FinTech, Blockchain Technology, and its Impact on the Financial Industry

5th Annual Rotman GRI Finance Forum

You just know it's important when it makes it to Dilbert

The Growth of Finance as % of GDP

Source: Philippon (AER 2015) "Has the U.S. Finance Industry Become Less Efficient?"

The Financial Industry is very competitive ...  yet unit costs have been flat!

Source: Philippon (AER 2015) "Has the U.S. Finance Industry Become Less Efficient?"

High-cost industries with  high rents?

What do we know from the long history of capitalism?​

Disruptive entry is bound to take place!

Prime Example of outside disruption: Equity Market Trading

Old Days of Trading: highly specialized humans

Modern Day Trading

Autonomous Algorithms run the show

Why?

  • Many trading strategies are more-or-less mechanical/probabilistic
  • Compared to humans, computers are
    • faster,
    • cheaper,
    • more reliable,
    • operate at much wider scope

Source: Bloomberg News, Feb 20, 2015

Note: The biggest disruptors (the HFTs) came from the outside of the traditional system (kinda).

Critical enabling factor: fundamental change in  infrastructure

Easier access and greater diversity of skills.

What about the financial sector as a whole?

Technology alleviated  structural constraints

Current Financial Infrastructure

  • cumbersome & clunky
  • slow
  • hard to get moving
  • but perfectly adapted to environment

Desired Infrastructure

  • nimble
  • fast
  • versatile

adapted from Philippon (2017)

Illustration of Clunky Infrastructure: Money Transfer

Stock Trade

Problem

Solution

=> avoid the existing, clunky infrastructure

And this is where Blockchain comes in...

Let's take a step back: how do we transfer value?

  • need to trust that the seller owns the item
  • for securities: issuer needs to know owner

Common Solutions

  1. Banks
    • verify ownership of assets (e.g., money)
    • must be connected for transfers
  2. Central registries
    • maintain permanent record of ownership
    • special privileges needed to make changes

Some Issues

  • reconciliation across silos (cash accounts, registries, fund flows)
  • connectedness of system entities
  • no "direct" transfers possible
    => need privileged access to the infrastructure

So how would we design value transfer?

central registry

Problem:

  • single point of failure
  • international connection?
  • changes are sensitive
    => only trusted parties invited
  • too many middle-men?

Option 1: Centralized

Technological challenge:

  • need consensus protocol to change registry

So how would we design value transfer?

Option 2: Distributed Network

Essence of Blockchain: consensus protocol in distributed network

  • keep track of all transactions of digital assets
    • can re-establish current ownership
  • rules for additions to chain
    • how are new transactions verified
    • who can add new transactions
  • consensus mechanism to accept changes across network

Illustration: Money Transfer

And there is more to it!

Why use banks?

Blockchains essentially allow everyone to partake!

Why is Blockchain Important? What can it do?

 

  • World Wide Web:
    • frictionless electronic transfer of information

  • Blockchain:

    • frictionless electronic transfer of value

Stock Trade with Blockchain

Market Design Questions

  • How much transparency?
    • explicit anonymization possible
    • implicit version: use many IDs
    • efficiency gains (I have a paper on this: Malinova & Park 2017)
  • How to incentivize verification and block creation? 
    • low activity environments
    • with privacy features: who is allowed to verify?
  • How fast should we settle?
    • capital commitment of intermediaries vs risk reduction (paper by Rotman faculty: Khapko & Zoican 2017)

Vocabulary Clarification

FinTech

Distributed Ledger Technology

Blockchain

My definition of FinTech: outside main financial institutions, usually post-2008

FinTech, DLT, Blockchain

Compliance

Wealth management

Cybersecurity

payments

Data & Analytics

Cryptocurrency

crowdfunding
(120+ FinTechs)
(19 equity CF platforms)

(P2P) lending

Public Blockchain

  • anyone can read and write (in principle)
  • large numbers of nodes
  • anonymity of user (but visibility of records)
  • immutability of records (subject to "hard forks")
  • verification must be incentivized

Private Blockchain

  • can have permissioned access for users
  • records can be changed
  • usually few nodes
  • authorized authentication
  • transparency, settlement speeds, user ID structure are design choices

Vocabulary Clarification

Public vs. Private

  • design new derivatives
  • bundle or slice and dice payments
  • BUT: only "complete" contracts

Vocabulary Clarification

Smart Contracts

Take Aways: Intrinsic Features of Blockchain

  • Blockchain requires no
    • "accounts"
    • dealers/brokers/bank
  • Blockchain does require
    • distributed network 
    • entities that process transactions
  • Blockchain ledger can be very transparent
    • => design choice.
  • Settlement is instantaneous
    • the trade is the settlement
  • Peer-to-peer is possible.
    • Who is your peer?

Link of Blockchain and FinTech

  1. remodel the back office 
    • traditional FI has expertise?
    • few blockchain developers
    • lose legacy systems (Fortran, Cobol, etc)
    • integrate databases
  2. back office => front office
    • peer to peer 
    • scope of data usage (VBA=         )
    • new instruments
  3. access for "outsiders" to larger market
    • broaden scope & offers new products to issuers and investors
  4. circumvent legacy infrastructure
    • crowdfunding + blockchain
    • "ADR" (coloured coin) trading

Disclaimer: Blockchain can be used for many other non-finance applications, e.g., health records, IoT, voting, prescription drugs

Market Design
with Blockchain

  • discussion on blockchain dominated by
    • tech talk
    • feasibility
    • cost savings
  • my view: focus on economics!
    • understand underlying economic mechanisms
    • back office => front office
    • which new business models?
  • market = transparent & equal access
    • BUT: marketplaces are built by self-interested parties
      • rules and institutions => frictions
      • frictions => economic implications => optimize market design

FinTech, Blockchain Technology, and its Impact on the Financial Industry

5th Annual Rotman GRI Finance Forum

Rotman Alumni Forum 2017

By Andreas Park

Rotman Alumni Forum 2017

a set of slides that I used for a presentation at Rotman's 2017 Alumni Finance Forum

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