APIs in Action: Open Banking & DeFi
We have stressed time and again that APIs have the power to transform a business. It is just that some industries lend themselves more to API-induced extendability compared to others. Finance is one such industry, and has benefited immensely from API-powered transformation lately.
Certain financial practices such as lending money or financing a purchase have been around for thousands of years since the days of overland trade networks under Assyrian and Babylonian monarchies. The bank as an institution as we know it, however, came into being in Renaissance Italy in the fourteenth century, where city-states of Venice, Genoa, Florence, and Pisa were running their overseas trade empires, and their merchants needed instruments to facilitate trade. The banking infrastructure expanded considerably over the centuries, but the services and products offered by banks have remained fundamentally the same. Two new concepts, open banking and decentralized finance, are slated to change that, apparently.
Open banking refers to a system where “banks open up their APIs to third-party service providers to access clients' financial data and conduct financial transactions on the clients' behalf." This concept represents a departure from the centuries-old practices of the finance industry where a few institutions monopolize financial data toward a more open model where new stakeholders like fintech companies will get access to the same data.
Open banking as a concept resulted from an effort in the UK to regulate the retail banking sector, which was dominated by a few big banks. In 2016, UK Competition and Markets Authority stipulated that the nine largest banks would open APIs for securely sharing customer financial data with third parties. EU took a similar step by enacting the PSD2 regulation, forcing banks to open dedicated APIs to let customers securely share their financial data with third parties. These two regulations had similar goals:
Increasing the competition in the finance industry so that customers could get access to a broader range of offerings that better fit their needs at a lower cost
Ensuring seamless transmission of financial data
Giving customers a single contact point for managing all of their financial products and services.
Open banking offers significant benefits to all parties involved in it. Legacy banks get to monetize their existing infrastructure by opening it to third-party users, and they end up creating a new stream of revenue. Fintech companies find a chance to build a business on top of the infrastructure of legacy banks and offer competitively-priced, innovative banking services to a customer base previously neglected by established banks. Clients, too, stand to benefit a lot from open banking practices. They can pick and choose from among a broader range of options tailored to their needs, get to enjoy lower service costs, and gain more visibility into their own financial data.
APIs prove particularly effective in facilitating certain types of transactions. They can automate the transmission of financial data and reduce the time and bureaucratic effort involved in arranging loans or financing. Additionally, APIs can expedite the reconciliation process among multiple bank accounts by allowing your accountant to access whatever data he needs without the need to request bank statements from each bank.
Stripe, the widely-popular payment processing platform, offers two services, Stripe Treasury and Stripe Capital, which help illustrate how open banking works in different cases. Stripe Treasury is a banking-as-a-service (BaaS) platform where Stripe gets access to the infrastructure of a legacy bank such as Goldman Sachs or Citibank, and opens that infrastructure to its own clientele. This arrangement has let banks achieve two goals: Lower customer acquisition costs and tap into an underserved customer segment. Customers benefited, too, by getting access to the regulated system of an established bank.
On the other hand, Stripe Capital is a lending program in which Stripe leverages APIs to lend money to merchants conducting trade on the Shopify platform. Stripe Capital introduces capital from legacy banks to small businesses in a much frictionless way, creating added value for everyone involved.
Open banking represents a significant stage in the customization and decentralization of banking services, but it is far from the pinnacle. That pinnacle today happens to be decentralized finance (DeFi), which is an ecosystem of financial applications and projects built on top of blockchain technology. Transactions in the DeFi ecosystem are not mediated by a bank, a broker, or a stock exchange but smart contracts, which are Ethereum accounts that can hold funds and send/refund them based on certain conditions.
DeFi threatens the whole financial system as we know it. It challenges the unquestioned authority governments and international institutions wield over the financial system. It reverses the data visibility game we have grown used to. What has always been visible to governments and opaque to individuals become entirely reversed now, with individuals gaining complete control over their financial data away from the prying eyes of governments. DeFi gives people excluded from the financial system a chance to get back in the game. This may prove especially vital for people like refugees who lack the necessary documentation to open a bank account and people who remain unemployed due to lack of access to a financial service.
Crypto exchanges facilitate DeFi transactions by opening APIs and letting users perform transactions via those APIs. This gives the end-users the chance to leverage the hardware of crypto exchanges without having to invest in such equipment. In that regard, DeFi practices are not that far off from open banking practices, where legacy banks open up their infrastructure to fintech companies through APIs.
It might be difficult for you to comprehend all the possible ramifications of opening up your platform to the outer world via APIs. The only factors limiting the possibilities are the imagination of your end-users and the power of your APIs. The lesson to be learned here is that APIs can help you keep your customers happy by enabling them to develop a solution for their problems and give you a resilient ecosystem built around your product.