Finternet – the new financial architecture

THE 2008 global financial crisis exposed governance issues in the traditional aristocratic capitalist financial system, triggering the Main Street versus Wall Street movement in the United States. Representing the general populace, Main Street issued a strong call for the financial services industry to serve small and micro enterprises, individuals, families, and entire communities. It emphasised that more people, especially those who have not been able to obtain financial services from traditional financial institutions, should benefit. Society sought to reform the financial system of aristocratic capitalism, moving towards “inclusive finance”.

At the same time, we witnessed the advent or breakthroughs of a series of digital technologies associated with the Fourth Industrial Revolution. This series of technologies – including the Internet of Things (IoT), big data, blockchain, artificial intelligence (AI), and cloud computing – empower new application scenarios through their integration. One such scenario is digital finance, which provides financial services in a digital manner using mobile devices like tablets and smartphones. This development allows people in areas lacking physical financial infrastructure to access financial services, giving rise to online financial services and inclusive finance.

The most representative innovation in digital finance is undoubtedly the paper published by Satoshi Nakamoto on Oct 31, 2008, entitled Bitcoin: A Peer-to-Peer Electronic Cash System. The cryptocurrency Bitcoin aimed to create a “decentralised” digital cash system that does not require trust, intending to eliminate intermediaries such as banks, brokers, and credit card companies that charge high fees, are prone to fraud, and pose security concerns due to any single point of failure.

Decentralised Finance (DeFi) does not rely on financial intermediaries to provide financial products and services. Instead, it uses public blockchains such as Ethereum and smart contracts to conduct peer-to-peer financial activities, enhancing the inclusiveness and democratisation of financial services. At one time, DeFi was seen as a promising development with tremendous momentum!

However, has DeFi achieved financial democratisation to date? Contrary to expectations, Satoshi Nakamoto’s spirit and original intention of advocating for “decentralisation” have not been realised in practice. Instead, it has become a shortcut for a small number of people to make a fortune, get rich and line their own pockets. In January 2022, Agustin Carstens, general manager of the Bank for International Settlements (BIS), severely criticised DeFi in a speech at an international forum: “So far, the DeFi space has been used primarily for speculative activities, and in practice, it actually involves a lot of centralised practices. And in the absence of regulation, fraud, hacks and so-called rug pulls have become rampant.”

On Apr 15, the BIS, otherwise known as the “central bank of central banks”, released a paper co-authored by Carstens entitled Fintemet - the financial system for the future. The paper proposes a new concept for the financial system.

The Finternet consists of “multiple financial ecosystems interconnected with each other, much like the Internet, designed to empower individuals and businesses by placing them at the centre of their financial lives”, the writers say.

“It would lower barriers between different financial services and systems, drastically reducing the complex clearing and messaging chains and other frictions that hinder today’s financial system. According to our vision, individuals and businesses would be able to transfer any financial asset they like, in any amount, at any time, using any device, to anyone else, anywhere in the world. Financial transactions would be cheap, secure and near-instantaneous. And they would be available to anyone, ensuring financial inclusion by meeting the needs of currently underserved segments of the population.”

To realise the vision of the Finternet, the article points out that the core structure entails creating “unified ledgers”. The concept does not mean “one ledger to rule them all” – or a single ledger that encompasses all financial assets and transactions in an economy. Depending on the needs of each jurisdiction, multiple ledgers could coexist. Application programming interfaces (APIs) could connect these ledgers to each other.

Unified ledgers have two defining characteristics.

The first is that traditional financial systems have independent and disparate databases to record the ownership of assets, such as land ownership registries or banks’ customer deposit records. Unified ledgers combine all the components needed to complete financial transactions – financial assets, ownership records, rules governing their use and other relevant information – in a single venue.

The second is that money and other financial assets exist on the ledgers as executable objects via tokenisation. Using tokenisation technology, software programs generate digital tokens representing ownership or usage rights of assets that can be circulated in digital form and stored on computer devices. This means that they can be transferred electronically using pre-programmed “smart contracts”. Together, these design features allow individuals and businesses to move money and other assets safely and securely, with less need for external authentication and verification processes or reliance on external clearing, messaging or settlement systems.

Notably, the Fintemet paper emphasises that “not everything should change”.

“Many of the key underpinnings of today’s financial system, such as the two-tier structure with a clear role for the public and private sector, should remain in place. Central bank money should still serve as the trusted foundation of the financial system, with settlement in wholesale central bank money on the central bank’s balance sheet being the determinant of finality in financial transactions. Commercial banks should retain a key role as intermediaries between savers and investors and as providers of commercial bank money. But even in these cases, the assets that these institutions offer to the public should take on more advanced technological representations, in the form of wholesale tokenised central bank money and tokenised commercial bank deposits.”

The article also makes the point that all participants should fully comply with all regulatory requirements and legal obligations, including lawful operation, protection of personal privacy and commercial secrets. Likewise, the application of advanced technologies will be a key driver for the security, compliance, speed and efficiency of the financial system. For example, the programmability of tokens can embed necessary legal and regulatory requirements into the smart contracts of tokens. In other words, policies and regulations will exist in the form of automatically executing code. Meanwhile, verifiable digital identities and seamless data transfer across ledgers will greatly simplify financial institutions’ compliance with “Know Your Customer” rules.

The above illustrates an important point: technology can streamline processes and improve operational efficiency, but any sustainable and sound ecosystem must have appropriate governance, checks and regulatory mechanisms in place. DeFi, which was ardently pursuing complete freedom without any regulation, was just a utopia.

Looking back at history, the previous industrial revolutions combined mechanisation, steam power, and mass production techniques to greatly enhance global industrial productivity. Now, the financial services sector is at a similar juncture, poised to leverage digital, information, and mobile communication technologies to shape a new, borderless financial ecosystem. This ecosystem aims to provide more inclusive, convenient, secure and affordable financial services to eight billion individuals and 300 million businesses worldwide, enhancing the overall efficiency of financial services and thereby achieving economic development and social progress.

The writer is an adjunct professor at four Singapore universities – NUS, NTU, SMU and SUSS. He was formerly director of banking supervision at the Monetary Authority of Singapore (MAS) and MAS Academy.