Disruptive innovation in financial services – what do the next five years hold?

Out-Law Analysis | 10 Nov 2015 | 9:51 am | 3 min. read

FOCUS: Financial services will change over the next five years in many ways. We know that big changes are coming to money, payments technologies and how financial advice is provided. Each will have a transformational effect on how we as a society engage with financial issues. 

To celebrate Out-Law's 15th birthday we are looking ahead to the big changes facing business in the next five years. Read more and follow our celebrations on Out-Law and on Twitter.

We will examine changes in payments technologies and financial advice in the coming days, but first we will turn to money.

The nature of money

The nature of money was not normally a question that came up outside of academic economic circles. But with bitcoin price fluctuations hitting the headlines over the last few years we have all turned our attention to questions such as: what is money? How does it work? And how do we assess its true value? These questions now trouble bankers, lawyers, regulators and business thinkers.

Prior to 2013 digital currencies received little serious attention from regulators but in the last 24 months regulators have given their opinions, engaged in consultations and in some cases taken steps towards digital currency regulation. This has resulted in heightened interest in digital currencies generally and more specifically in the usefulness of blockchain technology, the underling database ledger that enables bitcoin transactions.

Digital currencies are here to stay and bitcoin will be a useful initial test case for the application of blockchain technology to financial transactions.

Bitcoin

Bitcoin in its own right represents a shift in thinking and practice on a scale that has never been seen before. It is now seven years since its creation and the publication of the seminal paper that outlined it as a digital currency dependent on a decentralised distributed ledger system.

Like the pound, dollar and euro, bitcoin has been used as a medium of exchange for tangible goods and services as well as digital ones. It has also operated as a means of storing value separate from any coin, paper note or bank account. Bitcoin has therefore met two of the three generally accepted defining functions of money.

Where bitcoin has failed in terms of its legitimacy to be called 'money' is in its lack of use as a unit of account. This, however, is to be expected due to its decentralised nature and because it has been designed to be limited in total possible circulation number.

While we are not predicting that a digital currency will replace the euro, dollar or sterling at any time soon, we are confident that within the next five years a digital currency will address some of the issues that have held bitcoin back – from the lack of incentivisation to use it, to the question marks that remain around trust and how to address anti-money laundering concerns.

A discussion about digital currency shouldn't be all about the risk. Digital currencies solve some problems that those behind centuries of notes and coins never have, such as that of fakes and forgeries.

Counterfeiting continues to be a problem for law enforcement authorities in all jurisdictions. For example, in the first half of 2015 around 119,000 counterfeit banknotes were taken out of circulation by the Bank of England with a face value of £2.3 million. Last year 434,000 were removed at a value of ​£8.12m.

Due to the distributed nature of blockchain technology, bitcoins have a significant advantage over fiat currencies in combating counterfeiting, since 'blocks' serve as confirmations for transactions in a way that protects against illegitimate bitcoins being used to transact.

The future of digital currencies

A digital currency that addresses regulatory concerns at the design stage and builds on these benefits could within the next five years have a transformational effect on global finance and trade. It could also pose risks to financial and monetary stability. There is good reason therefore for the next crop of digital currencies to be designed at the development stage with regulation in mind.

The experience of the peer-to-peer lenders in the UK could serve as a prototype approach for future digital currency promoters. Instead of avoiding regulation, the peer-to-peer lenders devised their own code of practice before they were on the regulator's agenda.

If a digital currency consortium were to take a similar approach and give regulators the answers to the questions they have already asked, and those that they have not yet thought through, we could see a digital currency gain significant traction and general acceptance as a means of exchange, as a means of storing value and possibly also a unit of account within the next five years.

John Salmon and Luke Scanlon are experts in financial services and technology law at Pinsent Masons, the law firm behind Out-Law.com