Could Silicon Valley be the Encryption Killer?

If you value your privacy online then you logically must also be a supporter of encryption. It frightens governments, because encryption prevents them from undertaking mass surveillance on all of our communications. For the longest time, Silicon Valley has been the defender of encryption, but Kalev Leetaruwriting for Forbes, believes that the one-time protector of our privacy may be taking another road and rolling back the protections that encryptions provides us with.

The reason behind this change of heart is not to help out governments: it is. Leetaru suggests, “for their own profit-minded needs to continue mining, monetising and manipulating their users.”

Encryption puts a dent in profits

Encryption is a way of securing Internet communications and keeping them away from the prying eyes of the ‘Deep State’ as well as cybercriminals. In the early days of Silicon Valley, encryption was “a value-add that had no impact on their own use of their users’ data.” Then came Edward Snowden and the Valley firms portrayed themselves as standing up against governments on behalf of their users. However, what was also happening was that they were “encouraging their users to share ever more intimate information to be mined.”

As Leetaru points out, “The movement from HTTP to HTTPS was an easy sell for the major internet companies,” simply because the cost of migrating from SSL certificates and all the other changes required, were all borne by the websites; not Silicon Valley. The only thing they had to pay for “was the added cryptographic computational cost, necessitating some additional hardware investment.”

And here is something important to consider in this debate: SSL only protected user communications in transit. The major Internet companies could still access user data in unencrypted form and use it to monetise their users.

What will Facebook do?

However, end-to-end encryption is a threat to these Silicon Valley companies and the cash they can make from our personal data. Look at Facebook and Whatsapp, which uses end-to-end encryption. Leetaru remarks that Facebook’s “entire existence is prefaced on the ability to mine its users’ most personal and private communications.” And you can bet that Facebook is looking at ways of working around the protections of the Whatsapp encryption in order to continue mining its users’ private communications.

Unfortunately, “the rise of end-to-end encryption is finally aligning the interests of both governments and Silicon Valley,” and while we see governments as the enemy of privacy; it is Silicon Valley that poses a threat in the name of profit.

Crypto businesses run away from USA

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The USA usually takes the lead on new technology: after all it is the land of Apple and Silicon Valley, not forgetting many innovations of the past. However, when it comes to crypto startups it appears to be driving them away, right into the arms of places like Switzerland. It is true that some of the large comaniy’s like Coinbase and Ripple Labs, who are past the startup stage, are US registered, though even Coinbase has spread its wings far beyond the United States.

Jeff Kauflin writing for Forbes recounts a very interesting story about a meeting between Republican congressman Warren Davidson and the CEO of a crypto startup in 2018. The CEO was trying to decide where to locate his company and said to the Congressman, “Look, it’s nothing personal. We just don’t trust that you guys are gonna get this done right. So we’re feeling kind of Swiss.” What he meant was that with all the uncertainty around regulations in the US, they were thinking of going to crypto-friendly Switzerland.

This uncertainty and the slowness of the US regulatory authorities are damaging everyone. As Kauflin says, “most companies that created digital tokens and sold them through ICOs assumed they wouldn’t be deemed securities.” However, once they realised that the regulators, the SEC being the main one, were thinking differently, they knew there was going to be a legal problem. This drove them away from considering locating startups in the USA.

To remedy this, Warren Davidson has introduced a new digital token bill, aimed at removing uncertainty and making the USA more appealing for crypto startups.

Caitlin Long, a former managing director at Morgan Stanley, when interviewed by Kauflin said: “Lawyers right and left were telling clients, ‘Don’t issue tokens to U.S. investors and don’t domicile in the U.S.’”

By contrast, last year Switzerland declared that some ICO tokens are not securities, which went down well with crypto entrepreneurs. So much so that about 420 crypto and blockchain startups are domiciled there. The USA has 2,100 startups, but it also has a population that is 40 times larger than that of Switzerland. Mathematics says that Switzerland is out-performing the USA as a location for technological innovation.

Davidson’s Token Taxonomy Act aims to amend the Securities Act of 1933 and the Securities and Exchange Act of 1934, “to get the regulatory certainty that I feel like the market needs.”

Under the new bill, some of the criteria for exemption from security status are: the blockchain platform the token runs on has already launched; the token’s supply can’t be controlled by a single person or group of people; once finalized, transactions can’t be altered by a single person or group of people; and the token “is not a representation of a financial interest in a company, including an ownership or debt interest or revenue share.”

If this Bill passes it will create a significant change in the US for startups and would ensure that innovation stays in the USA rather than running away to Europe.

Online Lenders vs The Banks

The financial crisis of 2008 has spawned a number of innovations in the world of finance. Cryptocurrency and fintech startups are two of them, but these were preceded by a new wave of online lenders.

The truth is, and it remains so, that the Big Banks failed to respond to the financial crisis in a meaningful way for consumers. They caused the problem, but they remained in denial about the effects on the person in the street who needed access to credit. Furthermore, the banks simply didn’t want to take on more risk. The banks instead of thinking about people, concerned themselves with regulatory challenges and stuck to technology that first saw the light of day in the 1960s.

Online lenders get VC support

Enter the online lenders, supported by venture capitalists who could hear the money dropping into their coffers. Lending money appeared to be an easy and profitable game, however it wasn’t all plain sailing.

Still, online lenders had their customers well figured out: they knew what they wanted and what they didn’t want: they wanted instant access to loans and they didn’t want to visit a physical branch and discuss every detail of their lives with somebody in a suit. That aspect of it all went well.

Online lenders at a disadvantage

However, the economies of lending have been another matter. As fintech expert, Ben Cukier writes, “Loan profitability is driven by the spread (the cost difference between the interest charged on the loan, less the cost of funding those loans), the cost of acquiring the loan, and the default rates of those loans.” From the outset online lenders were at a disadvantage when compared with the traditional banks, because the old-school bankers uses low cost deposits to fund loans. By contrast, the new online lenders had to rely on “raising debt or even more expensive equity,” as Cukier points out..

Enter Big Data

Plus, customers knew the bank brands, whereas the newcomers had to invest a lot in raising brand awareness. But they did have a weapon that the banks did not posses: the newcomers had Big Data. They talked up their Big Data platforms, which use disparate data to better underwrite credit risk in ways common credit scores did not. And, they leveraged this data to target specific consumers on social media, and then used the data they mined from customer behaviour on social media enabled them to dictate borrowing terms.

Fintech is the real financial innovation

This gave the banks a wake-up call, and now bank customers can interact with their banks through apps and even get quick credit approval. Plus the banks offer a range of products, whereas online lenders only offer loans. Then fintech startups came along and offered more help to the big banks. Mark Hookey, CEO of Demyst Data says, “Fintech innovators demonstrated that a data focus matters, however banks can apply that insight at a far greater scale to know their customers and launch new products.”

In the end it is these fintech companies, rather than the online lenders, that offer the promise of a real revolution in lending.