Humans, Machines and Regulators: FinTech in the Human-to-Human Economy and Beyond

May 17, 2016

If you thought the financial crisis came as a sudden surprise, and if you perceived one of its consequences – the rise of alternative finance – as fast, challenging and disruptive, will you have words left to describe the brave new world of FinTech once it unfolds its potential? Do not fall into the mainstream trap of thinking that online banking is already part of the FinTech revolution – this is what established market players want you to believe, so that they appear innovative and exciting. We are talking the real stuff here: a tantalisingly close future you would not have been able to imagine a few years ago.

In its most widely used definition, FinTech is a lowest common denominator that comprises any software-based services for the financial sector. This includes everything from incremental innovation in traditional banking via collaborative crowd-based change to disruptive innovation of business models within and across markets, exemplified by distributed ledgers. While FinTech is thus any application that enables the pursuit of financial activities in a Web 2.0 based environment, my focus here is on those forms that offer the biggest opportunities for society yet prove most challenging for regulators.

I discuss the most disruptive part of the FinTech universe: distributed ledgers, exemplified by blockchain. I then explore the relationship between FinTech and crowdfunding as well as the opportunities – and risks – this creates for the human-to-human (H2H) economy, in which Web 2.0 based apps empower large groups of interconnected economic agents to interact locally with tools originally designed for global use and to reclaim many tasks previously entrusted to financial intermediaries.[1] Moreover, I flag the counterintuitive consequence that the same technology, which so much facilitates direct human interaction in the H2H economy, also forms the basis for economic activity that may no longer need any human input at all. This raises important questions on how to deal with such disruption from a policy perspective, and I conclude with some personal views on this latter aspect.


Blockchain in FinTech and beyond


Blockchain emerged in 2008 as the technology that enabled the digital currency Bitcoin. Since then, it has increasingly powered many other applications in FinTech and beyond. It is a permissionless distributed ledger (ie a decentralised dynamic database) that contains all data records of a specific type of transaction from the first execution of a contract onwards. Blockchain[2] enables encrypted registration and transition of ownership in real time without recourse to intermediaries (such as banks, notaries or estate agents). As it renders manipulation virtually impossible, it is in principle much safer than any traditional form of data protection in an online environment.

Current applications cover a broad spectrum that ranges from FinTech (eg virtual currencies, trading of securities) and the real economy (eg property records and transfer, supply chain management) to e-government (eg voting mechanisms and governance of citizenship). All applications have in common that they massively reduce transaction costs by saving time and money whilst enhancing the level of security and reducing the risk of fraud on a systemic level by increasing transparency.

Blockchain also enables the execution of smart contracts, ie automated computer protocols that can autonomously – without human intervention once an initial condition has been met – conduct and control the performance of a contract. Smart contracts provide legal certainty and security superior to traditional contracts, and they facilitate trades by saving time and money. Ethereum exemplifies its current opportunities: it is a distributed virtual system run on a network of all its users’ machines, combining the execution of smart contracts paid for by a virtual currency and secured by blockchain.

This latter example shows that distributed ledgers are increasingly becoming relevant for non-financial applications as well, including transfer of assets, supply chain management and the IoT. Imagine the IoT as a complex system of machine-to-machine (M2M) data exchanges, which form the basis of all kinds of actions governed by previously defined rules – in other words: smart contracts. As a result, smart contracts will become the standard type of contracts for the execution of any type of IoT-related tasks performed in an online environment. This offers tremendous potential for innovation and competitive gains but poses challenges for the design of regulatory frameworks … and the H2H economy. Let us first revisit the latter, before we turn to the former.


The interaction between FinTech and crowdfunding


Alternative finance, in particular crowdfunding, has rapidly proven its worth. From modest beginnings a few years ago, the sector reached a market volume of € 4.2 billion in the EU in 2015.[3] Crowdfunding not only enhances the spectrum of finance for enterprises, notably SMEs, but achieves much more: it creates dynamics of participation and interaction not witnessed in other parts of the financial sphere, it spurs innovation and growth, and it empowers trading at local level in collaborative, small-scale societies – the H2H economy, as I have defined it earlier.[4]

It is worthwhile reflecting for a moment on the tremendous pace of change. Ten years ago, crowdfunding was in its infancy. After the start of the financial crisis, it gained traction and connected ever more people with ever less recourse to established financial intermediaries, based on very simple technology. As a result, crowdfunding has become synonymous with the strongest challenge to traditional finance so far. Today, however, this statement needs to be reassessed. Crowdfunding will continue its steep rise and has established itself as an integral part of modern finance but the biggest potential of disruptive innovation in finance has moved to other parts of FinTech.

This is the result of an intellectual current still very much under the surface, and thus not yet on the radar of many policy makers. The extended financial and economic crisis triggered a heterodox entrepreneurial movement united only by the feeling that the established financial system had become too rigid to continue producing the width and depth of innovation needed to address societal challenges. This disenchantment resulted in a return to the drawing board, applying basic economic principles in a peer-to-peer setting. It led to vast experimentation and an as yet mostly sub-critical mass of exciting divergence. The crowdfunding branch was the first to flourish on this fertile ground. Now, it is springtime for the second branch: distributed ledgers.

There are many similarities between these two branches. In a bottom-up approach, start-ups driven by web entrepreneurs have created alternative trading platforms, virtual currencies (far more than only Bitcoin) or apps that increasingly turn financial transactions into a 24/7 mobile business at the micro level. You need a bank / money / an exchange? ‘Create it yourself’ is the mantra, or just log on to one created by your peers.


If you trust them, that is. Indeed, it is a weird irony of history that many of those who deeply reject the ‘impersonal’, ‘capitalistic’ economic ‘system’ have so much faith in virtual worlds, in which they have no clue who created them, who controls them, how they can enforce their rights and how they can exit without incurring total loss. A feast for sociologists and psychologists, I presume.

This problem of trust feeds two trends. First, both in crowdfunding and overall FinTech, global technologies mostly thrive in regional and local settings, where trust can emerge more easily. Regional cryptocurrencies, such as Sardex, which successfully enables small firms to acquire finance, are a good example. Second, established players jump on the bandwagon, pull their weight and use their resources to bring new ideas up to the next level, such as banks in crowdfunding or securities exchanges in blockchain (eg Nasdaq in Estonia and the USA).

In this environment, highly innovative cross-fertilisation emerges between the two branches, ie the socially driven crowd economy and the FinTech world. For instance, crowdoperators are developing blockchain-based protocols to offer crowdlending with Bitcoins, or they emit other financial products based on blockchain technology.

So all is safe and well? Not necessarily. The interaction between humans and machines promises enormous productivity gains, but it will also result in frictions, and it is an open question how such rapid and disruptive change should be governed by regulators.


M2M meets H2H: thesis, antithesis, synthesis?


Disruptive FinTech has much in common with the similarly innovative concept of crowdfunding within the H2H economy – so much that many people do not distinguish between the two. And yet, while FinTech and crowdfunding overlap, they are by no means the same. Crowdfunding can successfully flourish offline (notwithstanding that this has become a rarity nowadays), whereas not all forms of FinTech require crowdbased interaction. Indeed, FinTech may well work in a completely automated environment – a pure M2M world – that leaves no scope for human interaction at all once an initial condition has been met.

This latter aspect is of immense societal relevance. Actually, I do not subsume crowdlending as part of the H2H economy and distributed ledgers as a main driver of the M2M world to complicate things by introducing two abbreviations. Instead, I wish to highlight the line that separates the two: human aspirations, human interaction and human control form the essence of the H2H economy but are – beyond an initial stage – not needed in the M2M world. Unless you define a population of machines as a ‘crowd’, which is anathema to the world I feel at home in, such a matrix of interacting machines is the exact opposite of what crowdsourcing/-funding/-innovation is about.

FinTech in its extreme M2M variant may therefore be as much the culmination of its potential as it is the worst nightmare of those that currently embrace its more innocent forms. M2M operations are becoming so fast, ubiquitous, flexible and ultra-low cost that even the most socially excluded can afford running them on the smallest device that offers online access, and they can not only become economically active but also relocate, change citizenship or marry in the blockchain – e-government is already experimenting with such services.

Or, more down to earth, your wristwatch can notice a deterioration of your body functions, check with your fridge whether you have enough healthy food at home, place an order at your supermarket, have supplies delivered by drone and paid with virtual currencies – without you noticing it before you find a box full of broccoli in front of your door (and your health insurance will kick you out if you do not eat everything). You might smile at this silly example, which merely describes what IoT will bring about, but will you still smile if the hybrid H2H/M2M society you live in embeds a voting system on the blockchain (also already in trial phase) that will offer the choice as the next prime minister between an apparently perfect super machine and an imperfect human?

Beside all golden opportunities, this is the risk of too much M2M: It silently replaces the human control inherent in H2H by the algorithmic efficiency of the matrix – and it transcends values into something which may cease to be compatible with our economic system. Market-based capitalism – with all its shortcomings – always had an intrinsic social dimension, as markets (real or virtual) are places where humans interact. But what do you call platforms where machines interact autonomously? And how do you govern them?


Disruptive innovation and how to govern it


One of the most valuable insights economic history offers is that disruptive innovation can neither be foreseen nor planned ex ante, but structural similarities do exist. Change originating from Web 2.0-based apps meticulously reflects the classical pattern that any disruptive technology evolves in three phases: 1) a trial and error phase, in which the technology emerges and proves its merit in a niche market; 2) an extension in application and range driven by a desire to reach out and test the limits; and 3) a transition into mass application (which looks inevitable ex post, to the bemusement of those that have lived long enough to know better).

If you want to govern and regulate such processes, you are left with two choices: to allow or to prohibit. It is simple to prohibit cryptocurrencies, peer-to-peer lending, applications of blockchain and the like. However, they have so many advantages – from efficiency gains via the inclusion of socially disadvantaged groups to democratic empowerment if designed properly – that any outright prohibition would be circumvented, and rightly so. We already possess the technology to enable any citizen to buy or sell any tradeable good or service at negligible cost in real time, globally, without recourse to any intermediary. There is no perceivable risk assessment that could carry more weight than this simple truth – notwithstanding that the implementation of such a system will take time (more time than you might think; this is another one of economic history’s insights).

So we are down to one real option for regulation: to allow. This, again can be done in two ways. Regulators can limit themselves to set general rules that define the border of socially acceptable behaviour and allow everything that stays within these limits. Alternatively, they can try to predict what will happen and proactively set rules that channel behavour towards the desired direction. The more disruptive and unpredictable an innovation process is, the less feasible is the second course of action, of course.

This explains why there is no harmonised regulation yet of crowdfunding at EU level, as has just been confirmed in the European Commission’s latest analysis of crowdfunding in the EU.[5] An experimentation phase on the market necessitates freedom of choice, within the limits that define those risks society is not willing to take. Crowdfunding therefore continues to operate in a regulatory environment that has not specifically been designed for it. This works, because any services that result from it are categorised by their function, and they are regulated according to this function, precisely as any competing traditional service that fulfills the same function.


Equally importantly, while there is no harmonisation at the highest (EU) level, there is regulatory competition at national level. This creates differences to experiment with and niches in which to try new models at small scale. The important thing is not to streamline these activities too early. Rather, there is a need to enable a regulatory dialogue that monitors and learns as well as distributes best practice. There remains a risk that national regulatory divergences might become too big at a certain stage, so that they endanger the smooth working of the Internal Market, but this risk might be alleviated as well by regulatory dialogue.

FinTech is a similarly – if not more – heterogenous field as crowdfunding if defined by the functions it fulfils. For this reason, the regulatory approach towards crowdfunding might well be a blueprint for FinTech. Regulatory tools are already in place to control the risks; some finetuning might be needed and some definitions reassessed, but this stays within the limits of existing instruments. In addition, policy makers are well advised if they allow for small scale, local or regional, experiments, that foster experimentation and allow society to reap the benefits of a steep learning curve.


The broader debate – H2H versus M2M: heaven, hell, or something in between – needs to take place outside the field of regulation, but it must take place as well. Now.


Joachim Schwerin is Principal Economist, European Commission,
DG Internal Market, Industry, Entrepreneurship and SMEs. The views expressed in this article are his own and do not necessarily represent those of the European Commission as a whole.



European Commission (2016): Staff Working Document on ‘Crowdfunding in the EU Capital Markets Union’, SWD(2016) 154 final, 03.05.2016.

Schwerin, Joachim (2015): ‘Crowdfunding in the Human-to-Human Economy: Web 2.0 Based Finance for Jobs and Growth’, Computers & Law, vol. 26, issue 4, pp. 28ff. 

[1] Cf. Schwerin (2015) for a short introduction to the H2H economy.

[2] All further references to blockchain in this paper are unrelated to Bitcoin, as the latter is a limited application of distributed ledgers that does not – and has not been designed to – use their full potential.

[3] European Commission (2016), p.9.

[4] Schwerin (2015).

[5] European Commission (2016).