Finance is part of almost every endeavor in the modern world, from choosing where to go on holiday, to what job to take, to where we do our daily shopping. Little in our modern world would be possible without finance; no functioning companies, no shops, no factories, no products. One just has to look at a nation with hyperinflation to see that without finance much of human coordination drys up and ceases to exist. Over the course of thousands of years our global financial system has evolved to become an extraordinarily complex system; a multiplicity of overlapping networks that move trillions of dollars a day and serve billions of people enabling them to make purchases, invest their savings and trade with each other.
But for all of its great achievements, behind the scenes, our industrial age financial system is not feeling so well. Relative to what is now possible it is slow, expensive, lacks transparency and is thus prone to fraud, it promotes speculation and instability and it seems to create dangerous concentrations of wealth that leave societies divided. It begs the question what would a functional financial system look like, one that is normalized for an age of information, globalization and works for the economy and society?
Today with a relentless revolution in information technology, the internet is evolving into a new decentralized model where finance and technology merge in surprising new ways. With blockchains, distributed ledgers and the new financial innovation of tokens, we can see the potential for a very different kind of financial system to the one we know today, as new forms of decentralized financial systems are being born which are native to the internet. Historically we have created a centralized model to finance consisting of many closed organizations because that was the only way we could ensure trust in the system. We created trust by all of us trusting in a government and that government outsourcing it to the nation’s institutions that it regulated by ensuring they complied with requirements.
The result of this though is that all the resources in the system have to flow through those limited set of centralized institutions. A centralized model has advantages but it also has disadvantages particularly when the system becomes complex. In simpler systems, it is an effective method but as the system becomes more complex it results in sprawl, redundancies, compartmentalization, bottlenecks and overly complicated processes that render the system inert and non-responsive to user needs. But just as the first generation of web technologies radically change the face of communication through email and the second generation changed the face of media taking us from a world of a few centralized channels and newspapers to a world where everyone had their own channel on social media and blogs, so to the third generation web will soon offer the software solutions and connectivity to do the same to finance.
The internet of tomorrow will be a global services infrastructure, for the building of services and exchange of value. With distributed ledger technology and token economies, finance and the internet are now converging so that the internet has built-in capabilities to record, store and exchange value independent from the centralized institutional architecture that we know so well. The very way that we record and account for value is changing as a new set of information technologies provides the infrastructure for a globally distributed network of computers to maintain secure and shared records of value. This distributed technology allows us to remove a massive amount of administration and transaction cost and regulation by having an economy-wide accounting system, that is secure and transparent.
Such a system for coordination via distributed ledgers would have many advantages. It would drastically reduce the cost of recording and thus make it possible for us to expand formal financial systems to the billions that are currently outside of it. The 3rd generation web may well have native capacities to do what currently cost financial institutions billions of dollars in IT infrastructure. Which means that the financial industry will not be disrupted by the fintech startups of today, it would be more accurate to say that it will be disrupted by the internet itself.
In this paper on financial systems innovation we trace out the past present and future of the financial system in an attempt to trace through its evolution into the age of the decentralized web.