What the Heck is Web3?

With increased interest around Web3, making sense of the latest and newest technology trend — and its potential impact on financial services —  could add value to strategic discussions as leadership teams and boards consider their long-term strategies.

For early and seed stage venture capital, the top 15 firms invested $1.3 billion in Web3 and decentralized finance in the third quarter 2021, according to Pitchbook. The research company said investment in the space — which includes $900 million into the cryptocurrency exchange FTX and $120 million in Offchain Labs, a blockchain-based, smart contracts platform — beat out the separate fintech category, which landed in the No. 2 spot with $860 million invested.

Not everyone is convinced. In a December 2021 tweet, Tesla CEO Elon Musk called Web3 “more marketing buzzword than reality right now.” He was responding to a video of a 1995 interview of Microsoft Corp. founder Bill Gates with David Letterman, in which the TV host asked, “What about this internet thing?”

That question seems quaint today. Amazon.com had just opened for business as an online bookstore; Mark Zuckerberg would start Facebook roughly a decade later.

Facebook represents the current state of the internet, characterized by centralized platforms that own or leverage user content. But the web continues to evolve; venture capital firms and tech titans are using the term “Web3” to discuss this next phase. These changes encompass concepts that bank leadership teams and boards should be watching and regularly discussing.

“Web3 is really just a rebranding of a lot of the things we’ve already been talking about for a while,” says Alex Johnson, director, fintech research at Cornerstone Advisors. “It’s the collision of the internet and crypto in a way that allows for users of the internet to have verifiable ownership over the companies and products that they interact with.”

The expansion of digital assets underpinned by blockchain — including cryptocurrency and non-fungible tokens (NFTs), which represent ownership in art, music or even real estate — are reshaping the way that internet users think about ownership.

“There will now be the capability to give verifiable ownership — over content, over relationships, over access to special features, over [intellectual property] — to customers or users. And the potential impact of that is that companies that do that will have a significant marketing advantage and retention advantage,” says Johnson. Companies could use tokens to build loyalty and community, granting partial ownership to customers of products or ideas, similar to a referral bonus or share of stock.

Leveraging blockchain technology, investor Ryan Zacharia envisions consumers and businesses building digital identities. “People are going to effectively own and control their own identities and information, and hold that information in a digital wallet,” providing access when applying for a loan, for example. Zacharia is general partner at JAM Special Opportunity Ventures, which invests in up-and-coming bank technologies on behalf of partner institutions.

At the same time, a few banks are using blockchain to power real-time transactions. Last month, I watched the first real-time interbank transfer of stablecoins — cryptocurrency pegged to a stable currency or commodity — between two banks, $53 billion Western Alliance Bancorp., based in Phoenix, and $2.5 billion Coastal Financial Corp. in Everett, Washington. The transaction was facilitated by Tassat Group, which provides blockchain-based payment solutions for banks.

“The ability to have programmable money is a game changer for the whole economy,” says Chris Nichols, director of capital markets for SouthState Bank. “It’s the first time where you have value, the message and the ability to program all in one unit of code. … [T]his opens up a whole new set of products for banks.” Signature Bank, JPMorgan Chase & Co., Customers Bancorp and New York Community Bancorp are among the banks exploring blockchain-based products and services focused on payments and asset securitization.

Fintechs competing with banks are also taking advantage of the disintermediation trends promised by a Web3 economy. In March 2021, Block (formerly Square) acquired TIDAL. The artist-centered music streaming platform allows the Jack Dorsey-led digital payments provider to tap into another niche. In a press release, current TIDAL head and Square executive Jesse Dorogusker said the two platforms would “explore new artist tools, listener experiences, and access to financial systems that help artists be successful.”

Musicians and artists have been early movers on NFTs. Just last month, Ozzy Osbourne launched a “CryptoBatz” collection of NFTs, commemorating the notorious 1982 gig where the rocker bit the head off a bat. Earlier in 2021, the band Kings of Leon released the first NFT album.

“There is an opportunity for content creators, music creators, owners and writers and musicians to eliminate intermediation, connect directly to their fans [and] sell their music as NFTs,” says Zacharia. “That can generate revenue for the musician, and the NFT holders can receive programmatic royalties based on [a song] being played …  or what have you.”

Web3 requires an open mind and a firm foot in reality. Research into these concepts quickly unearth ideas that seem more like science fiction than traditional economics and finance. Facebook, for example, recently changed its corporate name to Meta Platforms as Zuckerberg expects people to interact more in the metaverse. Will part of the economy take place in a digital world, where we interact via avatars in a virtual space?

”It’s important to have conversations that contemplate what the world could look like in five or 10 years,” says Zacharia. The metaverse is an unlikely next step for a typical bank, but he could see an early-mover advantage for an enterprising financial institution that figures out how to bank the space. And despite the sci-fi luster, the evolution of the web promises to soldier on, bringing opportunities and risks for banks to consider, including fraud and cybersecurity. “There’s a tremendous amount of talent and effort and capital that’s going into this,” he says. “Frankly, I don’t think it’s a fad.”

Banking Blockchain: Making Virtual Currencies a Reality for Your Bank


blockchain-10-17-17.pngBlockchain-based virtual currencies are gaining in popularity and evolving quickly. Blockchain currencies often are described as disruptive, but also have the potential to radically revolutionize the banking industry in a positive manner. The reality is that blockchain currencies may develop into a useful tool for banks. Their acceptance, however, is hindered by their own innovative nature as regulators attempt to keep pace with the technological developments. Potential blockchain currency users struggle to understand their utility. Despite these hurdles, many banks are embracing opportunities to further develop blockchain currencies to make them work for their customers.

What Are Virtual Currencies and Blockchain?
Virtual currencies, also referred to as “digital currencies,” are generally described as a digital, unregulated form of money accepted by a community of users. Currently, blockchain currencies are not centrally regulated in the United States. For example, the federal government’s Financial Crimes Enforcement Network (FinCEN) and the Securities and Exchange Commission view blockchain currencies as money, the Commodities Futures Trading Commission sees them as a commodity, and the Internal Revenue Service calls them property. The IRS has attempted to define virtual currency as:

a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value [and] does not have legal tender status in any jurisdiction.

FinCEN, the agency with the most developed guidance regarding virtual currency, regards it in a more practical fashion as a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. Whatever the regulatory definition, virtual currencies need more certainty in form and function before their use becomes commonplace.

Blockchain technology brings benefits to payment systems and other transactions that are quite revolutionary. Blockchain technology is essentially a decentralized virtual ledger (aka, distributed ledger), utilizing a comprehensive set of algorithms that records virtual currencies chronologically and publicly.

Some examples of blockchain currencies currently in use are Bitcoin, Dash, Ether, Litecoin and Ripple. These currencies are constantly evolving and are being developed by individuals, technology-based peer groups or financial institutions. In August 2016, a consortium of banks, led by UBS, Deutsche Bank, Santander and BNY Mellon, announced the development of the “utility settlement coin” or USC. The USC is meant to allow banks to transact payments in real time without the use of an intermediary. It is expected to go live in 2018.

Blockchain Currency Opportunities for Banks
Despite their reputation for being tools of illicit trade, blockchain currencies may be useful to banks in a variety of ways and can achieve certain benefits. Blockchain currencies could:

  • actually reduce fraud, including hacking or theft attempts, because the technology makes every step of the blockchain transparent.
  • reduce costs and risks associated with know-your-customer (KYC) programs because blockchain has the ability to store KYC information.
  • allow a financial institution to establish a new trading platform for exchange that eliminates intermediaries.
  • potentially could transform the payments industry. An obvious example is the USC, which permits payments to be made in real time, without the use of intermediaries; and strengthens the confidence in the authenticity of the transaction. Banks that are either able to establish a blockchain currency or adapt a proven technology for their operations will generate operational efficiencies and obtain a significant competitive advantage.

What Are the Regulatory Challenges?
Blockchain currencies currently are not centrally regulated in the United States. As discussed above, the lack of a uniform definition is a fundamental issue. FinCEN has classified any person or entity involved in the transfer of blockchain currencies as a money transmitter under money services business regulations.

As blockchain currencies continue to evolve, however, additional federal laws and regulations must be drafted to address the most substantial areas of risk. Some states are weighing in on the topic as well. For example, the Illinois Department of Financial and Professional Regulation recently issued guidance on the use of virtual currency in which the Department views virtual currency through the lens of the Illinois’ Transmitters of Money Act.

Additionally, the Uniform Law Commission is developing regulations that would, among other things, create a statutory structure (for each state that adopts it) to regulate the use of virtual currency in consumer and business transactions. Regardless whether the federal government or the states enact legislation affecting blockchain currencies, a more uniform regulatory approach would greatly aid their development and utility.

Conclusion
Blockchain currencies, and the laws and regulations governing them, are in a promising state of development. As new technologies emerge and existing technologies continue to evolve, banks are presented with real opportunities for innovation by successfully adapting blockchain for use by their customers. Those that figure it out are poised for real success.

Blockchain Information Series: It’s All About the Block


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FinXTech Advisor, Christa Steele, has created a four part series to educate our community about how blockchain is changing the transaction of digital information, its implications and the players who are shaping this technology. Below is Part One of this series.

Part Two
Part Three
Part Four

I started researching blockchain in the fall of 2015 and became intrigued by the new digital currency called bitcoin. My attention quickly turned to how bitcoin was produced and the ways in which its underlying technology, the blockchain, was being explored in the financial sector. Early use cases were focused on international payments, foreign exchange, bond issuances, clearing and settlement processes. My intrigue has since broadened far beyond that of just the financial sector.

By way of background, I am not a programmer or developer. If you ask my friends and family they will tell you that I often struggle to properly use my (supposedly) universal remote control! My view of blockchain is from the practical application standpoint of how this technology can be integrated. Businesses today, whether you are a financial institution, manufacturer or a packaged goods provider, must be data driven and place business intelligence at the center of operations. There is a lot of low hanging fruit that can be picked from the proverbial fruit tree by utilizing blockchain technology—specifically, efficiency gains, cost saves, reduction in errors and redundancies, improved collection and storage of data without compromising good corporate governance.

For example, today in the financial industry, it is not uncommon for a stock trade to take two to three days to settle, or for bank loan trades to take in excess of 20 days to settle. Think about the amount of manual processes, double and triple entries being conducted today by multiple employees. Using blockchain technology, the average trade takes less than 10 minutes while at the same time effectively mitigating settlement, counterparty and systemic risk. Morgan Stanley Research group estimates the cost savings of using blockchain technology for trade settlements could save the industry in excess of $20 billion.

Who started it all?
First, let’s take a trip back in time and think about 1993. Were you a little reluctant to give up your old reliable friend, the fax machine, for e-mail? In addition to e-mail, we all became exposed to the worldwide web, .coms, social media and more sophisticated mobile phones, to name just a few communication advancements.

For the next several years, security and privacy became increasingly important as cybercrime grew to become a serious threat, and also when cryptography began to take center stage.

In 2008, Satoshi Nakamoto created the first peer-to-peer electronic cash system called bitcoin. Initially, it was all about currency and the ability to securely transact by eliminating all middlemen, costs and complexity of transactions. This was done through a shared ledger and network, cryptographically, using mathematical algorithms to confirm transactions and entities.

Though there are many passionate enthusiasts forging ahead with digital currency, it’s important to understand that this development will take time. It is unlikely we will see a conversion of all U.S. currency in our lifetime. Today, this would require the production of 21 billion bitcoin to replace all existing U.S. currency. However, it is realistic to assume some form(s) of digital currency will prevail at some point in the future.

What is it?
A software that enables data sharing across a network of computers.

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Today we are centralized. Blockchain offers a decentralized and distributed system through shared software infrastructure and trust. Users agree to a software protocol that describe the rules for the type, quality and transferability of data in addition to the rules for authorization, verification and permutation.

How does it work?
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Let’s simplify this very technical description of how blockchain works by remembering that a blockchain can be likened to an assembly line in an auto manufacturing plant in which each block represents a component of the car, or in this case, computers transferring blocks of records in a distributed ledger. The end product, the car, is the bitcoin or token used to record and transfer the asset.

If you want to learn more, Don Tapscott’s book “Blockchain Revolution” is a great and easy read. You can also visit Kahn Academy online for more bitcoin and blockchain tutorials.