Open finance is one of my favourite topics in recent months because of its growth potential and future importance.
Firstly, Open Finance refers to a concept of user data handling, a major shift from anything known before. This concept envisages accumulating all data relevant to a person’s financial activity into a digital identity. This identity is owned by the person and is shared with financial service providers at his/her discretion.
Consequently, this concept leads to a vision of a new financial system where financial services, products, and data are made available and accessible to everyone, regardless of their location, income, or financial status. Open finance enables the creation of new financial products and services that are more inclusive, transparent, and secure than traditional financial services.
There are 3 key benefits that open finance in centralized platforms can bring, including:
Open finance in centralized platforms can increase access to financial services, especially for people that are neglected by traditional finance, by providing more affordable and accessible financial products and services.
Even the slightest use of innovative data approaches can pose benefits to financial institutions and their clients alike.
For example, the use of an online psychometric questionnaire in the loan application process within a portfolio of self-employees, thin file customers in a European retail bank showed that the use of non-traditional data may be, at the same time, credit inclusive and a booster for the credit model accuracy, leading to dramatically lowering default rates.
As you can see in the chart below, write-off rates before the scoring deployment (2015 and 2016) were 30-37% and after the deployment (2017 and 2018), the write-off rates hovered at 6-8%.
Centralized open finance applications can leverage advanced security technologies, such as encryption and multi-factor authentication, to protect users’ financial information and assets. Centralized open finance applications can offer greater transparency, as transactions and financial data are stored on a public ledger that all market participants can access.
Centralized open finance applications can process transactions much faster than traditional financial institutions, as they can employ cutting-edge digital platforms and blockchain technology. On the other hand, open finance in centralized platforms can offer lower costs compared to traditional financial services, as their extensive use of technology and ‘tech-first’ approach reduces overhead costs and pass savings onto users.
All in one, these 3 key benefits combined are not just helping financial services improve overall user experience. They also enable the creation of more competitive products. Rich and accessible data create more opportunities, which can lead to better financial products and services for consumers.
The future for open finance is very promising, as it has the potential to bring many benefits to consumers and the financial sector. Some key trends and developments that are likely to shape the future of open finance include:
Open finance is likely to continue to grow in popularity, as more consumers and businesses adopt financial products and services that are based on open finance principles. One of the first waves for open finance is how likely it is to be integrated with traditional finance, as financial institutions and regulators recognize the benefits of open finance and look to leverage it to create new and innovative financial products and services.
Let's look at Robinhood as a centralised platform example for using open finance principles:
Robinhood uses open finance principles to make financial services more accessible, efficient, and cost-effective for its users.
One of the most frequent open finance applications is account aggregation meaning that customers can see multiple accounts from different providers on one interface (Plaid, Tink).
Also, open finance can speed up loan approval through instant risk assessment. This is enabled by platforms providing access to client data from different banks (Zip Pay, Klarna). These services contributed to a surge in the popularity of ‘Buy now pay later’ services. There are quite a few other successful examples of centralized platforms that use the open finance concept to different extents, such as Paypal, Coinbase or Square (embracing open finance principles by providing a platform for users to buy, sell, and hold crypto assets, and by offering small business loans). These, and many more such examples prove the open finance potential.
Also, another reason why open finance is likely to be integrated with traditional finance is improved security.
Centralized platforms that implement open finance can use advanced security measures, such as encryption and multi-signature transactions, to secure user funds and prevent fraud.
Regulation is likely to play a key role in shaping the future of open finance, as governments and regulators look to balance the benefits of open finance with the need to protect consumers and maintain financial stability.
Regulators around the world are grappling with how to handle the new and rapidly evolving world of open finance and its associated technologies.
Overall, regulation is a major challenge for the future of open finance. Finding the right balance between the two major objectives, innovation and safety, will be key to the success of open finance.
Open finance can be decentralized or centralized, but decentralization is a key principle of the open finance movement.
The growth of decentralized finance (DeFi) is one of the biggest trends in open finance.
Decentralization in open finance refers to the distribution of control and power of customers over financial services, products, and data.
DeFi refers to a growing ecosystem of financial applications built on blockchain technology that provides alternatives to traditional financial services, such as lending, borrowing, and insurance. Some examples such as Ethereum, Binance Smart Chain, Polygon, Aave (open-source lending platform), etc
There are still, however, so many existing challenges of DeFi such as:
That being said, it is important to note that the decentralized finance ecosystem is still in its early stages, and there are efforts underway to address these concerns and make these services more accessible, secure, and user-friendly.
Additionally, as more people become familiar with open finance, it is likely that trust in these services will increase and DeFi is definitely one of the biggest trends in open finance
Overall, the future for open finance is very promising, as it has the potential to bring many benefits to consumers and the financial sector.
As the trend towards open finance continues to grow, it will be important to monitor and understand its impact and to work together to ensure that it is developed and adopted in a responsible and sustainable manner.
Also published here.
The lead image for this article was generated by HackerNoon's AI Image Generator via the prompt "money and gold".