Web 3.0 in financial services – a transient concept…

Rapid technological development is connecting consumers and businesses through innovative solutions and business models. The internet is the primary technology used to read, write and share information, and interact with people all over the world. An estimated 4.95 billion people used it in January 2022.¹ And now we’re moving towards Web 3.0, representing the third generation of the web, also referred to as the Semantic Web or the Decentralised Web. But what opportunities does Web 3.0 present to the financial services industry and what are the implications for established players?

The shift towards Web 3.0 opens opportunities for a Token Economy

Conceptually, we can think of Web 3.0 as a collection of digital products and services enabled by a decentralized infrastructure, a distinct change from the centralized predecessors in Web 1.0 and Web 2.0. A key implication is that no authority owns, or has the possibility to change, the information once it’s verified, which provides secure value exchange without an intermediary. As a result, As a result, privacy and trust typify Web 3.0 applications as the decentralised as the decentralised infrastructure gives the user ownership of their data while simultaneously being immutable.

Blockchain technology makes decentralisation possible through its distributed ledger. All devices connected to the ledger, referred to as nodes, read, verify and distribute data within the network. Blockchain also enables the use of smart contracts. These are simple programs stored on a blockchain that run when predetermined conditions are met, enabling the execution of an agreement or workflow, automatically triggering an action when conditions in the contract are met. Additionally, the technology enables the use of cryptographic tokens to protect sensitive data while maintaining its business value. These tokens represent programmable assets or access rights and can constitute a store of value or a set of permissions in the physical, digital and legal worlds. Combined with smart contracts, tokens can efficiently facilitate value exchange between users.

Financial services see some emerging applications of Web 3.0 in payments and securities, representing the infrastructure of Decentralized Finance (DeFi) and cryptocurrencies. With a total market capitalization of $1.92 trillion,² cryptocurrencies have seen substantial growth, outpacing the total value of Euro banknotes in circulation, which was approximately €1.5 trillion in February 2022.³ Another application that has gained considerable traction within digital ecosystems is Non-Fungible Tokens (NFTs), often associated with digital files such as photos, video and audio. The ecosystems represent objects as NFTs with an intrinsic value that can be sold and traded in a market. This enables the introduction of financial products and services that mostly operate outside of the established financial system, controlled by the digital ecosystem rather than traditional financial institutions as we know them. This shift could challenge the ‘raison d’être’ for the current financial system and its participants. But at the same time, could also offer growth opportunities in the new, digital financial ecosystem.

Web 3.0 applications to expand the financial ecosystem

Web 3.0 presents growth opportunities for both start-ups and incumbent financial services providers across the centralised and decentralised financial infrastructures. Financial services companies are experimenting with blockchain technology and API-based integration with legacy banking services in their existing value proposition. This integrated approach seeks to improve the user experience and accessibility of existing services, while exploring new growth avenues in emerging digital markets. For instance, service providers in capital markets issue Exchange-Traded Funds that track one or several underlying crypto-asset indexes. We also see new service providers offering NFTs and tokenised objects within art, real estate and more. Financial service providers could incorporate similar offerings into larger products.

Cross-border payments

Cross-border payment processing is a profitable business area for banks and companies within the industry. But it’s costly and time-consuming for the customer, while crypto assets provide an infrastructure to move money globally almost instantly and at an affordable cost. So, Web 3.0 has the potential to radically change the cross-border payment market. This view is supported by the European Payments Council with more than 90% of its members believing blockchain technology will disrupt the industry by 2025.⁴

From a Nordic point of view, mass adoption of a decentralized cross-border payment solution that competes with SWIFT and corresponding banking solutions could lose banks substantial revenue. According to Norway’s central bank, the total amount of payments to foreign countries exceeds 6 trillion NOK annually,⁵ generating significant revenue through transaction fees.

Figure – The history of the web (Token Economy, Shermin Voshmgir, 2019)

Financial inclusion

Alternatives to traditional financial infrastructure are becoming increasingly relevant, also in Europe. Consumers and businesses in countries with limited access to traditional financial infrastructure can get access to payments and financing through applications leveraging decentralized finance. A very recent example is the conflict between Russia and Ukraine that has forced the Ukrainian central bank to limit digital money transfers, yet there’s a need to receive and distribute financing and donations from supporting countries. As a response, the Come Back Alive NGO has raised about $60 million in more than 120,000 crypto-asset donations since the invasion started.¹ In turn, the Ukrainian government recognises and uses the donations to fund the country’s relief organisations and military. Consequently, this provides a donation alternative that is open, transparent and accessible for individuals and businesses seeking to provide financial support directly.

Bridging the regulatory gap in the digital economy

Introducing technology and business models that aim to be truly open with no centralised authority might sound like a pipe dream for a highly regulated financial services industry. There’s currently a gap between the technology advocators seeking distributed ownership and legacy providers protecting a centralised approach. However, acknowledging a growing digital economy supported by a distributed financial infrastructure spurs a need for a common framework. In Europe, the Markets in Crypto Assets (MiCA) directive and the DLT (distributed ledger technology) regulation are examples of regulatory frameworks that seek to build an economy fit for the digital age.²,³

Regulation will increase the legitimacy of decentralized products and services for consumers and financial services providers, create consistency with existing policy, and promote innovation and fair competition. Cross-border taxation is another regulatory topic that will be increasingly important as assets are seamlessly purchased and sold globally. Provided there is sufficient regulation, financial institutions will play an important role in supporting national and cross-border tax authorities with validating transactions ownership and the financing of digital assets.

Digital financial infrastructure operating outside the legacy monetary system is a risk of growing importance to central banks. As a response, there are dedicated central bank initiatives in the Nordic countries, which are in a phase of testing and experimenting technical solutions.

Through a public-private collaboration, the Swedish central bank is piloting the concept of a Swedish digital currency called e-krona,⁴ exploring whether and how it can function alongside traditional means of payment. The key questions arising from the project relate to how core banking systems can interact with e-krona and how to facilitate secure interchangeability between e-krona and other types of money.

In Norway, a dedicated central bank working group is in the fourth phase of its investigation into the introduction of Central Bank Digital Currency.⁵ It’s currently performing experimental technical testing and extended impact assessments. The outcome will be to finalise a decision to move forward with a preferred technical solution. For further insights on this topic see our previous PA Perspectives article, Are CBDCs the future of money?

Web 3.0 will have a significant long-term impact, but it is still an emerging technology

The evolution towards Web 3.0 represents a potential shift in how financial products and services are created and consumed. Like its predecessors, Web 3.0 is expected to impact consumers and businesses gradually. Technical and regulatory aspects are still in an early stage and will require maturation before being broadly applicable in the financial services industry. Web 3.0 business models are predominantly adopted by younger companies operating within financial services and social media. However, Web 3.0 is likely to evolve, so having a fundamental understanding of the potential impact and how to position is key. Identifying growth opportunities within decentralised finance and seeking business development through digital assets will be important to ensure a lasting and sustainable market position in a future digital economy.