The disintermediation of finance

Why (in italian perche’) has always been my favorite word. 

Why, in my opinion, is the most powerful word we have, as it allows us to uncover the real essence of things. It is the key to understanding causality, one of the pillars of the scientific method.

The goal of this post is to ignore buzzwords and a blind deterministic approach, which permeates crypto, and try and understand why DeFi is the future of finance and what critical processes this will trigger. 

Essentially my post will discuss the disintermediation of finance and speculate a bit around its implications for society as we know it.

Disintermediation

One of the most important secular trends, that has unfolded over the last decade, is disintermediation.

“Disintermediation is the process of removing intermediaries from a supply chain, a transaction, or, more broadly, any set of social, economic, or political relations.”

Encyclopedia Britannica

Many established institutions of the contemporary age (19th and 20th centuries) are declining (as elaborated by Moisés Naím in The End of power), substituted by new agnostic organizations that act only as technological platforms.

Political parties are in crisis everywhere and leaders are talking directly to their voters; startups are getting funded directly by investors over crowdfunding platforms; newspapers are shutting down and thousands of news outlets grew organically out of social media; new fashion brands/stores are being created online without even passing for offline physical chain gatekeepers. We live in a world that has fewer layers.

The cause of this phenomenon can be traced back to the widespread adoption of the Internet, and, in every sphere, it presents two peculiar traits from my point of view: 

  1. Platformization of the means of production (thus easier creation). Means of production, that once were a barrier to entry and a competitive advantage for incumbents, are now taking the form of a platform that anybody can access

  2. Standardization of the distribution channels (thus easier distribution). The advent of these production platforms reshuffles the competition map and puts all competitors on a levelled playing field

A new paradigm

The earliest and most evident example of disintermediation has happened in the information space: traditional media (like TV, newspapers and radios) have been completely disintermediated by digital technologies.

The following post by Ben Thompson gives a fantastic overview of how different technologies have evolved into different types of content over the years: first transposing the content to a digital platform (newspaper to blog, tv to youtube, radio to podcast) and then evolving the format and consumption of the content itself (blog to twitter, facebook to instagram, youtube to tiktok, podcast to clubhouse).

What seems evident now, is that those innovations didn’t just change the technological platform of the content, they changed the paradigm in a way that profoundly impacted the users’ behaviour and the frequencies of interaction. Before smartphones and social media (pre-disintermediation) the average media consumption was certainly lower: people would  probably take no more than 30 pictures a month, with some peaks in holidays; audio and video were not easily accessible and, therefore, less common.

Everything is different now: media content can be produced and distributed everywhere at any time; and photos, videos and audios have become a fundamental part of our way to communicate and express ourselves.

The case of finance

How is this related to finance? Well, in my opinion, today finance is in the early phase of disintermediation, approximately where media was before social networks. 

Fintech companies have highly simplified access to financial products for the masses, and have built a decent digital interface for traditional financial products, but they haven’t yet changed the financial paradigm. Fintech companies have significantly improved the previous level of customer service, but not to the point of drastically changing user behaviour. 

The friction behind producing and distributing financial products is still not trivial: lots of fintech startups are born, but not everyone with an Internet connection can simply create financial products in a few minutes and make it immediately available to customers.

The production phase is accessible only to companies that have enough structure to support a huge cost burden. Some of these costs have been offset through financial infrastructure companies that are constantly growing, but there is no modularized and standardized platform yet to build financial products at scale.

Distribution of financial products is even less disintermediated at the moment. Traditionally, financial products used to be distributed by the users’ financial gatekeepers (banks) and this is still the model that many neobanks are pursuing (rebundling of fintech).

My hypothesis is that the new wave of DeFi primitives will do to finance what Facebook did to newspapers: they will create a new paradigm, through the introduction of a new levelled playing field, that will allow anyone in the world with an Internet connection to offer financial products to a global audience.

These new DeFi, blockchain-based, service providers will remove the friction of production and distribution and will allow hundreds of thousands of micro financial businesses to provide ubiquitous financial services.

The impact of disintermediated finance 

Why would people want ubiquitous financial service? There is one fundamental human universal need associated with finance: having more disposable income in the long term.

People would be interested in having access to ubiquitous financial products only if this brings a significant improvement to their financial life.

DeFi will get to the masses only if they will have a tangible financial benefit coming from it: more money to spend.

Today, DeFi is providing more income to its users, essentially in the form of higher asset prices, but this mechanism works mainly in a frenzy market and I’m not sure it is sustainable over the long term. Asset appreciation works today because there is always a theoretical marginal buyer willing to pay more for DeFi assets. But once the space gets to a critical mass, the marginal buyer theory can’t work anymore, you need value provided by the technology itself.

My hypothesis is that the main value blockchain will provide instead is optimization of people’s finances and expansion of their balance sheet. 

My idea is that, in a world with countless financial providers, where financial products are ubiquitous, the vast majority of the financial decisions of an individual will be automated and optimized on some specific goals. This automation will organically bring a net benefit to the average user, which today doesn’t necessarily optimize programmatically its wealth. 

In parallel, as I already described in a previous post, I’m confident that the adoption of more liquid financial tools, like the ones introduced by DeFi, will give the average Joe/Jane more borrowing power as more elements of the asset side of their personal balance sheet will be considered liquid, thus collateralizable.

Conclusions

Disintermediation is a secular trend that influenced our society deeply throughout the last 20 years. 

I’m convinced that disintermediation won’t stop to the media space, but will relentlessly affect many other human spheres, finance probably being the next one.

In particular my expectation is that, through disintermediation, a number of financial core platforms will emerge, allowing the creation of countless micro financial providers that will permeate our world of ubiquitous financial products.

This will consequently bring more disposable income to people, through a better (mainly automated) optimization of their finances and through an expansion of their individual balance sheets (easier credit).

The picture I presented above is still far from being reality and, as every prediction, it will not necessarily materialise. 

There are numerous risks and potential roadblocks to its materialization, first and foremost those related to regulatory and compliance. Nonetheless, if you look at the relentless pace of disintermediation and its impact on society, it’s clear that  the future will proceed in that direction.

Sources