At this year’s Singapore FinTech Festival, Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), explained succinctly why Web 3.0 was the theme for this year’s event.

“Web 3.0 can potentially disrupt the world of finance. This is the phenomenon of decentralised finance or DeFi where end-users perform financial transactions directly with one another using smart contracts, without the need for financial intermediaries. It is a fundamentally different approach to financial infrastructure, compared to the centralised systems of today,” Menon said in his keynote.

Decentralised finance or DeFi is a subset of Web 3.0. As an example of DeFi, Menon cites crypto tokens being bought and sold on decentralised exchanges, without the need for intermediaries to clear and record the trade. Another example is borrowing and lending, where anyone can lend and borrow directly to others via a liquidity pool managed by a smart contract.

Even as the talk continues, Singapore banks are taking a multi-pronged approach to growth initiatives for the next decade with green finance, trade finance, wealth management, and digital assets and tokenisation in their capital markets space. The backbone, technology and digital platforms for these initiatives are likely to be enabled by distributed ledgers and blockchain, which have also given rise to decentralisation.

However, regulators, experts and the general population aren’t really sure how Web 3.0 will work out because humans haven’t quite fully embraced it as a species.

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What we can see at present are the downsides of the current Web 2.0. This was demonstrated when the harmful algorithms in Facebook were brought to light both in US Congressional hearings, UK parliamentary hearings and in the European Union’s parliament. Facebook has renamed itself Meta (short for Metaverse) to move away from the notion of “doing harm”.

Indeed, if Web 3.0 clips Facebook’s wings, the world would cheer.

When asked whether Web 3.0 is seen as a threat or opportunity, Helen Wong, group CEO of Oversea-Chinese Banking Corp (OCBC) said, “Web 3.0 should be an improvement on Web 2.0.”

The group CEOs of DBS Group Holdings and United Overseas Bank (UOB) also gave similar answers although they backed it up with different examples.

Wee Ee Cheong, group CEO of UOB, sees uses for DeFi but believes regulation will still be needed to prevent chaos. He says, “This is a new concept. The benefit is financial inclusion, innovative products and transparency. What is more important is that we [as a bank] must make sure we protect user interest,” he says, referring to his customers, which he has said time and again that the bank must support in good times and bad. If a manifestation of DeFi is a product such as peer-to-peer (P2P) lending, then consumers need to be protected by certain regulatory frameworks.  

Piyush Gupta, group CEO of DBS, says, “DeFi is a big question. If you fast forward 10 years and asked me whether banks will be needed in a world of DeFi, I would say I don’t know because the whole construct of a decentralised system means you don’t need intermediaries. You could very easily make a case that in a future world, nobody needs banks or stock exchanges anymore. Everybody just deals directly with each other.”

Great leap forward?

One country which has experimented with a form of DeFi is China. In P2P lending, an individual borrower can be matched with a corresponding investor (or a few like-minded investors) who is interested in lending to the individual, with an agreed interest rate and duration. According to a McKinsey report back in 2019, this sort of platform unlocks unlimited potential for individual borrowers to find lenders, at lower rates for the borrowers and higher interest rates for the lenders, as banks and traditional finance companies get “disintermediated”.

Since all of these would take place online, many of the transaction costs and inefficiencies associated with traditional financing would be removed and this financial revolution would be led by nimble FinTech start-ups with new technology and access to funding.

To be sure, P2P lending did not start in China but it took off in China around 2014. By 2018, millions of retail investors lost their life savings on P2P lending platforms because of allegations of widespread fraud and mismanagement.

“The P2P lending space in China is a case in point. It had P2P companies trying to intermediate directly between individual savers and corporate and individual borrowers. Then two years ago, the authorities had to shut down many of them because there weren’t enough safety nets. I think over the next 5–10 years, rules will have to be built to protect individuals,” Gupta notes.

“Can you really get to a world where everybody’s dealing with everybody else and you don’t need intermediaries?” he wonders. “If you have a dystopian view, you could say you don’t need banks anymore. If you have a utopian view, you could say that intermediaries create scale enabling much wider participation between different customer sets across different geographies. The nature of intermediaries will change but they still have a role to play. How it pans out exactly is not easy to forecast,” Gupta continues.

Uses of DeFi

Wee’s view is that the technology that drives DeFi and blockchain can be used for UOB’s digital asset strategy.

“We are monitoring cryptocurrency and we are not 100% convinced yet [of its benefits],” Wee says. “What we recognise in the potential benefit of digital currency is [Central Bank Digital Currencies or CBDC] which will benefit the overall consumer and we are working closely with central banks on this and asset tokenisation. We have built strategic alliances with two companies’ digital exchange platforms, on the use of distributed ledger technology (DLT) to further develop the digital capital market infrastructure with Marketnode, ADDX. We have partnered SGTraDex and TradeTrust which are using blockchain technology in trade finance and supply chain. We are focusing on certain areas where the visibility is more obvious,” he adds.

UOB group CFO Lee Wai Fai indicates that the bank prefers to work with third parties on new distributed ledger and DeFi technologies. “We still believe for banking to be an intermediary there must be some underlying value in there [for the customer]. Our view is, we prefer to work with established third parties. We know how to structure the products. All we need is an exchange and we can serve up what the customer wants,” Lee says.

UOB has already piloted its own digital perpetual security on Marketnode and tokenised a Sembcorp Industries sustainability bond on ADDX. “We think CBDCs at some point will be an efficient way to clear the global system,” Lee adds, referring to the huge cross-border payments market.

DBS has built its own exchanges. Says Gupta, “Our view has been that the heart of any DeFi world would be blockchain and distributed ledger capability. So we need to make sure we are plugged into the technology, that we know how to use it and, where possible, start launching products we can leverage on. That explains DBS Digital Exchange (DDEX), Partior and Climate Impact X (CIX), so that we can play a meaningful intermediary role in the new world. Exactly what the role will be isn’t fully known, so we will be nimble and adapt to how the situation evolves.”

DDEX is a digital exchange where DBS’s capital markets team can originate deals, including fractionalising immovable assets such as property into tokens to list and trade on DDEX. Partior is a joint venture with JP Morgan and Temasek Holdings, to enable wholesale cross-border payments. In a pilot, Partior, which uses a form of distributed ledger, was able to undertake an SGD-USD transfer in seconds.

Menon said in his Nov 9 speech that DeFi has the potential to yield significant economic and social benefits. “By replacing intermediaries and central counterparties, these open crypto networks can potentially reduce the cost of finance. When firms of all sizes, and even individuals, can directly access financial infrastructure, it could mean more competition and inclusion,” he says.

CBDCs and the local banks

In his speech, Menon said that MAS frowns on cryptocurrencies or tokens as an investment asset for retail investors. The prices of crypto tokens are not anchored on any economic fundamentals and are subject to sharp speculative swings. However, CBDCs — which is the direct liability of and payment instrument issued by the central bank — are being experimented on by several central banks. These CBDCs are likely to be wholesale CBDCs for use within the banking system.  

MAS, along with the Reserve Bank of Australia, Bank Negara, South African Reserve Bank and Bank of International Settlements (BIS) Innovation Hub are testing the use of multiple CBDCs for international settlements in Project Dunbar.

The aim of Project Dunbar is to enable a multiple-CBDC platform for international settlements where cross-border payments — a market worth US$156 trillion ($210.19 trillion) — are made at scale, efficiently, cheaply, faster and, of course, safely. At the core of cross-border payments is correspondent banks, which could be disintermediated if banks can transfer payments directly, account to account, at scale, cross-border.

While it is too early to consider retail CBDCs, MAS has embarked on Project Orchid to build the technology infrastructure and technical competencies necessary to issue a digital Singapore dollar should Singapore decide to do so in future.

Partior’s use case

Partior is a blockchain technology provider for payments clearing and settlement that cuts settlement time to seconds from traditional settlement times of two days.

“There is a demand for instantaneous payments that happen within the Asian time zone,” says Lim Soon Chong, group head of global transaction services at DBS. A large part of the US$156 trillion in global payments is done within Asia. “In trade finance, with financial and logistic twinning, we can imagine many futures, whereby there will be a greater demand for instantaneous payment and settlement for trade, particularly for open account trade,” Lim explains.

For Partior to really take off, Lim is looking for more financial institutions to join Partior in a sort of partnership not unlike Star Alliance, the world’s largest global airline alliance. “You need airlines to fly the trunk roads, you need airlines that fly the regional routes, and you need connectivity, where other modes of transport, whether it be seafaring transport, land, transport, train, so on and so forth. I would say for money transfers are the regional routes, but for securities, they could be serving the world important routes compared to banks. And then you need to integrate with other partners,” Lim suggests.

In summary, the local banks believe they need to continue to invest in these cutting-edge technologies. UOB announced an investment of $500 million in digital innovation initiatives, including in its UOB TMRW digital bank platform.

DBS announced it plans to invest $300 million next year to boost digital and intelligent banking capabilities. Some of the investment is likely to be for DDEX, where assets under custody rose to more than $600 million in October, from $200 million initially. Gupta says, “Trading volumes in the past two months surpassed the entire volume in the first eight months of the year. So we think it’s a business worth putting some more money in to scale up.”

Wong of OCBC says 12% of expenses this year of $1.19 billion in 3QFY2021 ended September is spent on technology infrastructure excluding staff costs and OCBC plans more investments in technology.

As DeFi emerges as a trend, the local banks appear ready to embrace parts of it. “On Web 3.0, I wouldn’t say it’s a disruptor, it’s more an opportunity,” OCBC’s Wong concludes.