A friend writes that “FinTech is about enabling greater customer-centricity, while digital currencies are about faster and near-free exchange globally”.

In that sentence, one claim is made about FinTech, while two claims are made about digital currencies.

These claims are simultaneously true and not true.

Let’s take the first claim, about FinTech. Customer-centricity is certainly touted as a key reason for adopting Fintech.  However, in my experience, as customer-centricity can’t be measured, actual business cases for the adoption of Fintech rest on its potentially enabling economy, speed and reach.  In that sense, it is not true that Fintech is about customer-centricity.  In fact, the experience with Fintech so far is that it may even impede customer-centricity, in the same way as most customers don’t like automated voices when they ring in to any office.  It is far more customer-centric to provide human receptionists.

So let’s take the two claims about digital currencies.  One claim is that digital currencies are going to be “faster”.  Well, faster than what?  Presumably, faster than Dollars, Pounds, Euros, etc.

Let’s think about that a moment.  Are Bitcoins (or any other digital currency) really going to be transmitted faster than dollars, pounds or Euros across whatever means of transmission exist in say a year’s time (or ten or a hundred)?

Extremely doubtful, since the transmission of any two digital objects of the same digital size has little relevance to the speed of their transmission – and Dollars, Pounds and Euros have already become primarily digital themselves.

The next claim is that digital currencies will provide near-free exchange globally.  Hmm.  So far, advances in technology have certainly make it possible for digital objects to be moved more and more cheaply.  It is possible that further technological advances will continue to make it still cheaper to transport digital objects and information.  However, I doubt that digital currencies (whether of the Bitcoin variety or of the Dollars and Pounds variety) will ever be “nearly free”: legislative mechanisms always need to be paid for, regulatory arrangements need to be paid for, the cost of generating Bitcoin or any other electronic currency will not be markedly different from the cost of generating electronic Dollars or whatever, and the cost of transmission will depend on the cost of energy as well as the cost of the hard and soft infrastructure involved.

Lastly, we already have experience of things that cost nearly nothing to produce, but we have found that that is not usually in our world good reason to let people have those things for nothing.  Consider water, which is freely given by God, but everything involved in getting water from wherever it is to my location and indeed to my lips costs money. Further, everyone involved in the supply chain needs to be paid something – and usually wants to be paid as much as possible.  If all that is not organised nationally through the taxation system, it will be organised at greater cost to citizens (if for no other reason, than for reasons of economies of scale) by individuals, groups or corporations.

So the reason to use Blockchain and Blockchain-related products (whether FinTech in general or Digital Currencies in particular) is simply, solely and exclusively:  security.  Other reasons are piffle.

Oh and I should say that Blockchain-related products are not yet as secure as they need to be.

Regulators have historically focused on preventing the risks associated with “too big to fail” institutions.  As a result, they are tending to overlook or mishandle the conceptually distinct risks associated with multiple smaller-scale decentralized financial markets. The reality is that, in many ways, these risks can be greater than those presented by large institutions.  Decentralized fintech markets suffer from “the Systemic Risk of Decentralization”, are more vulnerable to adverse economic shocks, are less transparent to regulators, and are more likely to encourage excessively risky behavior because of the possibility of evading effectual monitoring; in any case, the technology “disincentivises cooperation” with regulatory authorities. That, in brief, is the argument of a paper titled “Regulating Fintech” by William J. Magnuson, Associate Professor at Texas A & M University School of Law, being published in its Legal Studies Research Paper Series as Research Paper No. 17–55 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3027525).

The Paper concludes by sketching regulatory responses that “may better correspond to the particular risks and rewards entailed by fintech”. 

Magnuson has four suggestions:

“First, regulators should adopt a “regulation lite” model that incentivizes fintech firms to provide information to regulators about their businesses and seek guidance on the applicability of current law.

Second, regulators should focus on limiting contagion in the event of unexpected economic shocks.

Third, regulators should attempt to leverage the idiosyncratic knowledge of fintech firms to encourage self-policing.

Finally, regulators should work closely with their counterparts in foreign countries to design regulations that work on the global level.”

Well, what are we to make of all this? 

The analysis is certainly perceptive and persuasive.

Moreover, the suggestions are apt.  However, I get worried, and most knowledgeable people get worried, whenever words such as “should” and “ought” start being used too often.  Because what matters is what happens after the “shoulds” and “oughts” have been agreed: there is the far more difficult discussion which remains, regarding *how* the “shoulds” are to be achieved.

On his first point, Magnuson thinks that better quality information can be produced by promoting “observed experimentation”. In other words, “regulators should create incentives for fintech firms to provide information about their business and voluntarily seek guidance on the applicability of current regulations”. If that makes you think of “regulatory sandboxes” as are now adopted by the UK and other countries, your thought is bang on target: sandboxes allow fintech startups to launch new financial products on an accelerated basis; he adds “and with minimal regulatory barriers” though there cannot be reduction in the “regulatory barriers” as there are none in most of these countries, at present. “The advantages” writes Magnuson” of (the sandbox) approach are clear, as it promotes greater transparency in the industry while simultaneously encouraging innovation”.  Yes, but what of the disadvantages?  Some firms are co-operating.  Others are not.  Those that co-operate take on the financial, managerial and time-related burden of doing so.  Those that do not co-operate are free of the financial, managerial and time-related burden.  This provides an advantage to those competitors who choose to avoid playing in the sandboxes.  In other words, sandboxes tilt the playing field against precisely those who choose to play in the sandboxes.  The second disadvantage is that, even when a company is playing in the sandbox, it is difficult to tell whether it is sharing “the truth, the whole truth and nothing but the truth”.  In fact, most companies would be foolish to share anything like the whole truth because that would simply betray their competitive advantages to rivals, particularly those who choose not to be burdened by the financial, managerial and time-related disadvantages of playing in the sandbox.  

While Magnuson acknowledges sandboxes as “one example” of what he considers an appropriate approach, he confines himself to merely mentioning other “ideas that have been floated” including “the centralization of regulatory authority, the creation of targeted fintech regulation, and simplified registration procedures”.  He does not discuss these, presumably because he is biased against them.  My own bias is, I hope, clear: voluntarism is fine for those who willingly accept the burdens that voluntarism imposes; and voluntarism is certainly fine for a short experimental period; however, there is no alternative to regulation that imposes an equal but minimal regulatory burden on all firms in a sector.

In any case, increased flow of good-quality information is not a panacea, as Magnuson agrees: “Merely increasing public disclosure regarding the risks of fintech will not address the fundamental sources of those risks themselves. A growing number of studies demonstrate the limitations of disclosure as a method for reducing systemic risk. Individuals are often unable to process the significant amounts of information available to them, and even when they are, they often fail to change their behaviors in order to reflect this information. Thus, additional disclosure will likely be insufficient to address the systemic risk concerns (regarding) fintech”. 

That is why Magnuson asserts that “fintech regulation must also impose substantive regulations on risk”.  Though such regulations will “necessarily depend on the nature of the innovation…. one common principle should underlie substantive fintech restrictions: limiting contagion”.  For example, some robo-advisors already include “circuit-breaker” type features in their algorithms so as to reduce market volatility and prevent domino effects as parties rush to limit their losses. Such features could be made a requirement. Or, in the case of virtual currencies, regulations might focus on ensuring the trustworthiness of settlement mechanisms and the accuracy of distributed ledgers, in order to prevent breakdowns in the system and curtail herd behavior by consumers”.  In addition, there is the challenge of what could be done once a stampede has started.  Magnuson doesn’t think that struggling fintech companies should be provided liquidity by a Central Bank.  Rather, the “willingness to allow any particular fintech firm to fail should reduce the moral hazard problems in the (financial services) industry”.  He suggests that insuring consumers from losses would be a cost-effective way of restricting the pathways by which contagion is spread. After all, if bank depositors are insured from a certain minimum level of losses, why not consumers in fintech?  It is a tempting thought, but of course it assumes that all fintech firms are regulated, just as banks are, to keep an eye on their risk-management policies, procedures and outcomes.

That brings us to Magnuson’s third prescription, which relates to the difficulty of even identifying, let alone monitoring, the relevant actors.  Magnuson’s solution is to encourage self-policing – not just voluntary self-monitoring (including reporting one’s own compliance with regulatory obligations) but also the encouragement of all firms to monitor each other.  His argument is that “Fintech firms are in possession of idiosyncratic information that is poorly understood by outsiders.  Robo-advisors know their businesses and investment algorithms better than anyone else.  Crowdfunding sites understand their models and related vulnerabilities better than anyone else.  Virtual currency platforms understand the way that their currencies work better than anyone else.  All of these actors are better placed than regulators to identify material risks in their industries, such as the introduction of new players or the discovery of unexpected features.  Thus, they have the ability to identify relevant players and monitor their behavior much more effectively than outside regulators.  Fintech firms are also closely attuned to the activities of their competitors.  Fintech firms are constantly reviewing the competitive landscape to identify ways to improve their business, and, at least in virtual currency, much of the technology is “open source,” allowing fintech firms greater visibility into the functioning of alternative firms.  Thus, self-policing is likely to be particularly effective in the fintech sector”. 

Hmm, there are several issues here. 

First, if I am aware of the existence of fintech company AAA, how do I know whether or not the regulatory authority has AAA on its radar, unless all Fintech companies are required to be regulated, and to display their Regulatory Registration Number on their site? 

Second, does “open source” mean “open access to everything in the business”?  Doubtful.  Magnuson evades that issue by using the weasel wording of “greater visibility”.  He doesn’t discuss the distinction between “greater visibility” and “visibility sufficient to be able to monitor what’s really going on”. 

Further, will fintech firms be at all interested in monitor ingtheir competitors, suppliers and “co-opetitors”?  This is a problem that Magnuson acknowledges: “Monitoring is costly, and thus companies may not be willing to expend the resources necessary to do it, or they may not monitor at the optimal level.  Even if they do discover risks in their industry that could potentially create negative externalities for third parties, they may have incentives to refrain from changing their behaviors to curtail these risks if the suspect behaviors are profitable.  Thus, regulators will need to find ways to incentivize fintech to engage in an efficient level of self-policing. One particularly powerful way to do this is to leverage collective sanctions, imposing costs on the group when an actor misbehaves.  Collective sanctions are an effective way to utilize the superior information held by individual actors in a group and motivate them to use that information advantage to advance regulatory interests. By allowing regulators to impose costs on an industry as a whole, rather than requiring them to identify individual bad actors, collective sanctions can incentivize individual companies to monitor the potentially risky behaviors of other members of their group.”  Naturally, this begs the question of how “their group” is to be defined and by whom.  Magnuson thinks that, for example, debt crowdfunding platforms might be under the regulation that if a high number of loans in the industry default, the regulators will ratchet up the regulatory burdens on the industry as a whole.  Apart from “shutting the door after the horse has bolted”, this begs the question of how any such regulation coheres with Magnuson’s previous concern to avoid contagion in any situation where the public is already jittery because of the vulnerability or collapse of one player.  Possibly for this reason (though he doesn’t say so), Magnuson goes on to a possibility that has already been touted in banking as a whole: all relevant companies could be required to contribute to an insurance fund to pay for bad debts in the event of systemic shock. Such suggestions are good but inadequate in view of dangers with which we are familiar as a result of recent experience: regulatory capture, and commercial collusion, as well as whether insurance payments will be high enough to be sufficient given that there is no financial history for actuaries to utilise. So I’m afraid Magnuson doesn’t take us very far in relation to his third point.

His fourth point is the self-evident one that the fintech industry needs “a more internationally-minded regulatory regime (that) would take into account three fundamental principles:  first, fintech activity is not solely domestic, but rather crosses national borders and often raises complex jurisdictional issues; second, regulatory actions in one country will have effects on other countries; and third, regulators in other countries will have useful information about the effects of particular types of fintech regulation”.  These three considerations of course apply not just to fintech but to financial services as a whole – though that hasn’t allowed sufficiently sensible financial services regulation to emerge, for example to prevent booms and busts on a global scale.  So I’m afraid that, on this matter, Magnuson doesn’t take us much past homilies: “Governments … have an interest in cooperating to prevent systemic risk from materializing in the fintech sector.  They also have a broader interest in ensuring that fintech is not used to evade national regulations.  These important governmental interests provide an opportunity for regulators to cooperate to create responsible and appropriate measures to respond to and limit systemic risk factors in the fintech sector. This does not mean that fintech regulation must be uniform.  In fact, uniformity is both unlikely and undesirable at this stage of fintech’s development…. The aim is not so much to impose a single regulatory framework on all jurisdictions, but rather to ensure that regulatory competition and experimentation occurs in a way that produces useful and usable information for governments.”  In other words, let’s do here for fintechs what we already do for financial services as a whole – even when doing so would have results that are not only predictable but have already been experienced.  My view here too is, I hope, clear: a single regulatory framework for fintechs across the globe is not only desirable, it can also encourage experimentation and competition.

Let me close by thanking Magnuson for his paper.  It is good to have his wide-ranging contribution to a key matter on which there hasn’t been much discussion so far.

 

The conference, running yesterday and today, is organised jointly by the Federal Reserve Bank of Philadelphia and by the Journal of Business & Economics.

It features papers on:

·   Fintech Lending: Financial Inclusion, Risk Pricing, and Alternative Information    

·   Fintech, Regulatory Arbitrage, and the Rise of Shadow Banks

·    “The Law of One Bitcoin Price?

·   Blockchain Disruption and Smart Contracts

·   The Price of a Digital Currency

·   The Economics of Distributed Ledger Technology for Securities Settlement” 

·   Competition in the Financial Advisory Market: Robo versus Traditional Advisors

·   Does FinTech Affect Household Saving Behavior?

·   Integrating the Troublemakers: A Taxonomy for Cooperation between Banks and Fintechs

·    “Financial Regulatory Implications of Artificial Intelligence

·   Market Design with Blockchain Technology

·   Between the Lines: Decipher the Firms’ Fundamentals with Artificial Intelligence

   “Law, Trust, and the Development of Crowdfunding

·   Profit Sharing: A Contracting Solution to Harness the Wisdom of the Crowd

·   Financing Efficiency of Securities-Based Crowdfunding

The speakers are from universities, companies and other institutions from (in no particular order) the US, Canada, the UK, France, Germany, Australia, China and India – and perhaps other countries.

 

An analysis of data regarding investors’ internet usage suggests that machine analysts and human analysts are competitors.

Also that human analysts’ are losing.

That raises the question of whether it is in response to this development that human analysts are producing more optimistic, less accurate analysis of FinTechs and associated matters.

“The change in reporting quality is greatest for stocks where analysts’ conflicts of interest are strongest”.

All that is to be found in a paper presented to a conference, running yesterday and today, organised jointly by the Federal Reserve Bank of Philadelphia and by the Journal of Business & Economics.

The authors are Jillian P. Grennan and Roni Michaely, respectively of Duke University, and of Cornell University.

 

 

 

Australia, Canada and the EU seem to want to toughen rules.

Japan’s FSA is to start systematic monitoring of crypto-exchanges from next week.

America’s SEC is creating a cyber unit to tackle apparently wide misconduct in digital currencies.

China is not yet strangling crypto-mining but has been killing off cryptocurrencies for some weeks now.

So: what future for Bitcoin and other cryptocurrencies?

Frankly, I don’t know.  Clearly, this is not the time to start investing in them – and, if you are already invested, you need to review your portfolio pretty frequently.

However, I am confident of the future of blockchain-platforms for the present.  Though I fear they will also come under scrutiny and eventually be regulated, they serve a different and rather more useful function.

Many companies have been started with the objective of creating a single secure “verified digital identity” which could have multiple applicability.

Indeed, some claim to have such a technology already.

But it may be sobering to consider the largest such effort in the world: India’s programme (“Aadhar”) to provide all its 1.2 billion citizens with verified digital identities.

That programme has been a disaster – though not only for technical reasons.

Further, it may be instructive to consider the following:

I don’t know if you have the problem of a burgeoning, if not bursting, pocket because of the number of cards for banking and other business purposes that have to be carried nowadays.

I certainly have that problem.

In addition to the several “verified digital identities” that I carry most days, I have to carry, every time I travel internationally, the “most verified” of these (my Passport).

So the problem is merely that my many verified digital identities don’t talk to each other.

Could someone please start working on that?

Perhaps someone is working on that already?

Perhaps even on the possibility of using my “most verified digital identity” (my Passport) for all banking and other business purposes?

But halt a moment!

In such an ideal world, what if my “most verified digital identity” was lost or stolen?

Would I then have, in addition to the headache of getting a new Passport in order to be able to return home or travel out, also the problem of obtaining a new identity for all banking and business purposes (or getting my new identity/ Passport accepted for each of these )?!

In that case, might it be better, after all, to continue to have multiple verified digital identities, however inconvenient that is?

If one of my digital identities is lost or stolen, I can, in the immediate aftermath, still continue to function, to a greater or lesser extent, on the basis of the other (unrelated) identities that still remain with me..

Perhaps there is something to be said for a small amount of bother and inefficiency every day, in order to prevent a huge bother and complete paralysis at any unexpected point.

It used to be called, in technical circles, “redundancy”.

Non-geeks used to call it “insurance”.

The words, and the legalities (indeed, the underlying concepts) are different.

The attitude is the same: there is such a thing as too much short-term efficiency, too much leanness.

That also has a name.

In medical science, it is called anorexia.

So how much redundancy should one have?

The rule of thumb used to be: as much as might be necessary to overcome the worst disaster that you can foresee.

And a little extra, in order to cover even worse disasters that one can’t foresee at present.

Horrors!

How could it possibly be that some thought processes from pre-digital ages might have some validity in our VUCA world?!

The last couple of weeks have been pretty damaging for blockchain adoption.  No one knows if the Chinese government’s ban on all ICOs is *temporary* (the cryptocurrency craze needs to cool), or *strategic* (would China like to have its own national blockchain system, not some foreign one that could eventually undermine the Communist Party’s rule)?

The other possibility is that the Chinese ban is going to be in place till there is a *global agreement* regarding how all cryptocurrencies and related financial mechanisms should be supervised. 

Here is the thinking behind the Chinese move, according to Li Lihui, a senior official at the National Internet Finance Association of China and a former president of the Bank of China: Digital tokens, like bitcoin and ethereum, are stateless, do not have sovereign endorsement, and do not have a qualified issuing body or a country’s trust.  Such tokens are not legal currencies.  They should not even be spoken of as digital “currencies”.  In addition, such tokens have been a tool for fund flows and investment deals that China considers illegal. In other words, China has now defined and institutionalised a distinction between digital currencies which may eventually be created by national authorities, and digital tokens such as bitcoin.  Digital tokens should be banned, while digital currencies (created and supervised by national or global authorities) could be used for good, if there is the right global regulatory framework.  Till the time that such a global regulatory framework is put in place, all blockchain activity in the financial sector should be halted.  And it is accordingly being be brought to a halt in China by the end of this month.  This is particularly significant, given that China has been hotter than almost any other country for blockchain activity.

So are we likely to get a global agreement regarding supervision of blockchains? 

In my view, it is inevitable.  And it will be agreed relatively quickly.

That will have the advantage of stabilising and embedding blockchain in global financial systems.

Simultaneously, the Chinese position removes the basis for the idealisation of blockchain by people who have anarchistic or libertarian illusions.

 

A contributor on a particular Fintech discussion forum made the following statement:

“Had an interesting presentation from one of the world’s largest banks today. I quote: ‘fintech adoption has been overestimated’. They didn’t say what their estimations actually were, but I’d be interested to know if they expected digital challengers like XX to have 400k users (equating to an estimated 0.6% of the UK current account market) whilst still in Beta, not to mention companies like YY now processing £800m in transactions a month.”

Well, if one of the world’s largest banks says something, ought that not to be taken seriously rather than being challenged in this kind of superficial fashion?:

While 400K users while in Beta is impressive, it doesn’t amount to much in the financial services industry which is by its very nature global.  So 0.6% of the UK, fine, but what percentage is that of the global current account market in terms of participants?

More important, in terms of trade volume, £800m in a month might sound as if it is worth taking seriously, but that is only just over £26m a day, and compares with *daily* global financial flows of USD 5 TRILLION each day.

Fintech does have huge promise, but also huge dangers – as recognised by the Chinese and Korean governments last week.

As always, what we need is not just enthusiasm and hype, which are of course good things to have.  But we also need rationality, proportionality, and perspective.

The Digital Evolution Index 2017 ranks countries (https://www.weforum.org/agenda/2017/07/these-are-the-worlds-most-digitally-advanced-countries) into four categories:

 

– Countries that are strangely titled “Stall Out” (i.e. the top scoring countries — e.g. Norway, Sweden, Switzerland, Denmark, and Finland – which “enjoy a high state of digital advancement” but which are considered to have “slowing momentum” – whatever that means); this categorisation echoes the economic category of “developed countries”

 

– Countries that are titled (also strangely) “Stand Out” – i.e. countries are reasonably digitally advanced but exhibit “high momentum”. These can be considered the equivalent of “countries that have some chance of catching up with developed economies, provided they keep up their current speed of development and provided also that countries which are further ahead keep a slowed down pace of development”

 

– Countries that are titled “Break Out” (i.e., low-scoring in their current states of digitalization but are “evolving rapidly”). In terms of traditional economic terminology, these countries can be considered the equivalent of “emerging economies that never emerge”, primarily because they are “held back by relatively weak infrastructure and poor institutional quality” – in other words, they are held back by their culture and consequent political structure. Examples of such countries include China, Malaysia, Bolivia, Kenya, and Russia. India is included in this category, though it comes in even lower than Mexico, Colombia, Indonesia, Kenya, Philippines and Morocco.

 

– Lastly there is the category of “Watch Out countries” (i.e. with low state of digitalization and low momentum; in some cases, even “moving backward”). These are the equivalent of Least Developed Countries.

 

The Index prioritises speed over achievement, which is an interesting way to look at things – but current speed can be a deceptive criterion as the primary measure, because everyone slows down sometimes and everyone speeds up sometimes.  The distance between the different categories, as well as the distance between the various countries within the categories, is an equally important criterion – and that is underplayed here.

FinTech and Digital Finance

Posted by Prabhu Guptara | Uncategorised
My sabbatical is over, and I have returned to the fray!

Though my blog was originally intended to range broadly over the all the fields of business, and may still do so, I find that at present the most interesting and significant developments are taking place in Digital Finance.

So, for the moment, that will be the focus.

Let me begin by saying that Digital Finance is having huge impact, but there are some some worrying factors to consider:

– Between 2013 and 2016, $62 billion had been invested from around the globe just in FinTech.  Clearly, many investors are betting on this sector, and on individual initiatives within it.  They foresee an opportunity to make money by helping the sector gain “efficiencies”

– However, every “efficiency” means a job lost for one or more humans

 – That means lower capacity to spend money by (ex-)employees, alongside the well-known chilling effect that lower spending by each group has on other groups, even if the latter have money to spend.

Or let’s look at another aspect of the matter.  Only *8* humans now own as much of the world’s resources as half the human population.  In January 2017, that was the report from Oxfam International.

However, just a year before that (2016), Oxfam had reported the number of people who had as much wealth as the bottom half of the world’s population was *62*!

And it was only a year earlier (2015) that Oxfam had reported the number of people who had as much wealth as the bottom half of the world’s population was *85* !!!

In other words, wealth concentration increased from 85 individuals in the 2015 report, down to 62 men in 2016, a huge drop!  And from those 62 individuals in 2016, down to only 8 individuals in the 2017 report.
If that incredibly swift trend continues, less than 10 individuals will end up owning perhaps as much as 80% of the world in a few years.
So what use are such “mass technologies” as Fintech when the men concerned can simply talk to each other to decide whatever they wish?
Yes, Fintech will allow their decisions to be implemented at speed, but will that really matter to these men?  Only if these men continue competing against each other – which is certainly possible! – but history also shows that small groups of individuals don’t always compete, they often form oligopolies or ruling cliques.

Whether that sort of consolidation continues is partly a matter of politics, and partly a matter of the choices made by these few individuals.

While we work for the best policies to be put in place and to be implemented, let us continue to admire the amazing inventiveness of everyone involved in the world of digital finance.