Intermediation is a fundamental fact of finance. Investment banks underwrite stock offerings for companies. Commercial banks safeguard the savings of workers. Fund managers invest the pensions of retirees. Exchanges match orders of buyers and sellers. Brokers facilitate trades of investors. Credit card companies advance funds to consumers. Collectively, these and other intermediaries form the fabric of modern finance. Yet in the face of all these financial links, entrepreneurs and and technologists continue to endeavor toward the possibilities of fundamentally disrupting and disintermediating these existential financial ties with innovations like ApplePay, Square, and Venmo.

Despite numerous extraordinary innovations in finance, true financial disintermediation has proven to be quite elusive. Instead of limiting financial intermediation, financial innovation has generally revealed the persistent boundlessness of intermediation. Instead of true disintermediation, where links in a financial process are eliminated, financial innovation has generally further strengthened intermediation through substitution and layering.

First, in terms of substitution, financial innovation has frequently created replacements for traditional intermediaries without eliminating the need for their services. The proliferation of capital market intermediaries and instruments has served as alternatives to traditional banking intermediaries as a source of funds and functions. It has allowed certain parties to disintermediate from traditional banks and replace them with other sources of financing. This type of substitutive disintermediation is more superficial than substantive in nature, as the need for intermediation still exists but is conducted by a different type of intermediary. For instance, while companies like Wealthfront have replaced human money managers with algorithmic programs, they have simply substituted a human intermediary with a computerized one. The same can be said for online banks and brokers. New technology did not eliminate the need for intermediated banking and brokerage services; instead, it has simply changed the nature of those intermediaries. This is akin to transitioning from a Ford Model-T car to a Tesla Model-S electric car but not the same as transitioning from needing a car as a mode of transportation to eliminating the car altogether. It should also be noted that traditional intermediaries continue to coexist with their newer counterparts thereby creating even more diversity and complexity in the intermediated financial ecosystem.

Second, in terms of layering, financial innovation frequently builds new layers of intermediation that can create the illusion of disintermediation without actually doing so. Apple Pay, for instance, has made credit card payments easier by allowing individuals to make payments with a simple tap of their phone, using their fingerprints as authentication. While the outward-facing technology of Apple Pay appears incredibly simple and convenient, it has not simplified the credit card transaction process. Instead of eliminating a link in that highly intermediated process, Apple Pay has added another layer of intermediation—Apple—into that process. Apple Pay may have disintermediated the steps it takes to find and use a credit card, but it has not simplified the overall credit card transaction process. As such, Apple Pay may have ironically created the mirage of disintermediation by adding another layer of intermediation. Another example of layering occurs in leading peer-to-peer lending platforms like Prosper and LendingClub. Superficially, it appears that these platforms are making it possible for lenders to offer loans directly to borrowers. In reality, a bank frequently provides the loan to the borrower and the platform then provides a note to the lender. As such, the new intermediation provided by peer-to-peer lending sites is actually built on a foundation of traditional banking intermediaries. The same can be said of most financial innovation, which builds or bolts itself onto the preexisting intermediated financial infrastructure. Therefore, while new financial technology may bring innovations that present a veil of convenience and simplicity, complex layers of financial intermediation frequently lie beneath that veil.

This discussion about substitution, layering, and the mirage of disintermediation is not to suggest that true disintermediation is impossible. Warren Buffet’s Berkshire Hathaway has a long-standing practice of avoiding or minimizing the use of financial intermediaries suggest that partially decoupling from certain financial intermediaries is possible. Furthermore, the advent of virtual currencies like Bitcoin indicates that decoupling from the conventional financial infrastructure is possible. Bitcoin has eliminated the classic intermediary of central banks. In lieu of intermediated governance, Bitcoin holders govern themselves through a publicly available block-chain ledger that manages large sums of money and millions of users.Nonetheless, despite their disintermediation from the conventional financial infrastructure, when Bitcoin holders seek to convert their virtual currencies into real world currencies, they usually have to go through third-party platforms for that conversion.

The persistence of financial intermediation in the face of unparalleled technological innovation suggests that while the functionaries of finance may have changed, the core functions of finance remain the same, and remain better when intermediated thoughtfully and sensibly. Core functions like risk management, market making, information clearing, and capital aggregation in many instances simply operate better and more efficiently with intermediation than without, for the time being. In the absence of thoughtful and sensible intermediaries, many financial transactions that we take for granted would be exponentially more difficult, if not completely infeasible. Imagine trying to execute a stock trade without a broker or stock exchange, or saving for retirement without a bank or mutual fund company.

In sum, while the cast of financial functionaries may change with new technology and market developments, the core functions of financial intermediation will remain steadfastly unchanged because of the interconnected nature of finance and its human users.

The preceding post comes to us from Tom C.W. Lin, Associate Professor of Law at Temple University Beasley School of Law, and is based on his recent article entitled “Infinite Financial Intermediation,” 50 Wake Forest Law Review 643 (2015).  A full version of the paper can be found here.