Blockchain Gaining Widespread Adoption but FinTech Poses New Risks

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Picture Credit: Oliver Wyman in WSJ -CIO Corner

Most financial professionals have heard about Bitcoin and early ValueWeb proponent George Howard  quipped that blockchain is a “distributed database that sequentially records transactions.” Bitcoin is simply the earliest example of some 750 cryptocurrencies. Ever the evangelist, Howard and many billionaires like Microsoft’s Gates, PayPal’s Thiel, Virgin’s Branson, and Google’s Schmidt (among others) have embraced blockchain as a disruptive technology:

Never has it been more important than to be the “patient zero” of a meme that goes viral; to coin a phrase that becomes part of the vernacular; to be the first to write, sing, paint, or otherwise express something that establishes you as a “creative,” a thought or key opinion leader.

LetsTalkPayments.com (LTP) explains that, “The blockchain network consists of nodes, i.e. distributed servers. All the nodes can accept and process the transaction. The nodes on the network share information about the candidate transaction.” A distributed ledger, above right, is a network that records ownership through a shared registry. 1) The devil is in the details as payments get approved autonomously when a “majority” or credentialed nodes accept a transaction and these systems can be overwhelmed or manipulated due to very uneven liquidity (look up the Koinify case). The technology could cut financial services firm costs by up to $20 billion annually by 2022, according to Santander’s Finextra.

“Blockchain technology continues to redefine not only how the exchange sector operates, but the global financial economy as a whole.”

–  Bob Greifeld, Chief Executive of NASDAQ

Earlier this year, bitcoin expert Chris Skinner released The ValueWeb (available on Amazon) which explained that the Internet of Things (IoT – or sensor-enabled machines) cannot operate in the framework of the old payments system and needs an Internet of Value (or “Valueweb”) to function.  Chris’s fall 2014 book Digital Bank explained how the planning activities of incumbent banks (Barclays in the UK and mBank in Poland), new start-ups (like Metro Bank), and disruptive new models of banking (like FIDOR Bank in Germany) and finance (like Zopa and Bitcoin) signaled early ValueWeb adoption. The problem with traditional banks is that they are a captured oligopoly with privileged access to the clearing systems at national central banks with excessive leverage and inadequate regulatory compliance and enforcement. 2) The breakup of the fiat or fractional banking system is another important looming risk from blockchain to a next generation ValueWeb payment system. Nonetheless, Business Intelligence cites KPMG data as demonstrative that this Fintech market opportunity is getting funded fast.

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LTP beautifully details how the Blockchain Platform is being used for various use cases and business models such as:

– Crowd Funding – Blockchain Technology is being applied to the crowdsourcing platforms. When individuals are granted certain responsibilities or chunks of business, a blockchain-like system could determine which of those individuals are worthy of credit. Blockchain has the potential to make crowdsourcing smooth and secure. Examples of such companies are  BitcoinCapital (a fund from RT’s Max Keiser), Koinify (which failed) and others. Max’s partner Simon Dixon of the BankoftheFuture explains the blockchain opportunity here and transactional vehicles like StartCoin.

– Identity Management-  In the field of identity management, user first scans his/her identity document and then signs it. Then, the mobile app will generate a private and public key to seal that record. It is encrypted, hashed and sent to the network of communicating nodes running on the Blockchain network. Examples of such companies  are  ShoCardBlockChain Factory and others.

– Smart Contracts – A cryptographic Blockchain is  used to digitally sign sensitive information, and decentralize trust; and this is being used to develop smart contracts and escrow services, tokenization, authentication, and other services. Examples of such companies are  SymbiontSAE and others.

– Remittance – Blockchain protocols are used by many companies already for P2P money Transfer across international borders. Its a segment worth $500 B. Examples of such companies are RipplelabsBitspark  and  BitPesa.

– Data Management & Analytics – Blockchain-based identity ledgers are used  in database management and data analytics to support various application. Examples of such companies  are  Factomnumsight and others.

– Trading Platform – Using Blockchain technology, individuals and firms can  produce and exchange financial contracts. This peer-to-peer contract creation and settlement means that all transactions are cleared on the Bitcoin Blockchain with no intermediary involved. Examples of such companies  are KrakenNasdaqMirror  and others.

Last week, twelve large banks in the 70 member R3 Consortium (Barclays, BMO Financial Group, CIBC, Intesa Sanpaolo, Macquarie Group, National Australia Bank (NAB), Natixis, Nordea, Royal Bank of Canada (RBC), Santander, Scotiabank, and Westpac Banking Corporation) just participated in a trial to demonstrate cost-cutting and increased efficiency of cross-border payments using startup Fintech player Ripple’s ‘digital asset’ XRP.

The Financial Stability Oversight Council (FSOC), a US Treasury entity, warned that blockchain technology and marketplace lending could present risks to financial stability. Henry Blodgett’s (of dot.com hype and convictions) BusinessInsider does cover blockchain closely which lists other risks:

  • Marketplace lending. FSOC warned that marketplace loan investors could become less willing to fund loans during a trough in the business cycle, increasing the risk of the model. It also said that as the number of marketplace lenders competing with traditional lenders rises, they might lower their underwriting and loan administration standards in order to attract customers. This would likely mean riskier loans.
  • Blockchain technology. FSOC suggested that risks associated with blockchain may not emerge until solutions are deployed at scale, because of participants’ limited experience with the technology.
  • Blockchain fraud. FSOC also said that some blockchain systems could be vulnerable to fraud, if a significant minority of participants colluded to defraud the rest (as the role of centralized intermediaries diminishes).
  • Regulatory diseconomies. FSOC also highlighted that financial firms using blockchain-based systems may operate over multiple regulatory jurisdictions or national boundaries.

Still interested ? MIT offers a FinTech certificate for a twelve week course starting November 21st, 2016 for $2600 – Cambridge is more fun than online.

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