Will FinTech Eliminate Financial Intermediation?
Intermediation is a fundamental fact of finance and now it is disrupted by FinTech. My recent literature review paper ‘Disruption of financial intermediation by FinTech: a review on crowdfunding and blockchain’ explores two main FinTech innovations (crowdfunding and blockchain) that attempt to disrupt and disintermediate traditional financial transactions. The main purpose of this paper is to provide further insights into a coming FinTech revolution.
A review of crowdfunding research suggests that crowdfunding does not eliminate the need for financial intermediaries; rather, it creates a substitution of traditional intermediaries. Current crowdfunding research concentrates on the determinants of crowdfunding success and the dynamic behaviours of investors using empirical approaches. The findings reinforce existing theories derived from long-standing traditional intermediaries and thus fail to contradict these theories. Although crowdfunding is believed to be an alternative financial investment instrument without standard financial intermediaries, we lack sufficient research to examine how this key feature of crowdfunding makes this FinTech innovation fundamentally different. Crowdfunding platforms do not eliminate the need for intermediaries; rather, these platforms are regarded as less regulated new intermediaries.
A review of ‘blockchain’ research suggests blockchain can eliminate the necessity of intermediation in some areas, bring new forms of intermediation and, at the same time, reduce the layers of traditional intermediation. The core of blockchain technology is that it enables people to reach a consensus in a decentralised way. It breaks the old paradigm of requiring trusted centralised third parties to dictate the validity of a transaction. This has historically been the major role of banks (traditional financial intermediaries). However, this does not suggest the traditional intermediaries will be eliminated by this emerging technology, as building systemic trust in transactions is not the only role that intermediaries play. On one hand, relevant applications of blockchain currently require a supporting structure of intermediates around them to integrate them into the current financial paradigm. On the other hand, blockchain can be used by traditional intermediaries to reinvent (i) their processes and (ii) the products they offer.
For the last ten years, global investment in FinTech increased by more than 2,200 percent from $930 million in 2008 to more than $22 billion in 2015 (Accenture, 2017), further nearly doubling to more than $40 billion in 2017 ( PwC, 2017). We are currently witnessing the evolution of financial intermediation, with traditional intermediaries adopting new techniques and new intermediaries beginning to emerge. They are either competing or cooperating. Industrial practices are moving much faster than our academic understanding, with new phenomena that cannot be fully explained by existing studies. We are blueprinting a new era for the financial industry, but we have very limited research to support us in doing so.
In the case of Bitcoin (a cryptocurrency built on blockchain technology), miners function as a new intermediary, similar to the role of a traditional bank: miners validate every Bitcoin transaction, they build and store all the blocks, and they reach a consensus on which blocks to include in the blockchain. In return, they are awarded with Bitcoins and transaction fees. The consensus in Bitcoin works well, but we do not have a developed theory to explain why it works well. This would be a very important question to be addressed in future research.
A more fundament area of future research is the role of financial intermediaries and how this role might be changed. Research has suggested that the current financial system is rather inefficient: the unit cost of financial intermediation has declined only marginally since the 2009 global financial crisis (see Bazot, 2017 in Europe and Philippon, 2016 in the United States). Most FinTech innovations are led by technology companies rather than by banks. Compared to highly regulated banks, these star-up FinTech new entries are not held back by existing systems and they are less or even unregulated. We might expect in a more competitive market that financial intermediaries will pass on more efficiency gains to customers in the form of reduced interest margins and fees. For the future research, it is worthwhile to examine how incumbers respond to these challenges and whether and to what extent the FinTech new entries affect the unit cost of financial intermediation.
Cynthia Weiyi Cai, Charles Sturt University, Australia