Disruption! How Blockchain Technology will Impact Consumer Lending

Blockbuster Video opened its first store in Dallas, Texas, in 1985. Over the next 20 years, they added more than 9,000 stores and 58,000 employees worldwide. In 2011, the bankrupt company was acquired by Dish Network for $320 million. The irony of this is that in 2000 former Blockbuster CEO John Antioco passed on an offer to acquire Netflix for $50 million, thinking it was just a niche business. Today, Netflix has a market cap of over $82 billion, while Blockbuster stores are but a memory.

The annals of business are replete with similar stories. For example, Yahoo passed on a chance to buy both Google and Facebook, and spent 2008 thwarting acquisition offers from Microsoft. In 2003, Friendster rejected a $30 million offer from Google, and they were soon after displaced by Myspace and Facebook. Each example illustrates a case where the company had achieved so much success that they did not take emerging threats seriously. Perhaps the old adage should be revised to say, “Nothing impedes like success”.

It is said that everyone has perfect vision when looking into the past. It is a different thing, altogether, to see things in real time. Blockchain technology is one of those things. It is the latest buzzword sensation, and companies are rushing to force fit the suggestion of it into their technology offerings in hopes of obtaining a higher valuation. All of the hype makes it very easy to dismiss, but blockchain technology is already having a profound impact on how lenders will operate in the future.

Blockchain overview
The initial concept of blockchain was published under the pseudonym Satoshi Nakamoto in 2009, and was first deployed as a core component of the cryptocurrency Bitcoin. The model is essentially a distributed ledger, meaning that each transaction is recorded in many locations (nodes). The transactions (blocks) are unalterable once accepted by the chain. Each new transaction must reconcile with a majority of the other nodes, making it virtually impossible to forge. There are numerous other benefits to blockchain technology, which will become apparent when considering how to apply this technology to consumer lending.

There are three basic configurations, which are public, private and consortium (often referred to as federated). In a public blockchain, anyone can send transactions, and see them if they are valid. In addition, anyone can participate in the consensus process. All transactions are encrypted and anonymous, but they are also completely transparent. Public blockchains are the slowest because the records exponentially increase with each new transaction, but they are still faster and cheaper than the traditional process of audit and reconciliation occurring between companies today. The middleman is cut out in the public blockchain, because each transaction must reconcile with other nodes in the network before it is written into the record and assets are transferred.

In a private blockchain, read permissions are kept centralized within one organization. Read permissions may be public or private, and a limited group within the organization is responsible for the consensus process. A consortium operates in the same way, except that multiple organizations share the responsibilities of maintaining the core functions. Private blockchains are significantly faster and less expensive than public blockchains, but are less secure due to their centralized structure (i.e., a single point of failure). The consortium offers a hybrid approach, where there is the speed and efficiency of a private blockchain, but power over the network is not consolidated in one company.

Applications in auto finance
The auto finance industry is large, fragmented and inefficient. A recent Experian Automotive report stated that for used vehicle finance (which represents two-thirds of the U.S. auto finance market), the top 20 lenders only accounted for only 38 percent of the total market share. The twentieth lender had less than a one percent market share, meaning that 62 percent of the auto finance market is made up of thousands of bit players. In addition to the multitude of lenders, there are approximately 60,000 franchise and independent dealers interacting with these companies. The speed, efficiency and security of blockchain holds the promise of numerous improvements throughout the industry. Some of the major initiatives that are presently in development are:

•    Dealer loyalty programs – There are a few constants in the universe. Among them are that dealers want to get paid, and paid quickly. Some of the most successful lenders have developed loyalty programs that incent dealers to create efficiencies by paying for a certain number of contracts, clean funding packages or other factors that drive down cost per acquisition. These programs can be cumbersome to track and time-consuming to administer, minimizing their value to the dealer. Blockchain allows for real time tracking and execution of loyalty rewards, which could have a substantial impact on program effectiveness.

•    Smart contracts – The terms of contracts may be embedded into programs that allow for automatic verification and enforcement, eliminating the need for a legal and/or accounting intermediary to certify. This construct can be fully or partially self-executing, saving a tremendous amount of time and money for all parties connected to the deal.

•    Credit reporting and identity management – A major point of frustration for consumers, and lenders alike, is that the three credit reporting agencies may produce different information on a report for a single individual. That can influence not only the consumer’s credit score, but also whether or not that person can qualify for credit. A blockchain system can resolve this age-old problem, by reconciling all transactions and payments. Furthermore, the ability of this technology to put control of credit information in the hands of the user could literally wipe out identify theft and make data breaches a thing of the past. When enough consumers demand this, it will not be up to the industry to change – it will be legislated.

Preparing for disruption
According to a recent report by Accenture, 9 out of 10 banks in North America and Europe are actively exploring blockchain technology for payments. The report estimates that this technology could reduce bank infrastructure costs by 30 percent. A 2016 survey, conducted by IBM with 400 banks and finance companies, suggests that 65 percent of banks globally will be actively using blockchain by 2019. Change is coming, regardless of whether we in the auto lending space prepare for it.

Consider that electronic documents and e-contracts have been around for nearly 20 years, but very few lenders have embraced them. Amazon, Google and Microsoft have amazing cloud technology on the world’s biggest and fastest servers. Superior technology and service is available from them for pennies on the dollar of what it would take a single company to develop, yet most lenders still build and maintain their own technology infrastructure.

Almost 15 years ago, I remember some senior operations managers I worked with commenting on how Capital One Auto Finance had transformed to analytic, model-driven underwriting (auto-decisioning) from a manual, judgmental process. One of these managers smugly quipped, “They just went out of business!” Of course, that did not happen – the company has done quite well. You might forgive such a myopic comment at that point in time, because the idea was fairly new.

Fast forward to 2012, and some of these same leaders were still laughing off the idea of auto-decisioning, saying it would never work. This was in spite of the fact that many of the players who were out-competing us in the market had been successfully deploying this technology for over a decade. Eight years before the Wright Brothers made their first flight at Kitty Hawk, famed British scientist Lord Kelvin said that heavier than air flying machines were impossible. It seems unimaginable that Kelvin would make that statement today, sitting in an office outside of one of the busiest international airports in the country.

The punchline in all of this is that the auto finance industry has been slow to adapt to new technological innovation. The size of the market, and the number of dealer intermediaries has allowed lenders at all different levels of sophistication to thrive; but, it is the nature of markets to become efficient – and blockchain is the technology to facilitate that.

The combined wealth of the top five tech-giants is greater than the GDP of all but four countries. Amazon has disrupted dozens of industries, and it is now focused on grocery and pharmaceutical delivery. Google has massive amounts of data on every consumer’s online activity, and has the analytic horsepower to make use of it. It is just a matter of time before these companies leverage their unprecedented amount of capital, and use technological innovation to change the competitive landscape of auto finance forever.
Banks, captives and independent finance companies who are not actively investigating this technology would be well advised to learn the lessons of Blockbuster, Yahoo and Friendster. At TruDecision, we are actively researching ways to leverage blockchain technology, so that we will be part of the new market and not a victim of it.

Daniel Parry is co-founder and CEO of TruDecision Inc., a fintech company focused on bringing competitive advantages to auto dealers and lenders. He is also co-founder and CEO of Praxis Finance, a portfolio acquisition company, and co-founder and former chief credit officer for Exeter Finance Corp. For questions or inquiries, please email danielparrynaf@live.com visit www.trudecision.com.