This Is What Disruption Looks Like: The Coming Shakeout In Transaction Banking

What does blockchain¹ disruption actually look like, on the ground? One hears about blockchain’s potential for disruption all the time, but mostly in generic sound bites that emphasize lower costs, improved transparency, higher efficiency, and the like. But seldom do those discussions get into the nitty-gritty of how disruption actually shakes out.

Now, in transaction banking, we have a small window into that process—what it looks like, how it affects markets, and how it may impact investors.

The consultancy Bain & Company issued a report estimating that blockchain technologies “have the potential to reduce trade finance operating costs by 50% to 80%, and to realize three- to fourfold improvements in turnaround times.” Bain is already seeing price declines in the SWIFT payments network as a result. Most important, according to Bain: “These forces are washing through every region and every product in the transaction banking portfolio.”

Therein lies the rub: all kinds of banks (global banks, local banks, investment banks) are currently piling into the transaction banking business, attracted by its steady fee income and high potential return-on-equity. Yet, as costs and prices are driven downward, thanks to blockchain adoption, that business may actually end up looking very different than it does today—in a few years, it may end up being a low-margin, commoditized business with just a few dominant players. It’s also very possible such operations may get carved out and sold off as profitability declines, splitting transaction banking from credit banking.

For investors, generic forecasts of blockchain disruption are not actionable, but use cases are. Here, that means understanding a portfolio’s exposure to transaction banking, across all its financial services holdings. In my view, one should be skeptical of any banks forecasting high profitability and revenue growth based on transaction banking operations—especially if those are new initiatives or planned expansions. Maintaining that revenue stream clipping fees is going to be very difficult if the cost of a transaction ends up approaching zero—as it may on a blockchain.

Further, in any disruptive trend, it’s typically the fastest moving, most innovative, best executing companies that end up thriving. Financial services companies that don’t have a record of innovation, and are following the lead of others into the transaction business, may not be the most attractive opportunities as this disruptive process unfolds

And now that they’ve stuck their toe in the water, I don’t believe it will take long for them to see the potential benefits of blockchain-based currency systems—i.e., “cryptocurrencies.” There is hardly any large-scale adopter that’s larger than a government. So this slow coming-about of the ship of state is potentially a huge development for blockchain technology applications, manufacturers, and implementers.

This Is What Myopia Looks Like: Central Bankers Doubt The Future

For every tangible and evolving use case, there is a choir of skeptics who will furiously insist that blockchain applications—in particular cryptocurrency² applications—will never fulfill the “hype.” Last week this skepticism took the form of a sensational report that if everyone in the world used bitcoin, it would require so much processing power that it would “bring the Internet to a halt.” The report was authored by the Bank for International Settlements (BIS), an institution owned by the world’s Central Banks.

It’s understandable that advancements in cryptocurrency would strike fear in the hearts of central bankers. But that doesn’t change the fact that central banking is ripe for disruption. It also doesn’t provide a sound basis for rational analysis. And I question many of their conclusions about the cost, reliability, and utility of cryptocurrencies.

The biggest problem with the BIS report, in my view, is that all its assessments are based on technology “at the time of writing.” They make no allowance for improvements in technology—not better chip technology, nor the possibilities of quantum computing, nor even just the newest crypto tech on the horizon. Lightning Network, a next-generation crypto-payments protocol, may be able to process transactions as fast, or faster, than Visa and Mastercard.

I put the BIS report in the same category as a 1981 TV newscast I recently viewed on YouTube. The San Francisco Examiner had just launched its first online issue, and the newscaster was guffawing at the horrible user experience: people using dial-up modems to access the online paper and then waiting two painful hours for it to download. His take on it was something like, “Well, this is never going to work.”

But just because it didn’t work then, didn’t mean it would never work. In fact, the Internet brought the newspaper business to its knees before they figured out how to deal with it.

Technology is changing at a blistering pace. Prognostications of doom, based on an analysis of today’s tech environment, entirely miss the point. Large-scale disruption is coming, and even if we can’t implement it fully today, that doesn't change the fact that someday it will arrive.

WHAT DOES MY 2CENTS ADD UP TO?

My view is that blockchain will do to financial services what email did to the Post Office—and it’s already happening. We don’t know 100% what it will look like once it all shakes out, but there is a massive disruption underway. Blockchain will have its role. Cryptocurrencies will have their role. Even advances in simple database technology will have a role.

The most lean, forward-thinking, best-executing companies will likely survive, while slow-to-change institutions could be left behind as markets undergo a radical reshaping over the next few decades. Crypto applications, specifically, have a huge addressable market in the financial services space, and that’s why I am invested in companies that support these systems.

As for the dilemma of central bankers, at a recent panel discussion I was asked for one trenchant thought on crypto. My answer: “Crypto will eventually disrupt central banking.” That’s my answer and I’m sticking to it.

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¹ Blockchain is a decentralized, digitally disseminated ledger of data. The basis of a successful blockchain system is once a new group of information, or “block”, is added, the information automatically disseminates and is downloaded to each computer on the network. This assures that a single computer could not change information on a block: it would be overruled by a consensus of all the other computers on the network. This process renders all information on a completed block decentralized and theoretically permanent.

² A cryptocurrency (crypto) is a digital currency typically utilizing a Blockchain system for transaction records and cryptography for security. The major differentiator from physical currency is it isn’t issued by a central authority and thus theoretically acts independently of traditional banking and government influence. A crypto-asset would be holding a certain amount of cryptocurrency, or a derivative for which value is driven by the price of an underlying cryptocurrency.