In this dizzying new world, one minor shock to the system can have a multiplying impact throughout the whole network, where the connections in the chain appear to stretch into the infinite.
FinTech challenges traditional financial services and forces them to adapt to remain relevant. For customers, it might imply greater access to better services. The global fintech industry is predicted to rise steadily over the forecast period 2022-2027, reaching a market size of roughly $324 billion by 2026, rising at a compound annual rate of around 25.18 percent.
FinTechs can enhance consumer access to financial services while simultaneously lowering costs and increasing efficiency. However, their fast rise in "systemic relevance" is posing regulatory concerns. "While most individual FinTech firms are still insignificant, they can scale up very quickly across both riskier clients and business segments than traditional lenders," stated members of IMF's Global Markets Analysis division.
As per the study, "there comes a problem in financial stability when services provided by fintech’s are bank-like, however, operate under less severe limitations than banks.” In the absence of appropriate rules, fintech’s business model depends on speedy progress, which may result in extreme risk risk-taking, mainly by banks determined to reserve their position in the market. “This can result in capital loss and increased systemic risk."
According to the IMF, despite the rising importance of FinTech platforms and neo banks in their respective markets, these platforms are more exposed to risks from consumer lending, which often has less barriers against losses since it is more uncollateralized.
Their exposure also involves more risk-taking in their securities portfolio, as well as larger liquidity concerns, notably in terms of liquid assets held relative to deposits, which are often lower than what traditional banks keep, as per the reports.
"However, these aspects also provide a challenge for regulators: most neobanks' risk management systems and overall resilience have yet to be tested in a financial crisis." FinTech businesses not only take on additional risks for themselves but also put pressure on long-established sector rivals.
Decentralized finance (DeFi), a crypto-based financial network without a central intermediary, is another technical breakthrough that has evolved significantly in the last two years. It is also known as DeFi, and it has the potential to provide more creative, inclusive, and transparent financial services due to increased efficiency and accessibility.
This relatively new method of blockchain-powered financing, which avoids traditional intermediaries, has seen locked-up assets expand from less than $1 billion in 2019 to more than $100 billion only two years later, drawing at least one million investors. With more institutional investors entering the DeFi business, the market is predicted to rise to $800 billion by 2022.
DeFi, on the other hand, includes the accumulation of leverage and is particularly exposed to the market, liquidity, and cyber threats. Cyberattacks, which may be devastating to traditional banks, are frequently fatal to these sites, taking financial assets and destroying user trust. The absence of deposit protection in DeFi contributes to the idea that all deposits are in danger. Historically, substantial customer withdrawals have typically followed reports of provider hacks.
Unsurprisingly, the disruption of the traditional banking system has resulted in requests for regulation, but the DeFi arena is unexplored ground.
As DeFi upsets the financial services industry, regulatory authorities are rushing to determine who has the authority to regulate this new profession and what those laws may be. Depending on how it is implemented, DeFi's quick development may decelerate in the future years.
Many DeFi networks are expected to increase their efforts to become completely decentralized by dissolving the linkages between specific users and their platforms in preparation for future regulation.
However, jurisdictions will be keen to evaluate the economic benefits of DeFi innovation against any regulatory control, as well as implement regulations like AML/CFT. The road ahead may be hazy, but DeFi investors should keep an eye on the growth of regulatory frameworks influencing this emerging financial industry.