Seven hundred years ago, the Medici family figured out something so clever and transformative it's like sci-fi to imagine the global economy without it. The Florentine bankers realized it wasn't necessary to own all the businesses (along with all the risk) to be wealthy and powerful; it was much better to keep track of their debts and credits, loan them all money and then take a slice of all their transactions. Risk was greatly reduced, banks did well in bad times and good, scale and opportunity for growth were limitless.
And lo, the modern bank — and banking business model — was born.
Canadians are really good at banking. In 2015, the World Economic Forum ranked our banks as the soundest in the world (for the eighth consecutive year), and in Q3 2016, our five biggest delivered almost $10-billion in profit. They're also global: TD Bank now has more branches in the U.S. than Canada.
But now, another innovation is poised to shake up the banking world on an almost unimaginably larger scale.
You've likely heard of bitcoin, which is cryptocurrency (essentially digital money). For now, forget everything you have read, heard or assumed about bitcoin; think instead about the software that makes bitcoin and other digital currency possible. It's called "blockchain," and inside of a decade, blockchain will upend the familiar order established by the Medici family in the 14th century.
Blockchain is open-source software (free to anyone who wants to code with or improve it) that provides unhackable, authenticated and indelible records of transactions — something that, until recently, only banks could approximate at scale.
Today, when you pay your hydro bill, for example, you're basically requesting a transfer of funds from your account to the hydro company's account. Your institution keeps a record of your balance, processes the transaction and then the bank (along with the receiving account's bank) verify funds have been transferred, each reconciling their separate records. Blockchain is disruptive because no bank or third party is required to facilitate transactions: it allows you to pay the hydro company directly.
Here's how it works. All transactions are recorded on a public ledger, which is available and accessible to all of the people on that blockchain. Blockchain software distributes identical copies of this ledger across thousands of computers, meaning that if you change your personal account ledger (or "digital wallet") to show you sent money you didn't have (or sent the same money twice) it won't sync up with the other records in the system and the transaction will not be accepted. Having thousands of identical copies of the ledger also means they're unhackable – you'd have to change each one.
When banks verify transactions, they're essentially ensuring there aren't two "copies" of the $100 you paid hydro (one in your account, one in theirs). With blockchain, because there is only one true record, you can conduct almost any financial activity (pay a bill, send a remittance, borrow) peer-to-peer and in minutes - no third-party reconciliation is required.
No more transaction fees
This means that banks ("your payment will be processed on the next business day") aren't needed to confirm that money has gone from account A to account B. The security (and delay, and cost) of bank authentication isn't required. Unfortunately, that's also how many banks make much of their profit. Transaction fees, anyone?
Obviously this description is simplified, but make no mistake: blockchain is an earthquake; it threatens the legacy position of banks as sole gatekeepers of the safe, accurate and verified financial transaction. They know this. Earlier this year, the Bank of Canada and 90 other global financial institutions presented their blockchain and digital currency research at an IMF/World Bank Conference hosted by the U.S. Federal Reserve. Most of Canada's big banks are also members of the R3 Consortium, a group working to develop global blockchain standards.
The world of banking (and many others) are facing reconfiguration of business models that have reliably delivered vast wealth. But in challenge lies opportunity: could Toronto or Ottawa be the Florence of the future? As business consultant Greg Satell likes to say: "Successful companies don't adapt – they prepare."