves little to no chance of profitability, in exchange for the expansion of risk.

Such a poor revenue outlook is quickly evident amongst DLT startups upon even a cursory examination of their business models. Most companies in the DLT space have already made their efforts free to all by open-sourcing their project code in full.

The path to revenue growth would appear to be, at best, 'consulting' contracts. This isn't exactly the glamorous growth model that propels Silicon Valley expectations.

The future for DLT?

So what's the future of distributed ledger technology startups?

Probably not much. There's no customer capture or network effect that would prevent incumbent providers such as Swift and ACH from merely incorporating any of the innovations that could conceivably be uncovered into their existing offerings.

Should the push for DLT be that we can finally remove the process of specialized reporting, then the question should be asked as to why these functions existed in the first place. The answer will likely suggest that mere databases and standardized message passing formats can already provide the technical solutions needed with less overhead than replacing the entirety of the incumbent software architectures.

If 'standardization' is the pitch of DLT proponents, who better to accomplish this task then the institutions that have specialized in such relationships for the decades that have brought us here?

As fintech businesses are quickly whitewashing yesterday's big thing, 'blockchain' – will the new branding finally add customer revenue to these operations? Or will it merely carry these unprofitable enterprises into the newest round of fundraising?

This brings us to the difficult truth of fintech's results up to the year 2017. Namely, there's a long list of idealistic goals that have met with profitless, regulatory encumbered failures.

Balloon and tack image via Shutterstock


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