The Central Theme of Blockchain Financial Services: Decentralization

Viewed through the lens of individual opportunity and entrepreneurial innovation, the blockchain revolution is enormously empowering to individuals. The central theme of blockchain is decentralization, devolving power back to the individual and enabling individuals to interact with each other directly with total trust even though they don’t know each other in advance. It’s all about bringing power back to the individual and giving them control, escaping from reliance on big institutions.

Innovations Start at the Edge

The blockchain innovations in financial services started at the edges of the financial services system and in niche markets. There were niche payments markets such as remittances to emerging markets that were early adopters of Bitcoin, for example. Migrant workers were facing huge fees and long-time delays in sending remittances back to their families at home. Now, companies like Abra provide person-to-person money transfers through an app, with a blockchain back end.

Note: The app lets users store digital cash (valued in any currency) directly on their mobile device. The user is not required to have a bank account to use the service—that is, no institutional intermediary. The user can send funds instantly to anyone with a smartphone.

Abra is one example of a company in this market, and it specializes in remittances between the United States and Philippines. Another innovator in emerging market payments is Bitt, which has relationships with multiple Caribbean central banks, and the innovation there is tremendous. In certain parts of the world, financial services simply don’t exist. These countries can skip over the infrastructure that the developed world took decades to build, and go straight to Internet money, such as Bitcoin.

Decentralizing Ledgers

In the United States, the big financial institutions are beginning to implement blockchain technology to replace their back-end, centralized databases. It makes no sense for different institutions to keep their own copy of the same data, and then reconcile their copy with that of other parties. Blockchains de-duplicate work by enabling multiple parties to see the same data at the same time on the shared ledger, which contains the single “golden copy” record that they can trust. Customers will experience better, faster, lower-cost services as banks implement blockchain.

Decentralization is true to the ethos of blockchain: enabling peer-to-peer exchange. All nodes on true blockchain networks are equal, which means no party has more control over the network than any other party. The laws of math, not of man, govern the networks. Fully decentralized financial systems on decentralized platforms may be 20 years away, but it’s already starting to happen.

Financial Services as Software

The big legacy institutions are working with blockchain, and also working with fintech start-ups on pilot programs. I firmly believe that financial services will be just software during my lifetime. The big financial institutions will not look like they do today. They make money today by running big, leveraged balance sheets and taking principal risk. But, in a blockchain world, they will make money on a fee basis rather than trading basis and no longer need big, leveraged balance sheets—so their business models with evolve from principal to agent. Some institutions will entirely be made obsolete, and others will innovate and survive by providing services that add value to customers. For example, when securities are offered in a public securities offering, the traditional role of the underwriter will change. Broker–dealers will still structure securities offerings, onboard clients, and bring buyers and sellers together, but they will do all of those things for a fee instead of for trading profits, as they do today, and they will no longer buy the offering onto their balance sheet, then resell it. Overstock.com, in 2016, pioneered the direct public offering of securities where its broker–dealer did not touch the securities at the initial offering, because the purchases were all direct. With the development of decentralized, self-sovereign identity solutions over time, individual buyers will even be able to avoid all the form filling and account opening that financial regulators currently demand when opening a new account.

Individuals and Small Businesses are Empowered by Decentralizing Innovation

This direction of innovation is enormously empowering to individuals and small businesses. The CEO and cofounder of Symbiont, Mark Smith, is a serial financial services entrepreneur, and he says that this start-up, his sixth, has been so much easier than previous ones to get off the ground. No need to buy our own servers—just use the cloud. No need to commit to a long-term office lease—just use WeWork and expand our office space flexibly as our team grows. No need to hire our own HR staff upfront—just use TriNet. These shared-economy innovations are all decentralizing when compared with the old ways of starting up a company.

Blockchain is an even further step toward decentralization. Blockchain and smart contracts permit radical automation of workflows involving multiple parties, and thereby de-duplicate work and entirely eliminate the need for reconciliation among parties. Blockchain innovation is occurring all over the economy and will radically automate administrative workflows everywhere. Automation of regulatory compliance will reduce legal costs, which are hundreds of dollars per lawyer hour. Supply chains will track goods from manufacturing lines to the store shelf, and execute automated billing at the appropriate stages. Doctors and hospitals will share the same medical information and improve care at lower cost, all with significantly improved cybersecurity relative to today (due to pervasive and layered use of encryption techniques in blockchain platforms). The increase in efficiency will be tremendous.

Small businesses will benefit in many ways. One of them will be access to credit. The state of Delaware—which is the key state for business incorporations in America—is actually developing new distributed ledger property registries that bring new value to small businesses. A business will be able to pledge property that it owns, such as heavy equipment in a construction business, and use it as collateral for a loan, and the lender will know that the borrower has not pledged that equipment for another loan without the need for an intermediary bank to vouch for it.

The Twenty-Year Blockchain Horizon for Broad Financial Services Adoption

Ultimately—not tomorrow, but in a couple of decades, perhaps—we’ll see the innovation in crypto-currency on distributed ledgers replacing central banks and other centralized institutions that pervade the financial system today. Whenever there is volatility in a country’s currency, there will be a rush to Bitcoin and other crypto-currencies. Regular folks will question what central banks really do. If distributed ledger technology creates trust with software, then why do we need central banks? Why do we need the DTC, CLS Bank, the Clearing House, and other powerful centralized institutions at the heart of capital markets if they don’t add value and instead create cost, delays, and counterparty risk where these would not otherwise exist? These institutions did not exist at one point in the past, and we won’t need them in the future.

Venture Capital Funds Innovation, but Few Individuals Have Access

Venture capital funds wonderful innovative companies and venture capitalists make all the money that is generated in their private gestation period and that’s just not fair. When you look at it, maybe there are a few thousand people, maximum, who are involved directly or indirectly as angels. Maybe there are a few hundred funds, if one is going to be generous, that count, but everybody else is basically left out.

How come an individual can’t get a shot to invest in these early-stage companies when they’re still private? There is an absolute need and, I think, a drive on the part of a lot of people to democratize venture capital investing, and OurCrowd is just fulfilling that need. We estimate that there are 10 million accredited households in the United States, but according to the National Angel Capital Association data, less than 2 percent of them have ever made any kind of an angel investment. It’s really pretty much a green field. That’s why we’re addressing a real need.

Crowdfunding Is the Wrong Answer—and Dangerous for Individual Investors

And simple crowdfunding is not the answer. Crowdfunding misunderstands the imperative of venture capital. They feel that at all costs, you’ve got to allow people to get money into some kind of a deal and it doesn’t really matter what’s going to happen after the day after you’ve made the investment. Just get the money invested. There’s a failure to understand that the work is not over the moment you’ve given these guys a check. It’s exactly the opposite. The moment you give them the check is when you start the work. Getting the check to them is the first part of the process, not, by any means, the end. Broad-based crowdfunding portals are basically new-fashioned placement agents where they’re getting some money for bringing you into a deal and then they skedaddle, hightail it out of there. They have nothing to do thereafter.

What’s even worse, the individual investors are now left with direct holdings of shares in these companies. Initially, they are common shares, ordinary shares with absolutely no rights, no representation on the board, no information rights, no antidilution rights. Nothing. And you’re doing a huge disservice to the company because you’ve basically now saddled these little companies with potentially hundreds of individual shareholders, which is a complete nightmare. It’s bad for the company. It’s bad for the investors and it’s not the way to do it.

OurCrowd Enables Individuals to Participate in Professional, High Impact VC Investing

OurCrowd is entirely different. We gather hundreds and thousands of individual investors, and we aggregate all their invested amounts into a single check to the target company we’re investing in. We are not screwing up the company’s cap table; therefore, our investment is much more palatable, acceptable, and desirable to a venture capital partner we co-invest with. We’ve co-invested alongside a lot of well-known name VCs, because we look to them like a normal venture capital structure, even though our Limited Partners are thousands of people. And because we’re aggregated and we can write a multimillion dollar check, we receive preferred stock, we get board representation at about 70 percent of our companies. We get the ability to manage this investment and participate in future venture rounds, which we have done so far in about 70 percent of our companies. We have a style in which we support our companies, where we go back a second and third and in some cases, already a fourth time to add to our investment, showing confidence in the growth of the companies.

We’re building a really strong portfolio for our limited partner investors. We’ve already had 10 exits in various degrees of success and only one complete blow up of a company so far out of a 100 different companies. So I think we’re providing a vehicle for these guys as individuals with as little as $10,000 dollars to actually pick a great investment.

We do an enormous amount of rigorous due diligence on candidate companies who come to us, selecting only 2 percent of the deals that we see. We actually deploy about 5 percent of the general partnership capital on our platform, so that the GP has real skin in the game, again, like any normal venture would, and we’re not interested in throwing our money away, or our investors’ money.

We Guide Individual Investors in Proper Portfolio Construction

One of the key emphases of OurCrowd to our investors is to build a portfolio. We want individuals to be in the asset class, but don’t want them to pick, even on our well-curated platform, from one, two, or three investments only. That’s a recipe for disaster because, given the venture power law, the odds of them hitting those outstanding returns that we hope to deliver on one, two, or three portfolio companies, even though they are curated, is not good. So, we are consistently preaching the need for building portfolios and we’re trying to make it feasible. For example, one of our projects is called the Portfolio Reserve, which allows an individual to make a $50,000-dollar commitment and then invest at a lower bite size from $10,000 to $5,000, so they can actually get investments in 10 companies in for $50,000.

We Generate Big Data about Venture Investing

In addition, OurCrowd is a huge, intelligent data play. We are collecting data on our investors, and on the companies in a very large portfolio now of a 100 companies. As we grow the platform, by the end of 2017, we’ll have deployed about $700 million dollars. We are hoping to deploy $1 billion in 2018. And we’re trying to learn from these data. What we’re trying to do is not just scale the investment and fund-raising, investment sourcing and diligence and the fund-raising process, but more importantly, the company-building process. What this really is in my opinion is not just a cool way to get new people into the asset class, but it’s a cool way to help build companies in the future.

We can use the power of our 15,000+ person investor network to help our companies. We hope to truly demonstrate in a repeatable way that we are good pickers and good builders because of the crowd expertise that we’re tapping into. By mobilizing silos of interested people—academics, entrepreneurs, big company executives, other venture angel investors, etc.—as a knowledge mechanism and a source of both deal flow and new due diligence filters and new growth guidance, then we’ll take OurCrowd to a new level.

Geographic Innovation Is Equally Important

Finally, there’s our geographic innovation. It’s hugely significant. We started in Israel, the world’s second most important source of innovation, certainly in venture capital activity in innovative finance. But, it’s very hard to access for an investor in San Francisco or in London or somebody who’s sitting in Singapore or Shanghai. Our platform provides access to international investors to these investments in Israel.

We are funding companies now around the world. We’ve invested in almost 30 companies outside of Israel. I think the real vision is to provide to a young, or not so young, entrepreneur not just an alternative source of capital and an alternative access to a great network, but an international network. So, what we offer is a real global platform. It’s available now to disadvantaged geographies where there wasn’t enough capital before. Now, there are hundreds of active investors to invest in your company through our platform, or it’s a thousand, hopefully going to 100,000 members of the platform.

Democratized Venture Capital Blows up the Elitism of the Asset Class

By opening up the whole venture capital asset class to a much broader range of investors, we’re going to unlock more money, more ideas, and make the process more democratic, overcome geographic limitations, and bring in more. We’ve got a lot of corporate members, like General Electric, Shell Oil, Hyundai, and a bunch of others. They see all of our deal flow, and can tell us what they’re interested in and pick their potential investment opportunities. It works with our $10,000 investor and it works for our $200 billion dollar company equally. That’s democratic and productive and good for our individual investors. They realize that with their $10,000, they’re investing alongside GE and getting the same terms and the same price for their shares and the same class of shares.

The Democratizing Impact of Blockchain

I think with blockchain, in general, there is democratization of a lot of aspects in our daily lives, with vast potential for further democratization in the future. The initial block chain, the Bitcoin blockchain, was meant for peer–to-peer payments, but actually as the community evolves and the understanding of the technology evolves, we realize that it’s actually the first-ever asset that is secure. Nobody can seize your assets because you don’t have to rely on a bank or other intermediary now, because you become your own bank. Your assets now are protected by cryptographic means. You hold your own private keys. Your money or Bitcoins don’t have to be stored in some central location in a vault. So, that in itself—that you become your own bank—is very powerful.

Let’s start with Bitcoin. The Bitcoin blockchain was meant for peer-to-peer transfers. Peer-to-peer meaning that there’s no intermediary in between. The global blockchain computing network is basically facilitating these transactions from one person to another person or one entity to another entity. We quickly see that you can use it for e-commerce, too. We can use it for remittances. We can use it as a notary service as well.

So, it’s kind of liberating or democratizing individuals, who can store some link data to the blockchain and be confident it can never be altered. So, you can use it for land registries and so on. You can actually verify, let’s say you can register that your land belongs to you. This is the document that shows it. Then you can present it again and basically it will show up that yes, it’s the same document. It belongs to you. These are the signatures and so on. So, it’s kind of a very unique combination. The technology in itself, it’s not only about the technology, but it’s also about the game theory, because there is no incentive to manipulate the network because you’d be playing against the value of Bitcoin itself. If you’re playing against the Bitcoin itself, it means the value will decrease and so there is no incentive for you as a participant on the network to manipulate it. That’s kind of a very interesting combination of different functions of Bitcoin, but that’s Bitcoin. That’s the first step in the blockchain space and it still evolves and it’s still very exciting.

The Expanding Blockchain Universe: E-commerce and Applications

But now, there are other networks that stem from the underlying blockchain technology. One is Ethereum Network, which is a global computing system for launching and distributing apps. Now, in the past year or so, we start seeing that, actually, the Ethereum blockchain is a lot more exciting because it’s now possible to actually create entire financial ecosystems and gain network effects by issuing and sharing and trading crypto-tokens. Similar to Bitcoin, you cannot seize the assets because they are protected with cryptographic means and keys and with the immutability of that transaction ledger.

Unstoppable Open Systems That Empower and Reward Individual Contributors

So, for individuals in the Ethereum era right now, it means that you can actually displace a lot of centralized applications. Let’s say you can displace the Facebooks, the Twitters, and the Ubers of the world, and so on. They are all centralized applications. And let’s say you can get back the individual sovereign rights to your own identity, your digital identity. Currently, all these centralized organizations such as Uber or Facebook use your data to create more services and they sell your data to other parties. Today, the centralized company takes someone else’s assets, such as digital identity, and uses that for their own profit. With the evolution of blockchain, individuals can actually claw all that back. You don’t have to give up your data. You don’t need to give up your personal identifiable information; you can protect yourself. I think it is a very powerful notion that you can create these decentralized apps that are literally unstoppable unless some really disruptive powerful forces disrupt the entirety of computing power in the whole world.

While this is a slightly idealistic profile of the blockchain technology, and it is still early days, and the market will adjust in terms of technology, coin adoption, and prices, yet people are slowly realizing the real potential of this technology, moving away from the early hype. There are still security vulnerabilities in the blockchain space with regards to Denial of Service attacks, attacks on nodes, and weaknesses in smart contracts. This will change over time, just as our laws have evolved over time. Nothing is perfect, but blockchain is the best bet we have where people rely on encoded terms rather than vague interpretation of law. Also, scaling the technology is a real issue right now because centralized databases are better positioned to process more transactions per second. However, the commitment of more and more developers will solve this issue sooner rather than later.

Retaining Individual Ownership Control over Information and Identity

In the upcoming years, we’ll see that these decentralized applications, because of their intrinsic architecture, mean you don’t have to give up everything to a centralized party, that you can actually distribute those benefits to all the participants in that ecosystem. Let’s say we create a new Facebook on a decentralized application, and let’s say all of the participants in that new Facebook would have a revenue share of the ads in that network. With this kind of incentive to participate in these new types of networks, it is possible to achieve large network effects, and that these types of applications will actually be larger than the current centralized applications.

Advertising will become tokenized. Consumer applications on the blockchain will have incentive-based platforms where individual consumers can participate in the network by buying the tokens, without paying with their identity let’s say. With the right applications, the right game theory instructions, it is possible to incentivize users to work in a way that will benefit all the network and themselves and not be harmful to them.

So it’s really exciting, because a lot of talent is flowing into these industries, and the talent is working on very revolutionary models that, in the past, were impossible to implement without the set of technologies combined on the blockchain. So, I think that’s kind of very exciting and nobody really knows where it will evolve, but it certainly holds a lot of potential in it.

Blockchain Evolution: UX, UI, and Apps

Right now, the blockchain space definitely lacks the UI and UX specialists to create more attractive user experiences and interfaces. Blockchain today is like e-mail when it first evolved. You had to actually create your own program to send one e-mail. You had to actually type in all these routing numbers and stuff like that. Your e-mail might go through, or it might not go through and you have no idea. Compare that experience with e-mail today.

The same will apply to the blockchain space as well. The holding of these private and public keys, that’s the main pain in the blockchain user experience today, actually. But, everything else can be built upon. Everything else is actually there. So, I think it will feel a lot like Facebook and Uber, it will just take time, and it’s just a natural progression of how things evolve in the technology space.

What FIC Network Is Building on Blockchain Technology

At FIC Network, my credit-trading start-up in the financial services space, we believe blockchain should accommodate not only native crypto-currency tokens, but at the same time also accommodate current standards in the market, current fiat currencies, and so on. We have taken an adapted technology that is not the Bitcoin blockchain, but has a lot of similar functions and solutions in terms of architecture. We have created a clean separate blockchain and adapted it just for the credit market standards with some sort of modifications in order to make it less risky in terms of operations and also more transparent. It’s a seamless open secondary loan market which can be accessed—initially—by financial institutions, such as lenders, on one side and investors on the other side. In the long term, we will evolve it as a framework for the whole fixed income space.

Complete End-to-End Financial Processes without Intermediaries

Let’s say an entity wishes to issue a corporate bond. FIC Network will implement the process from end-to-end, from sourcing, to underwriting, to trading and to servicing and closing, and in any currency. Whichever currency is preferred—currency, dollars, Euros, yen, Ether, Bitcoin, or any other crypto-currency. So, we want to become this framework for fixed income space in the long term.

Initially, we will concentrate on a very specific niche market. Currently, we offer a service to lenders to list their loans for sale on the blockchain, and to investors who want to buy a loan portfolio. Before FIC Network, it is necessary to go through a lot of friction in terms of auditors, lawyers, rating agencies, trustees, and all these special purpose vehicles in the middle. With our framework, you can streamline a lot of operations. First of all, as an investor, you can source individual loans and diversify and allocate capital across different originators, different asset types, asset classes, and geography, and also in time perspectives. So, that means that you don’t have to go through a third party’s process, but rather let the technology do all that, and have the ability to buy these loans directly from other counter parties. And what happens in the middle is that you can verify all the information. You can trade your assets further in this basically open network for financial institutions.

The Future: Open Access, Smart Contracts, Expanded Software Functionality

Later on, the next step is to launch exchange-traded private funds so that pension funds, family offices, and very diverse institutional entities can access them. We’ll introduce the ability to issue fixed income structures in crypto-currencies with smart contracts in order to distribute the coupon payments, and so on. FIC Network will become an open network for institutions, crypto-currency holders, and crypto-currency companies that lack the access to current money markets.

Any small business could become a crypto-holder and then enter the FIC Network ecosystem for access to the capital markets. The trend is toward the ability for any entity to transact on their own without the intermediary involvement or, scrutiny, or complexity currently required. There will be no need to rely on physical entities—a lot of that functionality goes to the blockchain-based protocol itself.

The Latvian Cluster: Talent, Education, Government, Fintech Specialization

I think the talent pool in Latvia is pretty adept in the financial sector. The talent pool in Estonia is actually, in my opinion, even more advanced because they teach a lot of IT subjects very early in their education system. Citizens’ residency is actually based on some sort of blockchain. And they are thinking about launching their own token actually. So, they are the first country in the world that has actually employed this type of technology at the government level. If some hostile state that is right next to the Baltic States invades the country of Estonia, the country and government are fully functional without actually being there. They can be fully digital, their election system will work without being physically there, and it’s just basically unstoppable. So, that’s how they have addressed their cyber security and also physical security of the country. I think that’s very clever. All the countries have a lot to learn from these types of examples.