What would it take for FIs to embrace DeFi?
- At Tearsheet's upcoming Big Bank Theory Conference, traditional FIs and upstarts will explore the emerging world of DeFi.
- Publicis Sapient's David Donovan shares his thinking around how incumbents can compete in this new world.
The Big Bank Theory is Tearsheet’s most ambitious conference yet. We’ve brought together the best in digital banking with the best in embedded finance to talk about the future of banking products and services. Firms like Goldman Sachs, Bank of America, Square, Intuit, Cross River, N26, and Galileo will be there in attendance and presenting. Get your ticket here.
To whet our appetites, I spoke with David Donovan, head of financial services for the Americas at Publicis Sapient and a sponsor of the event, to talk about the DeFi opportunity for traditional banks and FIs.
The Biden Administration’s moves in crypto are telling in terms of where the market may be headed.
David Donovan, Publicis Sapient: I don't think anybody would question the fact that we need regulation. The important thing to understand is that the crypto market/DeFi is different from your equity market or fixed income market. You want to put in smart regulation that creates investor protection, but you also want to consider that it's a unique asset class. It's an alternative asset class that's going to be very exciting. The real power of what DeFi will unlock is creating a better financial system -- if done and regulated correctly. Just like the internet, where there was this incredible growth in this incredible unlock; but within that journey of the internet, there were also some fits and starts, where some companies that had crazy valuations went to zero. I can think CMGI, Flowers.com, and all those different companies that actually came public and went to zero. That's part of markets: there are going to be companies that rise and fall. When you fast forward to today, from the year 2000, the world is better off with the internet. It unlocked some incredible companies. I see a similar evolution in DeFi.
The financial industry tends to be a straggler when it comes to transformation. Sure, the industry consumes and spends a lot of money on tech but the business models are generally the same. DeFi is a huge opportunity, and a huge hurdle.
Going back to the internet, there were a couple industries that never really transformed. One of them is financial services. Financial services is the same today as it was 20 years ago. We're on ACH rails. We're on SWIFT. We have billions of people in the world that are unbanked. If you want to send money cross border, they're going to charge you 10% or 15%. To me, that's just gouging and the fact is that it may or may not get there, because most of these people don't have access to banks. They need to use alternative services that can be predatory.
So for me, what DeFi does is it allows many of the unbanked people, who sometimes live paycheck to paycheck and get hit with overdraft fees; it just opens up the financial services industry and brings it mainstream with the rest of the world.
Financial services firms are very much thinking about crypto right now. Mostly, it’s about offering trading services to their clients. What’s going on behind the scenes?
They're certainly aware of what's going on. I'm not a conspiracy theorist, but I think it's pretty much well known that they've slowed down the adoption as much as they could. It's well known banks have strong lobbyists in Washington and, through those conduits, have gone to Congress and haven't necessarily stopped it, but essentially, created doubt and asked questions. Some of the questions are good. But at the end of the day, I find it kind of interesting that the CEO of JP Morgan comes out and says bitcoin is worthless, yet JP Morgan has one of the best blockchain protocols called Quorum. It's an institutional protocol, one of the fastest out there in the marketplace, and they have their own stablecoin. Like anything with banks, there are always two sides to the equation.
Dave and Publicis Sapient work with many of the top bank brands on their digital transformation. He believes that most large financial institutions are formulating a blockchain/crypto strategy right now, but they’re doing it slowly by taking small steps.
Sometimes timing is everything. And it seems like at this point, the timing is right for banks to realize that if you can't beat them, you've got to join them. We're kind of at a tipping point, where they're going to get involved because they have no choice. If they don't get involved, they risk being disintermediated into the future of financial services.
While banks take their first crypto steps, DeFi continues to grow and attract investment. I asked Dave what he would do if he took over the CEO job a large bank.
If I was going to lead a large financial institution, there would be two things I would do. One is transform my infrastructure. If I was going into a legacy bank, I would transform my infrastructure to be as cloud native as possible. And I would also re-architect my infrastructure to create the most seamless, frictionless data layer that I could possibly have. So I'll have all the information that I can monetize about my client base in one place where it can be easily accessible, so that I can give the best advice and create the best optionality for our clients.
And then as it relates to the crypto world, we have to walk before we run. And I think there's some some very foundational advice that we can start with to create a foundation for essentially growing the market. What it would really be around is focusing more on the the much more mature currency, which can underpin the ability to then use other services that can come out from taking a position in something like Bitcoin or Ether. What I mean by that is that Bitcoin and Ether are, although volatile, much more stable than some of the other cryptocurrencies out there.
Of course, you're seeing rapid speculation of many different currencies but those two currencies are widely adopted. There's a maturity to them, they've been around for a while. There's a lot of factual data to support their longevity in the marketplace and the way DeFi can work. I make the analogy to gold: people buy gold as an alternative investment. Sometimes it's an inflation hedge and sometimes it's just diversification within your portfolio. I look at those cryptocurrencies, Ether and Bitcoin, as similar to gold, only they unlock other opportunities by having a position in them.
Banks could be in the business of custody. They could be in the business of storing keys. The way you transact in crypto is by having two keys: a private key and a public key. Your private key is really the most important key. And if you lose it, that's really where you could run into trouble, because it's very hard to replicate the key once it's been lost. So having that private key stored at a reputable institution like JP Morgan or in one of the five major banks could be a huge service for banks.
Once you have a position in crypto, you can create services around it, like what we call staking. Staking is where you don't sell your crypto position -- you always hold your crypto position -- but you can pledge that position to institutions like Coinbase, Binance and others, who then lend it out and pay you a much greater return from an interest perspective on your crypto borrow.
They pool a bunch of funds that are supported by people staking, and in turn, they then lend that money or coins out. The people that borrow will pay back interest on that borrow, and the interest will then be transferred back to the individuals or corporations that stake their coins. The central exchange will take a much smaller fee than the traditional banks. So it's a little bit of an intermediary, but not really. But you know, you could start with services just as simple as that.
DeFi isn’t just about creating new services -- it’s also about providing access to people who haven’t been included in the traditional banking and payments ecosystem.
The great thing about crypto is that it allows for people that don't have access to banks the opportunity to do things they weren't able to do with the traditional financial services industry. I think that's the most important thing. There are things that are going to be unlocked that have been frustrating for everyone, not just people that are unbanked. Just the fact that you have to wait three days for checks to clear. You get hit with overdraft fees. You can't seamlessly send money cross border. These are all things that you can do. You can even do them in the safest form by just transferring dollars into a stablecoin, like USDC which is created by Circle or Paxos, where the way the stablecoin is 100% backed by US dollars. It's a digital dollar.
As a start, you can start crawling by just creating rules around actively using stablecoins as a way of unlocking financial services. We could even just start there and then build upon that with other services as the mainstream public gets more and more comfortable with using coins versus paper.
It’s clear that crypto has spawned an active startup community -- money and ideas are flowing. At some point, there’s a bridge being built between the incumbent financial system and DeFi.
Getting back to your original question about being an officer at a bank, I would actively and openly recruit institutions that have much more knowledge of the crypto market than I do, as a way of partnering with them. I think one of the biggest mistakes banks have made up to now has nothing to do with crypto. It has more to do with transformation in technology -- they lacked people at the board level or in the C suite that really understood emerging technologies and how they can unlock enterprise value within their company.
Don't make the same mistake. Go get help. Partner with the right institutions that understand this space, where you can create a partnership that benefits both parties, and will essentially also unlock enterprise value for that bank. It's funny, we talk about technology in other industries, like automation or AI, and people say, 'Well, those are going to be job killers.' And then there's this argument that, 'Well, it'll unlock other jobs for people, because technology will create other needs for people.' So whether it is the proliferation of AI, it creates more data science jobs or more data engineering jobs.
I believe the same thing will happen with crypto. So people say, 'Well, crypto is going to disintermediate banking as we know it, but it won't really disintermediate banking.' If they do it in a smart way, what it will do is create new services for banking to support, because what's a better business to be in as a bank than the custody business of crypto holdings, keys, security, or validation? Those are all things that banks could do better than anybody, because one of the things that banks have that no one will ever dispute is people trust banks.
It's a great position to be in. And if they advocate and actually partner with the right institutions that will help further educate them on the crypto market, then they can become an advocate for the industry and actually shape the industry in a way that will benefit them, as well as all these other individuals that we talked about, like the underbanked. This is actually kind of a nice little magic bullet that banks could essentially nurture, to bring that emerging demographic -- which is currently leaving in droves right now because they're unhappy -- back into their institution.