a16z: The financial services industry, with a market size of $25 trillion, will embrace the trend of the open-source movement

Written by: Angela Strange, General Partner at a16z, previously worked at Google and Ruba.com
Compiled by: Perry Wang

Open source will spark the most dramatic transformation in the financial services industry in history, a sector worth $25 trillion, shifting power from corporate executives to developers as it evolves. This change will not only occur in fintech companies but also in traditional financial institutions with centuries of history.

Until recently, financial services were known for their high complexity and costs. Existing companies and startups have struggled to cope with pervasive regulatory oversight, outdated core systems, complex payment architectures, compliance hurdles, and fraud.

But imagine a different picture: financial services built with building blocks like LEGO. These building blocks can be flexibly assembled to support hundreds of different use cases. Moreover, each piece of this LEGO is the result of continuous collaboration among the world's brightest minds, constantly iterating and improving. This is the immense potential of incorporating open source into financial services.

Open source allows many people, regardless of their location, to continuously contribute to the code, improving it over time and making it freely available to everyone.

From "Core Framework" to "Banking as a Service"

Due to long-standing structural challenges, core banking systems have traditionally been monolithic, running "on-premises" on expensive, customized data centers within banks. Today, banking systems are becoming modular layers in the cloud, with various components like deposit accounts, credit card issuance, and compliance available in an "as-a-service" format. Banking as a Service makes it much easier to build and add financial services than ever before. Therefore, any company (not just banks) can now offer financial services: for example, the U.S. ride-hailing company Lyft can provide bank accounts for drivers; ServiceTitan can offer loans to its contractors.

The Driving Force of Future Evolution

Although Software as a Service (SaaS) has made significant strides in rebuilding existing financial products, user demand and developer supply will drive further modernization of banking infrastructure.

User Demand: Financial services were previously monopolized by banks, but now any business has the capability to enter the fintech space. As consumers and businesses become more ambitious about fintech products, they also need greater customization in financial infrastructure to develop creative solutions for their customers.

While fintech has traditionally operated on a local basis—most banks are driven by specific national regulations, infrastructure, and consumer payment preferences—many multinational companies are now adding financial services. For example, the music streaming service Shopify operates in many countries and must collaborate with various local providers to handle payments, loans, bank accounts, etc. As more multinational companies seek to add financial services, they will need to build globally applicable banking applications. Open source can help address these multinational operational challenges.

Moreover, there are still 3 billion people globally completely excluded from the financial ecosystem. Around the world, more and more talented entrepreneurs are gaining insights into the needs of unbanked and underbanked communities and are exploring innovative solutions. Readily accessible open source libraries will undoubtedly accelerate this process.

Developer Supply: Currently, thousands of developers are seeking out-of-the-box solutions to address frustrating, recurring problems. Over 40% of banking code is written in COBOL, a programming language that is over 60 years old. Although most fintech companies rely on more modern infrastructure, it is nearly impossible to avoid interacting with this legacy technology. Writing the same boring code repeatedly is painful, but developers find themselves forced to build the same infrastructure over and over again.

Whenever developers build something repeatedly, they find a way to automate it. Better yet, they open-source it, allowing others in the community to help improve it. Thousands of developers are currently working to solve challenging infrastructure issues and are ready to open-source their work.

While Banking as a Service will continue to address many issues, there remains a significant demand and supply that will drive further development of our banking infrastructure. With the momentum of the open source movement, we are at the forefront of the latest evolution in infrastructure.

Open Source Evolution

What if we further break down these "as-a-service" layers into their most basic primitives? In fintech, primitives (meaning not developed or derived from anything else) could be a basic ledger or a reference library for sending specific types of payments. These primitives will be open source: they will benefit from the ongoing collaboration of the world's smartest minds. They are composable, meaning they can be freely selected to combine and assemble to meet any specific user needs.

The widespread availability of open source primitives will spark new use cases we have never imagined. For example, we will be able to seamlessly combine the worlds of cryptocurrency and fiat currency, allowing users to dynamically spend, save, or lend both fiat and cryptocurrency.

Or, for a long time, people have talked about how software should help us make better financial decisions. Imagine: a bank account could help us make decisions about spending and saving, fully automating our financial lives. Composable open source primitives will give rise to thousands of such experiments; it is hard to predict which project might become the next billion-dollar fintech unicorn.

More specifically, open source can transform the financial industry through four key pathways.

Driving Standard Development and Enhancing Reliability

Standards exist in payments, but they are outdated and built in a very tedious manner. For example, last year, $55 trillion was transferred through the ACH (a format created in 1970) standard, and 1.3 billion transactions were reported to U.S. credit bureaus each month via Metro2 files (a format created in 1997). Open source libraries can not only save developers the trouble of building such standards from scratch but also create modern reference points.

Payments have thousands of edge cases that even large teams cannot fully address. Many open source contributors run payments through open source libraries and fix edge cases in the process, making modern open source libraries increasingly robust. For example, the open source company Moov.io uses open source primitives as a starting point, allowing developers to easily embed functionality into their software to send, store, and receive customer funds.

Open Connections

From the UK to Brazil, many countries are pushing for regulations on open banking, requiring banks to create and maintain APIs that allow consumers to grant third-party applications access to their banking data. Open and accessible banking data can help consumers improve their financial decisions. For example, budgeting applications require continuous streams of bank transaction data—data that is often held by banks. With customer permission, budgeting applications and any interested third parties should be able to access this data.

Developers at banks around the world are building similar infrastructure (connections to traditional core systems, APIs for exposing data) to comply with these open banking regulations. Countries and banks are continuously repeating this process—banks will benefit from starting with open source libraries.

For instance, Tesobe, based in Berlin, is the creator of the Open Banking Project, helping European banks comply with the Payment Services Directive (PSD2), which is legislation aimed at creating a more integrated payment market in Europe. Tesobe's open source libraries provide code for connecting to traditional banking systems and serve as a starting point for the required underlying APIs. These open source libraries are continuously updated according to the latest regulatory changes, greatly simplifying the important work of individual developers and policy teams. Tesobe makes it easier for businesses to comply with open banking regulations.

If banks use a set of common open source projects to develop their APIs, and these projects maintain connections with thousands of banks worldwide, it becomes much easier to obtain services and connections from our global financial system.

Combating Global Banking Cybercrime

Globally, money laundering amounts to $2 trillion annually, often funding drug trafficking and terrorism. In 2019, banks worldwide spent $30 billion combating money laundering; however, their efforts effectively stopped only 3% of such crimes. That same year, despite software systems continuously alerting compliance teams to potential issues, several banks paid $10 billion in fines for failing to comply with U.S. federal anti-money laundering regulations (95% of these alerts turned out to be false positives). Clearly, this system is ineffective.

Each bank independently monitors hundreds of global sanction lists, develops identification logic for matching entities (e.g., John Smith, law-abiding citizen John Smith vs. money launderer John Smith), and creates rule sets to flag suspicious transactions—all done in isolation. Furthermore, when one bank does improve its detection and enforcement efforts, it inadvertently shifts the problem to another bank: money launderers know where the system's weak points are.

With open source libraries, banks can contribute their hard-earned algorithmic intelligence for the benefit of the entire banking system. When one bank makes a breakthrough in addressing a specific pain point (e.g., entity matching), it contributes to the collective good. We are beginning to see some progress in this direction, such as early projects that allow intelligent searches across sanction lists. Similarly, open source giant Red Hat has also open-sourced rules for identifying risky transactions and improving entity matching.

Making Services More Accessible to Customers and Reducing Costs

Open source can also make previously prohibitively expensive proprietary software more accessible.

There are 3 billion people worldwide without bank accounts or adequate banking services. Why don’t banks around the world serve low-income customers? One reason is that they make too much money. For example, banks in Latin America have the highest ROE (Return on Equity) in the world. However, another factor is the fundamental cost structure of banks: if maintaining an account costs $20 per month in software fees, it will always be a losing proposition for banks to serve low-balance account holders who will never use loan products that are profitable for banks.

The Mifos Initiative, the leader of the Mifos X platform, is now an Apache project and is a core product for open banking. Developers can access its free open source libraries and benefit from the expertise of the global community to build cost-effective banking service applications for microfinance institutions and QR code-based payment solutions for micro-merchants. These new solutions focus on serving the bottom of the socioeconomic pyramid.

The Impact of Open Source Evolution

The open source movement will catalyze more financial services companies while also enabling existing companies to innovate more rapidly.

In particular, it will impact how developers build software in financial services. Developers in companies of all sizes are beginning to contribute to the collective good of the industry through existing open source projects. It is more likely that, as we are in the early stages of this change, developers will find themselves building an infrastructure, realizing how many other companies might need the same thing, and exploring how to turn their tools into a new open source project—perhaps creating a new infrastructure company.

Developers will not only be the creators and sellers of these financial primitives; they will also be buyers. With a robust ecosystem of open source libraries, product management and development teams will no longer need executive approval for large budgets to purchase proprietary software. They will be able to experiment with solutions to existing problems and entirely new use cases for free (or at very low cost).

The impact of this shift will extend far beyond startups. As the open source movement breaks down barriers to independent product experimentation and innovation, existing financial institutions will need to double down on recruiting, retaining, and empowering engineering teams.

Consumers will be the biggest beneficiaries of this wave of financial open source movement. Open source financial primitives will provide building blocks to create financial services for new use cases at lower costs, serving audiences across all levels of the socioeconomic spectrum.

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