Finances are a critical modern issue, particularly in developing and underdeveloped economies as well as for new startups, small companies or individuals. Türkiye is also suffering from a lack of access to low-cost and long-term financial capital. Business life, the real sector and labor markets are all extensively impacted by these credit crunches. Yet, this issue is likely to gain even more attention looking forward. Recessionary expectations in the West, and financial and monetary tightening could potentially exacerbate these financial issues.
Small- and medium-sized enterprises (SMEs), in particular, are almost over 90% dependent upon banking funding in Türkiye. This is surely stressful and could lead to many more financial difficulties, especially during financial turmoils. It is time, therefore, now to think beyond conventional funding methods. For example, rising costs of finances (especially following the monetary tightening periods) and issues in extending the due dates (during the tightening cycles of 2022, for instance) turned into a nightmare for many businesses. Public banks and public authorities have to step in each time and find new means or kick off new support packages for the economy.
While this is a reality (even in Türkiye), I recall a late 2022 TV interview where a news anchorman once replied (with slight anger) to my comment, asking: “Are there any alternatives to the banking-based funding options though?” Meaning, he was not aware of any other alternative financing opportunities one could appeal to. The reality is that even nowadays there are numerous archaic and many new-generation alternative funding or financing schemes out there. All waiting for businesses and national economies to exploit. Some of these alternatives are equity-based while some others are non-equity crowdfunding platforms.
Alternative funding schemes
Thankfully there are indeed many alternative sources, nowadays. Blockchain technology is even opening wider new horizons and more efficient alternative opportunities. As an example, crowdfunding platforms such as Kickstarter and GoFundMe help startups and new ideas get funding from the public. And blockchain is further facilitating, speeding up and increasing the efficiency of these types of new-generation alternatives.
Lately, Islamic finance-related new options and blockchain-based new financing models are also popular in Türkiye. These new alternatives enable even small investors to take an active part in funding production and growth. And they both are (tangible or intangible) asset-based funding models, as opposed to conventional debt-based funding instruments. While access to funding is a bigger issue in developing economies, it is much more crucial in particular, for SMEs and individuals that do not have easy access to the equity markets. In that sense, blockchain could also render possible overcoming credibility and trustworthiness issues.
A few of the alternative financing schemes (to the banks) would include DeFi tokens, flash loans (uncollateralized lending by the DeFi), direct peer-to-peer lending and borrowing, by eliminating intermediaries (cost of financial services will decrease), low-cost capital via B2B (business-to-business), crowdfunding, and other public funding schemes such as Initial Coin Offerings (ICOs).
Blockchain, in particular, allows safe and simple, and in the meantime fast and less costly funding alternatives. It could be effectively utilized with the peer-to-peer (P2P) and business-to-business (B2B) platforms. P2P platforms such as Prosper and LendingClub allow individuals to easily lend to each other. Crowdfunding type new generation funding tools are an important alternative that is used more frequently in parallel with technological developments today. Micro-credit and Initial Public Offerings (IPOs) are other popular alternative methods to conventional banking-based financing.
All these new technologies, together with rediscovering some archaic and efficient methods as well as the growing interest in alternatives to the costly and bureaucratic conventional banking funding once again redirects focus toward new alternatives today. New digital tokens, coins, or other forms of crowdfunding tools are likely to disrupt and transform all these financing instruments looking forward.
Technological transformation is in order. For instance, 27 members of the European Union have recently agreed to form the European Blockchain Partnership in an effort to facilitate, fasten and secure intra-Europe and international trade and financial transactions. Meanwhile, these efforts are aimed at leading (from the current monetary and trade union) to a European digital single market (eIDAS), in the medium run. Contracts and funding papers traded on blockchain networks will also easily have secondary markets and hence will be more liquid. Ethereum blockchains are actively used for this purpose.
Low-cost capital via B2B could also be easily enabled with the help of blockchain technology. One question at this point would be if borrowers could also use blockchain-based credit scores to get loans. Could blockchain replace credit scores, as a new mechanism of proving trustworthiness, by increasing transparency and mitigating lending risk? Building trust is certainly a key contribution of blockchain technology. The rest is yet to be verified.
Blockchain also enables selling the rights to access the final products, just as in the Salam contracts (the prepaid forward sale contracts) in Islamic finance. These contracts and the accruing funds are fundamentally strong contracts and would be able to compensate for many of the modern banking system or financial system’s weaknesses. They could even easily replace conventional futures or forward contracts.
ICOs, on the other hand, is a new type of crowdsourcing instrument that is starting to become popular in the cryptocurrency world. This tool provides financing to projects by selling access rights to the products to be produced and is a financing model carried out on Ethereum platforms. It is a new type of public offering and a fundamentally new form of collecting funding.
ICOs differ from conventional IPOs and venture capital investments in that it does not provide any sort of company shares to the investors. Coin holders use these digital coins to buy the final goods. In a way, products rather than company shares are bought and used for transactions. Moreover, in contrast to IPOs, ICOs are used by relatively small and new startups or ventures for early-stage funding. IPOs, on the other hand, are used by trustworthy and credible big companies, with a long enough history of credibility.
Increasing digitalization in finance
Rather than the modern-day tulip cryptocurrencies, blockchain-based CBDCs and digital tokens representing some tangible or intangible assets are the future of digital technologies and a more digitalized finance. They are expected to even increase the efficacy of monetary policy, improve the authority of the central banks and increase financial inclusion. A few of the benefits of the CBDCs and the related blockchain technology would include, but are not limited to:
– Improved financial inclusion in countries where a large population does not have any bank account or access to financial services.
– Direct peer-to-peer lending and borrowing, by eliminating intermediaries.
– Increased and facilitated international fund transfers (remittances).
– Increased transparency, formality and traceability; hence decreased informal transactions that could lead to higher tax collections.
– Social transfers and welfare transfers will also be facilitated.
– Economic activity will be recorded and formalized (on accounts and calculated much better).
– Transaction costs and risks will be decreased and hence huge business efficiency gains will be enabled.
– Making transactions much safer and secure.
– Blockchain-based supply chains also increase transparency and make it impossible to have unfair, unequal income distribution over the supply chains, and hence increase sustainability.
On the other hand, in the case of CBDC financial innovation, the following disadvantages and weaknesses should also be noted:
– Too many fund transfers toward digital wallets could weaken traditional banks and the financial systems,
– Tougher identity verification mechanisms are required to prevent money laundering or other illegal or illicit activities,
– Limit controls on the highest amount users can hold should be considered.
Blockchain’s extensive use in finance, payments and settlement systems should be noted. Its widespread use in finance, banking, cybersecurity, payments and smart contracts, on the other hand, leads to even more investment and venture capital into this technology.
Blockchain technology is also a crucial opportunity in terms of trade with national currencies. New technologies such as blockchain aim to end the negative effects of conventional instruments such as the dollar and the global monetary system based on them. Islamic finance options and blockchain-based new financing models are also asset-based funding models and could collaborate to increase the efficiency of and propagate new funding sectors.
Debt or credit is an inseparable part of modern economies, business life and the financial system. It is usually not a problem as far as the benefits and profits are higher than the cost of obtaining that debt. It could leverage higher profits for the equity. However, this credit is also often misinterpreted as income, and hence the ever-increasing, excessive debt burden.
The liberal Western economies are totally dependent upon these credit growth cycles. Economies mostly run over credit growth cycles. Public and private debts overhang, therefore, rises. Just as in the United States case today. The credit markets would also be too complex and nontransparent. That is why, every now and then, loans and even mortgages pose significant crises in Western economies and financial markets.
[Daily Sabah, February 02 2023]