Fintech Innovation - Where is it Headed?

We have clearly entered into a new world in terms of financial technology that is slowly but surely altering the landscape of banking, payments systems, and even perhaps legal tender currencies. All this technological innovation is filled with buzzwords and companies trying to become "the next big thing" that changes the world in a truly meaningful way.

We have "Bitcoin", "Blockchain", "Distributed Ledger", "CBDC" (Central Bank Digital Currencies) as new buzzwords that have popped up in recent years. Lately we see even newer efforts to try and innovate to improve "blockchain" (see Hashgraph here). I believe there are now over 1,000 private "cryptocurrencies" vying for capital in the marketplace. 

Right now there is so much happening so quickly in terms of competing ideas and technologies, it can quickly become overwhelmingly confusing to most people who are not technological experts and just want a simple, inexpensive, and secure way to transact their business with a currency that holds it value over time. 

We have covered this topic pretty well here, but as it can be quite confusing and things keep changing constantly (funny how innovation works that way), I thought perhaps an analogy that most people can relate to might be helpful to see where things stand right now. With that in mind, let's use the old Sony Betamax vs. VHS technology battle as our guide. 

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Readers from my generation will quickly recall this technology battle. Younger readers might find it an interesting footnote in history that illustrates how there is a constant technological struggle to gain universal adoption that really never ends. Even in this case, after the VHS technology for video players won out in the marketplace, it was eventually replaced by DVD's, then Blue Ray etc. But perhaps this process can help us understand the ongoing technology battles in the fintech arena?

First, here is how the Betamax vs. VHS battle played out as described in this wikipedia article on the topic:

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Videotape format war

"The first video cassette recorder (VCR) to become available was the U-matic system, released in September 1971. U-matic was designed for commercial or professional television production use, and was not affordable or user-friendly for home videos or home movies. The first consumer-grade VCR to be released was the Philips N1500 VCR format in 1972, followed in 1975 by Sony's Betamax. This was quickly followed by the competing VHS format from JVC, and later by Video 2000from Philips. Subsequently, the Betamax–VHS format war began in earnest. Other competitors, such as the Avco Cartrivision, Sanyo's V-Cord and Matsushita's "Great Time Machine" quickly disappeared.

Sony had demonstrated a prototype videotape recording system it called "Beta" to the other electronics manufacturers in 1974, and expected that they would back a single format for the good of all. But JVC in particular decided to go with its own format, despite Sony's appeal to the Japanese Ministry of Trade and Industry, thus beginning the format war."

. . . .

"Sony had met with Matsushita executives in late 1974 or early 1975 to discuss the forthcoming home video market.^[6] Both had previously cooperated in the development and marketing of the U-Matic video cassette format. Sony brought along a Betamax prototype for Matsushita's engineers to evaluate. Sony at the time was unaware of JVC's work. At a later meeting, Matsushita, with JVC management in attendance, showed Sony a VHS prototype, and advised them it was not too late to embrace VHS "for the good of the industry" but Sony management felt it was too close to Betamax production to compromise."

Outcome

"The main determining factor between Betamax and VHS was the cost of the recorders and recording time. Betamax is, in theory, a superior recording format over VHS due to resolution (250 lines vs. 240 lines), slightly superior sound, and a more stable image; Betamax recorders were also of higher quality construction. But these differences were negligible to consumers, and thus did not justify either the extra cost of a Betamax VCR (which was often significantly more expensive than a VHS equivalent) or Betamax's shorter recording time.

JVC, which designed the VHS technology, licensed it to any manufacturer that was interested. The manufacturers then competed against each other for sales, resulting in lower prices to the consumer. Sony was the only manufacturer of Betamax initially and so was not pressured to reduce prices. Only in the early 1980s did Sony decide to license Betamax to other manufacturers, such as Toshiba and Sanyo.

Sony's decision in 1975 to limit Betamax's maximum recording time to one hour (for NTSC systems) handicapped its chances of winning this marketing war. VHS's recording time at first release (1976) was two hours—meaning that most feature films could be recorded without a tape change. It was not until the early 1980s that Betamax offered recording times comparable to VHS. In UK, the L-750 Betamax tape lasted 3 hours and 15 mins, while VHS was limited to a 3-hour maximum (The E-180), though later on an E-240 tape lasting four hours became available, though picture quality wasn't as good.

By the time Sony made these changes to their strategy, VHS dominated the market, with Betamax relegated to a niche position."

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So, how can we relate this old technology battle to what we see going on in Fintech today? I think in a number of ways. 

 As with most technology battles, what is being sought is a universal standard that everyone can easily use and will want to use. Before a universal standard is adopted for anything, there are usually competing versions of new technology vying to become the universal standard. Once most manufacturers pick what they want, one technology tends to "win out" and become what everyone adopts. Sometimes it matters less which technology is actually "superior" than it does which one gets adopted by the most manufacturers. Once a critical mass of adoption takes place, the standard become accepted across the board.

Applying this idea to the new banking and currency technologies we see just about everywhere now, I think we are in the process of seeing which innovative technology will gain the broadest adoption by the key "manufacturers" in this arena. In this analogy, I think the major banks and central banks are the "manufacturers" because whatever most of them adopt is more likely to become the global "standard".  The general public (as always) will have the final say because whatever end "financial product" is adopted will have to meet the needs of the end users (we, the people). 

It is important to distinguish between the underlying ledger technology that is used to support a currency system and payments system (blockchain and hashgraph for example) and the actual currency unit itself. As an example, one new Fintech innovation just introduced (Glint) does not use blockchain at all, but does hope to re-introduce the idea of gold as a currency people can use in daily transactions. Ben Davies of Glint has this to say about the ledger system they are using:

"One way we did it was to create our own ledger systems using micro-services architecture. It was about taking cutting edge technology and integrating into financial services. The innovation is in the application of that technology.”

Right now what we are seeing is that the major banks and central banks around the world are looking at which underlying supporting technology (like blockchain, hashgraph, various hybrids, etc) works the best in real world testing. 

Until we can get to a universal standard for this kind of underlying ledger technology, it is not really possible for central banks to move forward with the concept of central bank digital currencies. The currencies themselves are not really the innovation. They are just another electronic version of the legal tender currencies they already produce now. 

What is needed is an underlying ledger system that makes it possible to implement a digital version of their currency that is inexpensive, fast, and secure.  It also needs to be "interoperable" (connect to) other banks and central banks existing systems (Bitcoin running on very slow blockchain ledger technology cannot do this and will remain a private virtual currency).

The first technology that central banks can adopt that meets these goals will likely "win out" and gain widespread global adoption in the existing banking system. At that point in time, it becomes more realistic to think in terms of a new "global digital currency" that can utilize whatever new underlying ledger technology eventually gains adoption as the universal standard. Just as VHS became the standard for video players, some new underlying ledger technology will likely do the same in the banking system.

Conclusion

I see the process above as playing out over time in stages. I believe right now we are in the middle of the technology battle for universal adoption of an underlying ledger system that all banks and central banks can plug into. Until that stage is completed, I would expect most central banks (and the IMF) to hold off on moving towards so called central bank digital currencies. I would expect a few central banks to step into the central bank digital currency waters first on test basis using what they believe will become the universal underlying ledger technology that all banks can plug into relatively easily (I am watching Singapore in 2018 for now). 

If and when these initial tests prove successful and the general public finds it attractive, I would then expect to see more and more central banks join in around the world further cementing the technology chosen as the "universal standard" that everyone can plug into. After all that, it would not surprise me to see the IMF look more seriously into the concept of an "IMF Coin" as they mentioned recently. 

This seems to me like the logical way for things to progress over time and why I have said I expect this process to take some time to unfold. What is sometimes overlooked is that it always takes more time than many expect to test out various concepts in the real world and make sure they will actually work and truly meet the end objectives of the final end users. In this case, the final end users would be the general public which will have the final say on what they prefer to use. I

I view that as a good thing. The final product (for a new official global reserve currency) will have to be easy to use, safe, and inexpensive. Any such currency will need to be able to demonstrate it can hold its value over time and retain the public confidence. If legal tender currencies fail in that regard, people will look elsewhere (perhaps to new gold payment systems or virtual currencies like Bitcoin). These days, there are more of choices available for people to consider. That also helps keep the system more honest. If people have real choices, then you must offer them a genuine product that meets their needs and has their confidence or they will opt out to another choice one way or another.

Meanwhile, innovation moves forward as it always does and we wait to see what emerges as the universal standard (or if one actually does emerge).