5 challenges that traditional players are unable to overcome.
In my previous article, I identified five key signals that are shaping the alternative finance space in the Eurozone. Each of these signals is valuable when considered individually. More interestingly, however, are the counterintuitive relationships that arise from their interplay. When we take a closer look, we can pinpoint the barriers preventing traditional players in the financial sector from creating and operating a cohesive single market ecosystem on their own.
To shape Europe’s digital future, I believe novel business models such as Regulated Decentralized Finance and Distributed Ledger Technologies to be key in paving the road for a single market ecosystem. But first, let us dive into the 5 challenges traditional industry players are unable to overcome.
1) How can we all benefit from EU-wide harmonization while maintaining local differences?
The harmonization of regulatory frameworks within the European union aims to level the playing field, allowing all countries to reap the same benefits when scaling their products and services to serve small and medium-sized enterprises (SMEs).
However, in practice, this will lead to a small number of well-positioned countries swallowing the market shares of those solely protected by their national differences. A previously diverse SME sector would suddenly be at the whims of the countries with sufficient legal and commercial power to serve the entire market. This aim comes to companies naturally, as they intend to maximize their shareholder value.
To ensure a healthy and diverse market, it is crucial to have them co-exist with local advisory firms that play a key role in onboarding SMEs, as this will remain the dominant route via which SMEs will be served.
2) Who will pay for an ecosystem that is supposed to lower barriers to entry?
Progress is change, and change isn’t always in everyone’s best interest.
The creation of a new, open, digital financial ecosystem requires a new infrastructure that may not serve the status quo. Such an infrastructure would allow for the reduction of intermediaries, the abolishment of switching costs, and the pruning of service fees. Investors would be able to shift between service providers with ease, including stock exchanges, crowdfunding platforms, and the like.
Players in the industry as it exists today would see their ability to lock users and value into their platforms diminished. For the moment, evolution does not seem to be in their best interests.
3) How can we allow operation at increased scale and still be SME affordable?
When scaling a company, every stage comes with its own opportunities and limitations. Tapping into a new central digital platform might be challenging and either financially or time-prohibitive.
Large stock exchanges today have to contend with high fee stacks resulting from large corporate departments. A central European platform that operates at scale runs the risk of following in the same footsteps, essentially making onboarding and participation on the platform economically impossible for SMEs.
The challenge will be to create a platform that interoperates at scale while remaining affordable and achievable for SMEs.
4) How can we share information freely without revealing SME trade secrets?
SMEs are, by nature, riskier investments.
To successfully grow their business, they must keep their innovations or trade secrets close to their chest. Full transparency is a liability, which means public information is scarce and sometimes less trustworthy. Obtaining relevant information about the financials and potential of an SME is often very costly, making it more difficult to appeal to investors.
A central European platform that serves and compares SMEs would require a homogenized data flow, with each SME forced to put all their cards on the table. If these SMEs are expected to do so, trust in the systems created for this data flow must be fostered and the incentives must be persuasive for companies to participate. Having this kind of data at the disposal of a centralized gatekeeper would not be beneficial to SMEs, causing them to abstain from participation.
5) How can we innovate asset types to properly match SME funding needs?
Due to the aforementioned risk involved, banks are not keen to invest in SMEs. If the nature of your business doesn’t have a proven success record or isn’t immediately profitable, banks are unwilling to take the risk. Clearly, there is a desire for alternative financing and venture capital to fill the gap in SME funding left by banks.
But not all funding is created equal. Where bank financing is primarily debt-based, venture finance and crowdfunding are often equity-based. A fair and healthy market for SMEs needs to provide a combination of both.
Long equity lockups will result in capital inflow but no capital movement, thereby worsening liquidity. Also, companies need their equity to compete in a competitive digital space, using it to bind customers, partners, and employees to their vision.
For SMEs to thrive and grow their business, they should have access to a combination of both types of financing. Lopsided funding would result in inflexible SMEs and decreased investor liquidity. As traditional equity funding is mighty expensive nowadays, SMEs are reliant on alternative methods of financing, and in need of technological innovation to bring down costs of funding.
Balancing the 'Greater Profit' and the 'Greater Good'.
By solving these challenges, we can envision a new ecosystem. An open, cross-border platform that allows for local needs, yet benefits from the European scale, while also offering flexible financial instruments at low cost. As it stands, many existing players would find themselves at a disadvantage in this brave new system. After all, how does one generate immense profit from such a balanced ecosystem?
However, the alternative is industry stagnation; building something that trends towards a copy of today’s system will result in the creation of a platform that will not see any adoption. Key players would opt for the maximization of their own segments, and in doing so, exclude an entire sector from adequate funding.
A successful new platform will therefore not be solely built out of the incentives that drive the private good (i.e. companies and their bottom line); it will also include elements that are driven by serving the public good (i.e. free, open systems that everyone can use). That is why we need a solution that is public, but respectful of the privacy of information, inexpensive in its usage, and widely available to all kinds of investors, companies, and service providers.
In the next article, I will explain how Dusk Network can become this catalyst towards the future of finance. With an affordable, public, privacy-preserving, and self-sustaining ecosystem like Dusk Network, Europe’s vision for a single digital market can see the light of day.
Business director Dusk Network