2. RISKS AND
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The financial revolution
we’re witnessing can be
broken into three phases:
digitization, disaggregation
and decentralization.
Executive Summary
It’s the end of financial business as usual. So-called “fintech” startups and the
incumbents—traditional banks, insurance and financial services entities—are
best described as frenemies, mutually dependent in many ways, but diverging
most dramatically in IT capabilities that enable the startups to aim their “short
stack innovations”—a multitude of consumer-friendly apps and dashboards
running on advanced algorithms and APIs— at the traditional players. The
financial revolution we’re witnessing can be broken into three phases. The
first is the digitization of currency/capital itself, a Pandora’s Box in terms of
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introducing unquantifiable risk, complexity and liability into the banking
system, along with ease, speed and more financial inclusion. The next and
current full-throttle phase is buffeted by the triple play of disaggregation—of
data, the products/services of banks, insurance and finance companies, and
the sector itself. The third incipient phase is all about decentralization of the
current central electronic ledger system. The technology threatening to upend
the centralized model is blockchain, which, while potentially eroding margin
for Wall Street interests, is projected to save the overall financial sector $20
billion by diminishing the complexity that plagues the opaque payments and
settlement systems. Blockchain technology applications range from storing
client identities to handling cross-border payments, from clearing and settling
bond or equity trades to smart contracts that are self-executing. Blockchain
technology was once eyed warily by the incumbents in the wake of wild Bitcoin
currency fluctuations and the Mt. Gox and Silk Road incidents. But now, there
is no higher priority undertaking than blockchain experimentation at almost
every major bank worldwide. Finally, there are huge developments in PII and
identity authentication, with blockchain contributing here as well.
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“FINTECH” HAS INTRODUCED
SOME MUCH-NEEDED HIGH
TECH AND PARADOXICALLY
AUTOMATED HIGH TOUCH TO
THE STAID FINANCIAL WORLD.
The Frenemies of Finance
As it has with media, music, transportation, and hospitality, digital technology is
revolutionizing every aspect of our financial lives: How money is moved, stored,
spent and managed, even what constitutes currency in the first place. The current
revolution features two apparent adversaries: old guard financial institutions and
the financial technology startups that are in a position to grab up to $4.7 trillion
in revenue and $470 billion in profits from them, according to a recent Goldman
Sachs study1
.
“Fintech” has introduced some much-needed high tech and paradoxically
automated high touch to the staid financial world, prompting irrational
venture capital exuberance and everything from utopian post-banking-world
prognostications, which bring the “unbanked” onto the global ledger, to more
dystopian scenarios about shadow banking business as usual. One thing is
certain: This is a high-stakes game, as global GDP is predicted to reach $85
trillion by 20202
—a four-fold increase over four decades—and this translates
into greater demand for financial services everywhere.
Let’s take a look at the two sides of the revolutionary coin, so to speak. Fintech’s
slick, simple apps and actionable dashboards—running on data-mining
algorithms that reverse centuries of financial services’ back-office opacity—
should double usage in 2016, says Ernst Young. These startups are often long
on innovation—algorithmic lending, pattern extraction on IT logs to detect fraud,
real-time spending analysis on transaction data, block chain-based transactions,
etc.—and short on regulation. But despite the appearance of a complete break
with banking as usual, fintech owes a largely unrecognized (at least to the average
consumer) debt to the financial infrastructure, as most use incumbent financial
institutions as their backbone for real cash, regulatory bona fides and government
guarantees. The NYSE, for example, began a real-time price index that tracks
the valuation of Bitcoin based on data provided by Coinbase, a leading Bitcoin
platform at the forefront of the industry and the first regulated Bitcoin exchange
in the US. Coinbase was chosen by the exchange because of its commitments to
transparency, security and regulatory compliance.
1. “Slings and Arrows,” Economist.com, May 9, 2015
2. “Fintech: Friend or Foe?,” BankingTechnology.com, Dec 22, 2015.
5. The traditional financial services industry, long on regulation due to 2008 crisis-
precipitated changes, increased reporting and transparency requirements, is short
on open source software, mobile, cloud and digital innovations. They owe fintech
a debt, as some expect it to cure many of the diseases of the financial system—
such as opacity, complexity, lack of competition, poor business culture, and high
operational costs.
From payment processors and alternative P2P or marketplace lending firms to
automated investment services, aka “robo-advisers,” fintech brings fresh ideas
about making the security, movement and performance of money easier and
generally cheaper.
One model of “easier’’ is Betterment, a startup that provides automated investment
services and personalized advice. Inc. reports that Jane Bryant Quinn, a prominent
financial journalist and retirement expert, recently sang the company’s praises: “I
love these automated financial advisers, and not just for millennials. Betterment is
the only one that has an automatic plan for dealing it [your money] out over your
retirement. The others will probably get to that eventually, because you really need
both kinds of automatic planning.”4
Lending Club is an example of cheaper. Its ongoing expenses as a share of its
outstanding loan balance is about 2%; the equivalent for conventional lenders
is 5–7%. Banks borrow heavily to fund lending; the new marketplace or P2P
platforms do not. Fintech lenders like Lending Club, Prosper and Zopa simply
match borrowers and savers directly.
When consumers use bitcoins instead of credit cards, both merchants and
consumers save. Credit card and debit fees in the U.S. totaled $72 billion in 2013,
according to Gil Luria, an analyst at Wedbush Securities Inc.5
Bitcoins also make
buying unused gift cards cheaper on Purse.io and Starbucks, Target and Whole
Foods purchases cheaper on the Fold mobile app.
Insurtech, lagging fintech
a bit, is nevertheless in the
disaggregation game as well,
“chopping up the Gecko,”
as Core Innovation Capital
colorfully puts it.
3. Fig. 1. “Lending, Investments, and Personal Finance: 102 Startups Attacking the Banking Value Chain,’
CBInsights.com/blog, February 3, 2016.
4. Zoe Henry,“8 Emerging Fintech Startups to Watch in 2016,” Inc.com, 2016.
5. Anthony Effinger, “Coinbase Leads Move to Bring Bitcoin to Masses,” Bloomberg.com, September 30, 2015.
6. Fig. 2. Arjan Schutte, Thomas Smythe, “Slicing Up the Gecko: How Tech Start-ups Can Disrupt A $5 Trillion Industry,
Core Innovation Capital, May 2015.
Fintech companies are disaggregating the financial sector via marketplace
lending, direct lending and underwriting, bill pay/money transfer, online
mobile banking, personal finance and robo advisors.
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FINTECH COMPANIES AVAIL THEMSELVES
OF APIS AND FLOAT THEIR PRODUCTS
ON CLOUD SERVICES SO THEY CAN BUILD
AND DELIVER FASTER.
Partial and Full Stack Technological Change
One way to characterize the financial revolution underway is to talk in
terms of partial and full stack technological change. The consumer
experiences that US-based fintech startups are engineering are
shaking up incumbents using legacy systems sometimes 30 years
old. Fintech companies avail themselves of APIs and float their
products on cloud services so they can build and deliver faster.
In effect, they access API data like an on-premises database, but
not one that is compliance-constrained and resource-strapped.
Stripe’s API enables merchants to accept payments in 130 different
currencies and Square’s Connect API lets merchants and third-
party developers improve the Square platform for payments, refunds
and deposits. Big players are in the financial API game too: Google
offers two popular Wallet APIs for streamlining payment and loyalty
programs, and MasterCard, Visa, PayPal and Apple are advancing
mobile wallet and money transfer in myriad ways.
According to Joe Boroi, Associate Director of Technology at
Resource/Ammirati: “Today, you no longer build a website, or build
a web application, or even build a mobile app. Instead, you build a
distributed system of loosely coupled solutions deployed in the cloud.
The world started to embrace agile delivery because we needed
to build faster, more modularized iterations that are redundant
and scalable.”
Insurtech startups are also using API-enabled big data, giving
them a real-time edge. Traditional insurance companies pool risk
by collecting disparate data about scale populations to foresee
risks and price against the odds of them occurring. That actuarial
advantage is eroding as data becomes more widely distributed
and accessible.
7. Rather than reviewing a decade’s worth of static data, insurtech companies are
using structured and unstructured data, including data from sentiment and
social network analysis, to power predictive modeling.
Both fintech and insurtech are unbundling the front- and back-office functionality
of established “supermarket” or soup-to-nut players. But for all that, most fintech
companies are not quite as disruptive as they’re perceived to be by consumers.
They’re offering “partial stack technology” solutions because they don’t have the
means to design, build and distribute a new product, all while creating the entire
ecosystem to support it. Most rely on banks or fully disclosed clearing firms to
run their businesses.
On the other hand, “full stack technological” change to the financial services,
banking and insurance industries would entail an end-to-end solution (similar to
the cases of Uber, Tesla or Netflix). Standard Treasury is a startup creating a set
of APIs that make it possible for any firm to more efficiently create a full stack
solution—and to round out their own ecosystem, they were acquired by Silicon
Valley Bank. Interestingly, an API survey recently conducted by Bank Innovation
and the Berlin-based Open Bank Project revealed that 26% of banks surveyed
already had APIs built or underway, while 38% planned to build one in the
next year.
FINANCIAL SERVICES VALUE CHAIN
IN THE SUPERMARKET AGE
THE NEXT-GEN FINTECH STACK
7a. Fig. 1. Doug Nelson, “Financial Services Unbundling, Revisited,” medium.com, February 11, 2015
7b. Fig. 2. Doug Nelson, “Financial Services Unbundling, Revisited,” medium.com, February 11, 2015
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But the star of full stack technology is blockchain, whose most notorious
application is Bitcoin. Ajay Vij, vice president and head of financial services at
Infosys in Europe, describes blockchain technology this way:
The distributed ledger—the central nervous
system of the Bitcoin system—is the most
sweeping departure from the long-standing
financial bookkeeping practices followed
since the codification of the Medici’s
double entry accounting system… Satoshi
Nakamoto, the mysterious creator of the
bitcoin,solvedabigproblemofbookkeeping
in a decentralized way. He did this through
a distributed ledger called a blockchain.
It takes the form of a distributed database,
hardened against tampering, against which
anyonecanverifythevalidityoftransactions.
This operates alongside a unique set
of monetary incentives (i.e. bitcoins) to
encourage network’s owners (the bitcoin
miners) to keep the ledger up-to date.8
8. Ajay Vij, “Blockchain: Ushering a New Era in Fintech,” BankingTech.com, December 21, 2015.
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“THERE WILL BE NO REAL, NON-
CONTROLLED CURRENCY IN THE WORLD.
THERE IS NO GOVERNMENT THAT’S
GOING TO PUT UP WITH IT FOR LONG.”
—Jamie Dimon, CEO, JP Morgan Chase
The financial market is split between private blockchain consortia—
such as R3 (which has 42 bank members) and DAH (Digital Asset
Holdings)—developing permissible ledgers that exploit trusted
networks, and open-ended blockchains—such as Ethereum—
that are closely aligned to bitcoin’s original design principles
and applications.
Overseen by the Linux Foundation, IBM is leading a blockchain
effort called the Open Ledger Project with other tech giants and
leading banks, including Intel, Cisco, JP Morgan Chase, London
Stock Exchange Group and State Street. The Open Ledger Project is
developing a library of custom-distributed ledger solutions that are
not reliant on public blockchains and are aimed at cryptocurrency
but also contracts, supply chain and Internet of Things applications.
IBM Fellow Jerry Cuomo said, “I think bitcoin is an interesting
application for blockchain but there are thousands of applications
and wider use cases beyond that.”
And JP Morgan Chase CEO Jamie Dimon had this to say about
bitcoin: “This is my personal opinion, there will be no real, non-
controlled currency in the world. There is no government that’s going
to put up with it for long...there will be no currency that gets around
government controls.” However, Dimon said, bitcoin’s underlying
blockchain technology has a brighter future: “The technology
will be used, it may even be used to transport currency but it will
be US dollars.”9
And other foreign currencies, it seems. Epiphyte’s software
programs allow financial service providers to convert the currency
of one nation to bitcoin, make an international transfer and change
the bitcoin into the currency of the destination country. On the
blockchain battlefield of established players and fintech startups,
Epiphyte is somewhat unique, aiming to build a bridge between
established finance and cryptofinance in a low-risk, compliant way.
9. Yessie Bello Perez, “Jamie Dimon: Bitcoin Will Not Survive,” coindesk.com, November 5, 2015
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The Digital Identity Frontier
Blockchain, beyond its distributed cryptocurrency application, holds tremendous
promise as digital identity management. Vitalik Buterin, one of the originals in
the Bitcoin media space as the co-founder of Bitcoin Magazine, and the creator
of Ethereum, said: “I think decentralization is particularly valuable for what I
call “base layer” services: stuff that everything else relies on. Identity is a great
example; I think that the current regime of having to “sign in with Google/Twitter/
Facebook” to everything is simply insane, and have even made the point that if
this continues 10 years from now, it may be harder to change identity providers
than it is to change countries.”10
Credits, “a federated blockchain framework that can communicate agnostically
withotherchainsandactsolelybasedoninformationcontainedoutsidetheledger,”
is close to rolling out a KYC/identity platform with the Isle of Man government.
Perhaps most audacious of all the blockchain identity and notarizing services
is Bitnation, which recently announced a deal with the Estonian government
(arguably—if astoundingly—the most advanced digital nation on the planet).
Bitnation is giving blockchain IDs to refugees so as to provide unbanked arrivals
with bitcoin debit cards.
Another startup, GlobalGateway, enables businesses to perform frictionless
identity verification for more than 3 billion people in over 40 countries via 145 data
sources—the widest coverage in the market. GlobalGateway helps businesses
comply with Anti-Money Laundering (AML) and Know Your Customer (KYC)
identity verification needs, and provides a reliable way for businesses to evaluate
new and existing users through one, single portal or API.
10. Vitalik Buterin Conducts AMA Re: Ethereum,” Crytocoinnews.com, September 4, 2015.
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BANK CHALLENGERS ARE ALSO
INVESTIGATING THE USE OF BIOMETRIC
TOOLS LIKE VOICE RECOGNITION OR
APPLE’S FINGERPRINT RECOGNITION.
Me2B technologies for the financial industry will soon propel
another big change; individuals will be able to update and control
the use of their PII data. According to Trunomi, a fintech company
providing software for financial institutions to comply with know
your customer (KYC) regulations: “By granting a bank or business
real-time permission to access their personal data, consumers
protect their personal information and streamline processes such
as opening a bank account. They will also be able to control who
uses and accesses their data, eliminating the Big Brother factor
and ensuring prior consent to its use is granted, backed up by
regulatory enforcement.”11
For identity authentication and security, bank challengers are
also investigating the use of biometric tools like voice recognition
or Apple’s fingerprint recognition. But, according to Alphaville/
Financial Times columnist Izabella Kaminska: “A financial system
entirely dependent on Touch ID fingerprint or voice recognition
tools not only discriminates against those not lucky enough to have
fingerprints or voices (the limbless, the maimed, the cancer victims)
it also encourages fraud to take a more human form again—from
ransom and extortion to property theft and hostage-taking. It also,
by the way, encourages the propagation of counter-Touch ID tech of
the fingerprint skimming or voice synthesizer variety. (After all, it’s
not like we don’t leave our fingerprints behind on a lot of surfaces or
our voices in the air.)”12
11. Chia In, “Hype or Here To Stay: Emerging Trends of Fintech,” Trunomi.com, June 2015.
12. Izabella Kaminska, “Fintech Paradoxes, Blacklist Edition,” FTAlphaville.FT.com, January 8, 2016.
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IoT (Internet of Things) and Data Minimization
Six years ago, for the first time, the number of
“things” connected to the Internet surpassed the
number of people. Yet we are still at the beginning
of this technology trend. Experts estimate that
as of this year, there will be 25 billion connected
devices, and by 2020, 50 billion. The economic
impact of IoT applications could be anywhere
from $3.9 trillion to $11.1 trillion per year in
2025, depending on a number of factors,
including declining costs of technology and the
level of acceptance by consumers and workers.
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“HUMAN JUDGMENT IS BEING
REPLACED BY AUTOMATIC
ALGORITHMS, AND THAT BRINGS
WITH IT BOTH ENORMOUS BENEFITS
AND RISKS.”
—Bruce Schneier, Harvard’s Berkman Center Fellow and CTO of Resilient Systems
To encourage consumer acceptance and confidence, privacy and security must
come with near ironclad guarantees. Because of the collection of personal
information, habits, locations and physical conditions over time, that is to say,
all manner of contextual, behavioral (and, with wearables and ingestibles,
biometric) data, companies could use this data to make credit, insurance and
employment decisions. Harvard Berkman Center fellow Bruce Schneier observes
that: “Human judgment is being replaced by automatic algorithms, and that
brings with it both enormous benefits and risks. The technology is enabling a
new form of social control, sometimes deliberately and sometimes as a side
effect. And as the Internet of Things ushers in an era of more sensors and more
data—and more algorithms—we need to ensure that we reap the benefits while
avoiding the harms.”13
The FTC staff discusses data minimization in its report on the Internet of Things:
Privacy Security in a Connected World:
Data minimization refers to the concept that
companies should limit the data they collect and
retain, and dispose of it once they no longer need
it. Although some expressed concern that requiring
data minimization could curtail innovative uses of
data, the FTC staff believes that companies should
consider reasonably limiting their collection and
retention of consumer data. Data minimization can
help guard against two privacy-related risks: larger
data stores present a more attractive target for data
thieves, both outside and inside a company—and
increases the potential harm to consumers from such
an event. Second, if a company collects and retains
large amounts of data, there is an increased risk
that the data will be used in a way that departs from
consumers’ reasonable expectations.
14
13. Bruce Schneier, “Replacing Judgment with Algorithms,” Schneier.com/blog, Jan 8, 2016.
14. “The Internet of Things: Privacy Security in a Connected World,” FTC.com, January 2015.
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According to a landmark study by LexisNexis®
Risk Solutions, despite their view
that more data is better for security, many banking experts agree with the FTC
and hope to reduce the amount of PII they collect and subsequently store. The
study found that unlike the retail sector, which, battered by recent breaches,
has lost some consumer trust, consumers still have a high level of trust in
financial institutions, with 60 percent very willing to share PII with banks, credit
unions and other financial institutions.
“Incidents of data breaches and identity theft have become pervasive threats to
consumer trust,” said Dennis Becker, LexisNexis Risk Solutions Vice President.
“Organizations need to be cognizant of how consumers’ fears and experiences
affect their willingness to share sensitive data and seek ways to minimize the
amount of personal information being requested.”15
15. “Companies and government agencies seek ways to reduce consumer friction by ensuring collection
of most relevant personally identifiable information (PII),” Lexisnexis.com, December 21, 2014.
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The Financial Future Is Already Here
Though the tug of war between innovation and regulation, between access and
privacy, between permission-less and permissioned-only networks will rage on
for years, the financial sector’s current upheaval holds the promise of digitally
demystifying personal finance—and empowering consumers everywhere.
Blockchain technology, once a weapon wielded against banks by libertarians,
is now being heralded as their ultimate back-office makeover. Rather than
wait to see how it nets out, financial professionals would do well to prepare
for the future that’s nearly here by learning blockchain and decentralization
technologies and rethinking identity ownerships for their customers.
Blythe Masters, formerly of JP Morgan Chase and now leading the
blockchain start-up Digital Asset Holdings, said, “You should be taking this
[decentralizing, blockchain] technology as seriously as you should have been
taking the development of the Internet in the early 1990s. It’s analogous to
email for money.”16
Dr. Nita Rollins
Director of Thought Leadership Cultural
Insights (and newly minted blockchain geek)
16. Jane Wild, Martin Arnold and Philip Stafford, “Technology: Banks Seek the Key to Blockchain,” FT.com,
November 1, 2015.
