The heart of fintech revolution-block chain perspectives and implications

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Fintech is an acronym which stands for the coming together of the world’s largest force multipliers, finance and technology together to change the way people transact forever. It signifies not only the coming together of these two behemoths but also coming of age of the fourth industrial revolution, the term coined by Klaus Schwab, the founder and executive chairman of the World Economic Forum.

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International Journal of Management (IJM) Volume 7, Issue 7, November–December 2016, pp.344–351, Article ID: IJM_07_07_038 Available online at http://www.iaeme.com/ijm/issues.asp?JType=IJM&VType=7&IType=7 Journal Impact Factor (2016): 8.1920 (Calculated by GISI) www.jifactor.com ISSN Print: 0976-6502 and ISSN Online: 0976-6510 © IAEME Publication THE HEART OF FINTECH REVOLUTION-BLOCK CHAIN PERSPECTIVES AND IMPLICATIONS Mansi Kapoor Symbiosis Centre for Management Studies, Symbiosis International University (SIU) Viman Nagar, Pune-14, Maharashtra, India ABSTRACT Fintech is an acronym which stands for the coming together of the world’s largest force multipliers, finance and technology together to change the way people transact forever. It signifies not only the coming together of these two behemoths but also coming of age of the fourth industrial revolution, the term coined by Klaus Schwab, the founder and executive chairman of the World Economic Forum. This revolution signifies the coming together of man and machine to co inhabit planet earth and will cause a shift not only in how we know “homo economicus” but will redefine the term humanity as well. Cite this Article: Mansi Kapoor, The Heart of Fintech Revolution-Block Chain Perspectives and Implications. International Journal of Management, 7(7), 2016, pp. 334–351. http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=7&IType=7 Technical interventions in Finance – A Timeline Finance is and will be the core of any economy and will set the trends in how people and businesses transact with one another but so far, financial institutions and central banks have been driving the change but now, technology has entered the space and has a greater role to play in not only how we transact but with what and with who and how and consequently will alter lives in a very profound way. The role of technology in finance began in the sixties with the invention of semiconductor microprocessors which enabled data being captured and stored in a digital format. With mainframes in the seventies, batch processing became possible. With terminals and personal computing in the eighties, we saw the advent of automated banks and branches and also offline remote banking became a possibility. Also with the proliferation of local networks, there was the intranet and corporate systems. The internet of the 1990s of course made it possible to have global exchange of data and consequently the rise of the multinational corporations. Since 2015 however, technology is causing changes at an exponential rate. The technologies that been driving not only banking and finance but also other sectors are cloud computing, cognitive computing, machine learning or predictive analytics, quantum computing and robotics. These have been altering business processes at lightening speeds. In short these technical interventions ensure that massive quantum of data can be now not only processed but also analyzed in nano seconds. Analytics which was a core human function can now be handled faster, with more precision by our machine counterparts. http://www.iaeme.com/IJM/index.asp 344 editor@iaeme.com
The Heart of Fintech Revolution-Block Chain Perspectives and Implications However, the technology that is firing the imagination of the finance and banking industry worldwide is blockchain technology also called Distributed Ledger Technology or DLT .It is right now the heart of Fintech and is all set to hit the pinnacle of the fourth industrial revolution. Basics of Blockchain • It was blockchain technology that was behind the invention of Bitcoins in the year 2008. • The technology uses cryptography to create a shared ledger which is a digital ledger of transactions that people in the network can see or access. • This network is comprised of a chain of users in which all must approve an exchange before it can be verified or recorded. • For example if A wants to send money to B then in Blockchain technology : • This transaction is represented online in a block. • This block is broadcast to everyone in the network. • Those in the network approve that the transaction is valid. • Money is transferred from A to B • The block is added to the chain. • Each block provides an indelible and transparent record of transaction • And so on, various blocks can keep getting added to the chain. • To explain in a layman’s language, before the age of the internet, if we had to communicate with others we would write a letter, put it in an envelope, buy a stamp and paste it on the corner, go to the nearby post box and slide it in. Depending on the schedule of duty a person called the postman would make the rounds, could be the same day or the next or a week later etc. The postman would put the letter in his leather satchel and deposit it in the locality post office. The letter would then be sent to a central post office and after stamping the date of the receipt, would again follow the same process in reverse. It would be handed over to the postman of the area who would come and drop it to the person’s physical address. The whole process of sending and receiving would take days, weeks or months depending on the geographical distance between the sender and the receiver with off course the efficiency of the postal department playing a role as well. Step into the nineties, with the internet, this process seems insane. We send an email which is received instantly by the person who might be in any part of the world. Post Office ?? Postmen ??? Time ????? The previous example referred to how the process of communication changed with the advent of internet for data and information. Now imagine the future, but instead of moving data, we will be moving assets or things we value. To take a simple example, suppose we want to transfer money to somebody. See what happens now, we send a request (cheque, demand draft, online) to a bank in which we have an account. The bank then transfers the money into the account of the person which might be with another bank. The process called settlement takes hours, or days. (Though with SWIFT it’s faster)Again the process needs intermediation and causes costs and delays. With blockchain technology what will essentially happen is this exchange will happen instantly, just like an email. You send currency or money and it is received instantly with just a ping. The concept of money can now be extended to any asset which can be digitized, like shares, bonds, music etc. In fact blockchain technology can even be used for elections and votes can be digitized. • Blockchain Protocol is essentially based on the following core concepts : • Chains hold blocks of information. • Trusted Computing: These are technologies and proposals for enhancing computer security problems through hardware and software interventions. This enhancement is a collaborative venture between a group of vendors who call themselves Trusted Computed Group. http://www.iaeme.com/IJM/index.asp 345 editor@iaeme.com
Mansi Kapoor • Smart Contracts: These are contracts which have legal provisions embedded in the program so can be executed automatically or in other words they self-execute. To take an example. We are now in a Shared Economy of sorts. Suppose a person wishes to rent his/her car, like people rent out their apartments. The person wishing to rent the car will forward a certain sum of money which will be sent first to pre agreed smart contract algorithm ( Smart Contract) which would enable an authorization via the renters smartphone , then this person would have access to the car . Within the contract would be build mechanism for protection of the owner’s property which in this case is the car. The would be provisions to monitor the drivers speed etc. . If the data captures over speeding or rash driving, a greater amount would be deducted from the initial amount sent. Implying that third party interventions that are required to ensure compliance of contracts will not be required. • The distinguishable feature of DLT is that trust is embedded in the system, digital identity is created and indelible traces of information is stored in blocks which can be accessed by the participants. • Authorized participants can alter the ledger without awaiting approval from a central authority, often resulting in faster and more secure transactions that can save institutions time and money. Global Investments in Blockchain Technology In August 2016, World Economic Forum released a report in association with Delloite titled “The future of financial infrastructure- An ambitious look at how blockchain can reshape financial services. “The report is based on twelve months of intense research involving experts from the entire spectrum of financial services and beyond. Five global workshops were held around the globe which bought together regulators, subject matter experts, innovators and industry leaders. In 2015, the workshops were held in Singapore (October), New York (November) followed by London (December) and in 2016 in Davos (January) and finally Sydney in April. According to this report • Currently, more than 24 nations, 90 Central Banks and many corporates are working on this technology. • More than 2500 patents have been filed worldwide. • Over the last three years over 1.4 billion USD have already invested in blockchain. • It is predicted that 80% of all banks will initiate blockchain projects by as early as 2017. Many large central banks are funding startups which are working on blockchain applications. R3, a blockchain startup founded in 2014 by a Wall Street professional David Rutter is a consortium which consists of 30 large financial institutions that have agreed to develop and pilot blockchain technologies. According to the R3 website, they describe themselves as “an alliance of the world’s largest institutions, with a mission to realize the benefits of distributed ledger technology.” Its members include Goldman Sachs, Morgan Stanley and Credit Suisse. R3 is currently building “Corda” which is a distributed ledger designed to help member banks to use the technology for interbank transactions and settlements. It is reported that member banks have pledged 200 million dollars for development of blockchain technology. Some Key Blockchain Applications in Banking & Finance A report released by Deloitte titled “Blockchain Applications in Banking,” specifically talks of two areas where the technology will result in greater efficiency and huge cost savings. One is KYC and the other in payment processing. http://www.iaeme.com/IJM/index.asp 346 editor@iaeme.com
The Heart of Fintech Revolution-Block Chain Perspectives and Implications According to the Deloitte report • Efforts to check money laundering and financing of terror is currently extremely expensive and difficult. • In 2014 , cost of compliance ,globally ,for banks was approximately 10 billion USD • Apart from costs, the process causes delays which can range from 30 to 50 days. • Due diligence also causes duplication of efforts amongst various agencies. Currently, banks are fined rather heavily for failing to comply with KYC guidelines. Taking an example from India, as recently as July 2016 RBI has imposed penalties to the tune of Rs. 27 Crores on 13 Banks for Violating KYC and FEMA guidelines. Some of these penalties are as follows. • Allahabad Bank – Rs. 2 Crores • Syndicate Bank – Rs. 3 Crores • Bank of Baroda – Rs. 5 Crores • Canara Bank - Rs.2 Crores • HDFC Bank – Rs.2 Crores Internationally, according to a Thomson Reuters Survey, from the period 2004 to 2010 the monetary penalties levied on banks are: HSBC (1.92 billion USD), Standard Chartered (327 million USD) and BNP Paribas (8.9 billion USD). Also according to the report an average bank spends 40 million USD on KYC Compliance. According to the Delloite study referred to earlier • Sharing of customer information is already taking place , eg SWIFT established KYC registry with 1125 sharing KYC information but so far this accounts for only 16% of the banks • Use of DLT will automate processes and reduce chances of errors • DLT will not only remove duplication of effort but the ledger will also enable encrypted updates to client details to be distributed to all banks in near real time • The ledger will also provide historical records of all documents shared and compliance activities taken for each client. Example In Netherlands, Dutch banks are already partnering with INNOPAY which is a startup and has expertise in Digital Identity and E-Business, to enroll a number of banks to use the distributed ledger amongst them. Some of the key findings of the World Economic Forum report regarding blockchain applications are as follows • DLT has great potential to drive simplicity and efficiency through new processes. • Operational Simplification: Reduces/eliminates manual efforts required to perform reconciliation and in dispute resolution. • Regulatory Efficiency Improvement: DLT will enable real time monitoring of activities. • Counter Party Risk Reduction: Use of Smart Contracts and also because agreements will be codified and executed in a shared immutable environment. • Clearing and Settlement time reduction: There will be no need for third party that supports transaction verification. • Liquidity and Capital Improvement: Provide transparency into sourcing liquidity for assets. • Fraud Minimization : Full transaction history will be recorded http://www.iaeme.com/IJM/index.asp 347 editor@iaeme.com
Mansi Kapoor • Applications of DLT will differ depending on the users, technology will be leveraged in different ways for diverse benefits. • Creation of Digital Identity is a key Enabler. • Digital Fiat will amplify benefits. • Impact of DLT will only be created when there is deep collaboration between innovators, regulators and incumbents. • DLT will redefine processes and challenge orthodoxies prevalent in the banking International Trendsetters in DLT – A Case Study Ripple – Enabling the Internet of Value Founded in: 2015 CEO and Co-Founder: Chris Larsen Profile: It is a venture backed start up with operations in San Francisco, New York. London, Luxembourg and Sydney Recent Funding: Has recently raised 55million dollars in venture capital. Key investors include Accenture, Google Ventures and Standard Chartered. Vision: “Ripple works with Banks to transform how they send money around the world- a necessary step to compete in today’s global economy. Our Vision is to enable the internet of value so that the world can move value the way it moves information today.” Competitive Advantage: Their solutions lower the total cost of settlement by enabling banks to transact directly, instantly and with certainty of settlement. ACHIEVEMENTS AND INFLUENCE • It is a member of the Federal Reserve’s Faster Payments Task Force Steering Committee • It Co-Chairs the W3C’S Web Payments Working Group. • As on September 15, 2016 their clients include Standard Chartered, National Australia Bank, Mizuho Financial Group, Shanghai Huarui Bank • Japanese Consortium of 15 Banks has also signed up. • Ripple’s global network now includes 15 of the top 50 global banks, 10 banks in commercial deal phases, and over 30 banks that have completed pilots. CUSTOMER SPEAK “With over $155 trillion of cross-border payments being made between businesses annually, it is crucial that we continue to innovate to make international payments easier and faster not just for our clients but also for the future of the payments industry. As a leading international bank committed to facilitating trade, commerce and investments, this partnership will go a long way in progressing our digitization agenda to develop innovative solutions for our clients.” —Gautam Jain, Global Head, Digitization and Client Access, Transaction Banking, Standard Chartered Chain: Enabling a new medium for assets. Founded in 2014 CEO- Adam Ludwin Profile: Blockchain startup, headquartered in San Francisco http://www.iaeme.com/IJM/index.asp 348 editor@iaeme.com
The Heart of Fintech Revolution-Block Chain Perspectives and Implications Funding: Chain has raised $45M from leading venture capital firms and strategic investors. The company's board of directors includes the former CEO of American Express as well as one of the founding executives of PayPal. Vision Statement: “The team at Chain has built products at Google, Salesforce, Visa, Microsoft, Square and Heroku. We envision a smarter and more connected financial industry that reaches every person and device on earth.” Mission: “Chain partners with leading organizations to build blockchain networks that transform markets.” Competitive Advantage: They” design, deploy and operate scalable blockchain networks that meet the security, privacy, and compliance requirements of the financial services industry.” ACHIEVEMENTS AND INFLUENCE 1. In May 2015, NASDAQ appointed Chain as partner to for a pilot study to use DLT for trading shares in Nasdaq Private Market. 2. Was awarded the most innovative startup by Customer Speak “We are excited about the potential impact of this new endeavor with Chain on the transaction process,” “The manual process of tracking shares can be overwhelming. As blockchain technology continues to redefine not only how the exchange sector operates, but the global financial economy as a whole, Nasdaq aims to be at the center of this watershed development.” Bob Greifeld, CEO of Nasdaq Bloomberg: 2nd May 2016: Inside a secret meeting where Wall Street tested digital cash On a recent Monday in April, more than 100 executives from some of the world’s largest financial institutions gathered for a private meeting at the Times Square office of Nasdaq Inc. They weren’t there to just talk about blockchain, the new technology some predict will transform finance, but to build and experiment with the software. By the end of the day, they had seen something revolutionary: U.S. dollars transformed into pure digital assets, able to be used to execute and settle a trade instantly. That’s the promise of a blockchain, where the cumbersome and error-prone system that takes days to move money across town or around the world is replaced with almost instant certainty. The event was created by Chain, one of many startups trying to rewire the financial industry, with representatives from Nasdaq, Citigroup Inc., Visa Inc., Fidelity, Fiserv Inc., Pfizer Inc. and others in the room. The Indian Scenario for Blockchain. In an online article in Coindesk, by Stan Higgins, published on 22nd Jul, 2016, It was reported that the Deputy Governor, Rama Gandhi mentioned in her speech that banks must work to develop digital currencies and distributed ledgers. The report also mentions that RBI has been working on blockchain applications since 2014 and the then Governor Raghuram Rajan said that RBI should issue digital currency some time in the future. In another press release, dated 27th July, 2016 in international media, it is reported that the RBI has established ReBIT to look at technological interventions including Blockchain. There are reports that ICICI Bank has created a new position of Chief Technology and Digital Officer ( CTDO) to take on new technologies The bank is planning to use blockchain technology in import/export trade .According to Chanda Kochar “ moving the process to distributed ledger will make the process more transparent thereby reducing fraud and removing data entry mistakes.” http://www.iaeme.com/IJM/index.asp 349 editor@iaeme.com
Mansi Kapoor Currently, In India blockchain technology is in its nascent stage but awareness will definitely increase subsequently. CHALLENGES TO ADOPTION • Regulations: The Banking Industry is currently highly regulated and needs to be so. Building new regulations is a challenging task because the concept is highly technical and so regulators have to be on boarded. • Legal Risks: Legal challenges for digital identities and cross border standards will have to be evolved. • Cost Sharing Model: An elaborate cost sharing model will have to be developed because blockchain technology will succeed only if it leads to inter-operability. Here size and operations of different banks could be an issue. • Cynicism: Bitcoins attracted a lot of criticism because they were used to finance drugs, weapon etc, using the dark web. People will tend to transfer the negativity and cynicism to other blockchain applications as well. • Changing Power Structures: Geeks and technocrats will make an entry into the financial services sector causing a change in the existing power structures. • Unknown Risks: There might be unforeseen dangers in having only digital records on a huge scale. In case of the system collapsing, there would be total collapse and chaos. CONCLUSION In a feature in Time magazine, CEO and Co-Founder of Chain, Adam Ludwin commented that in a quest to understand how DLT will change banking and finance, many are asking the wrong questions. Right now, most people in the banking industry are asking how blockchain can be used to streamline middle and back office processes. The right question to ask according to him is what is the new role bankers wish to play in this new networked model? Blockchain has the potential not only to alter an organization but the entire industry and sector. Needless to say, that a lot of research is ongoing and many exciting pilot studies, but for blockchain technology to be adopted rampantly, there are still roadblocks on the way. The banking and finance world is one of the most conservative, orthodox and highly regulated sectors in the world. Since the meltdown of 2008, the banking and finance sectors have witnessed a diminishing of trust, anger and a lot of worldwide resentment. It is indeed an irony that the founding principle of banking is based on generating trust between strangers by providing the financial intermediation and enforcement of contracts so that businesses and economies may grow. Now with DLT, the system is set to do away with this major link in the financial ecosystem because many have had to pay a very heavy price for buying trust. The biggest fallout of the DLT is dismantling of financial intermediation and all the costs and the delays associated with it which is largely what technology is doing in all sectors of the economy, be it music , grocery , communications etc. In short, blockchain technology heralds the dismantling of legacy systems. In the years to come or probably months because a year is too long in the technology era , we will witness the adoption or not of this revolutionary technology and also see a change in the power structures and an altered pecking order in the enormous chain of players . Where once we had governments, central banks, commercial banks and intermediaries in the landscape, we will now see an entry of geeks from Silicon Valley. When other industries are changing structures and are witnessing the entry and exit of players, we are all talking, but not this loudly. A shake up in banking systems will obviously change economies and will have a profound influence in the way people across the globe live their lives and make fundamental choices. If the current technology combined with knowledge and services sector is being called the fourth industrial revolution and obviously drastic changes are in store. The first industrial revolution changed the http://www.iaeme.com/IJM/index.asp 350 editor@iaeme.com
The Heart of Fintech Revolution-Block Chain Perspectives and Implications way people lived, their work and consequently changed political systems too. The fourth will also bring out revolutionary changes and most of these changes are antiestablishment and might cause a major shakeup in the role of governments and institutions. One such experiment that is currently underway is Bitnation, a world without borders where it’s citizens have made their own constitution and rules and is being run on block chain technology. If harnessing the power of steel was what sparked the industrial revolution, blockchain technology and the internet of value will ignite the fourth industrial revolution. The world is poised for a quantum leap, but most do not know the full implications of what man and machines working together will have on humanity and the future of our planet. Work is going to be redefined in a big way. It is obvious from the research that intermediation soon will be a thing of the past. Most jobs or services that we know of today that are attributed to people will be taken over by machines. What kind of things will men do ? Also if there is no work, what will be exchanged and why ? It’s right now difficult to imagine what the future has in store for millions across the globe. But what needs attention is that the capability to run things or to take key decisions will be left in very few hands. This capability will only be with a few people who can right codes. Power as we know it now is rapidly changing places and could be even more concentrated than it is now. As Nick Bostrom , who heads the future of humanity project at Oxford says that for any new idea, one needs to look at “ crucial consideration” which in his own words is “ an idea or argument that might plausibly reveal the need for not just some minor course adjustment in our practical endeavor’s but a major change of direction or priority” In the case of adoption of blockchain technology, the crucial consideration is who or what will ultimately control the system and what might happen in case of unimagined dangers or threats. Too finally conclude, quoting Bostrom again on a chilly note: “Machine intelligence is the last invention that humanity will ever need to make.” REFERENCES [1] Bostrom N, Superintelligence, Retrieved from http://www.nickbostrom.com/views/ superintelligence.pdf [2] Chain Website, https://chain.com/ [3] coindesk.com, July22nd,2106, RBI Calls on Indian Banks to Explore Blockchain, Retrieved from www.coindesk.com › News [4] Deloitte ,UK ( 2016) , Blockchain applications in Banking, Retrieved from [5] https://www2.deloitte.com/.../Deloitte/.../ch-en-innovation-deloitte-blockchain-app-in-ba [6] Deloitte, UK (2016),) Internet of Value Exchange, Retrieved from https://www2.deloitte.com /content/dam/../deloitte-uk-internet-of-value-exchange [7] Deloitte, UK, (2016), Blockchain- Key Challenges, Retrieved from https://www2.deloitte.com /content/dam/.../deloitte-uk-blockchain-key-challenges.pdf [8] Mckinsey & Company ( 2015),Cutting through the FinTech Noise : Markers of Success, Imperatives for Banks, Retrieved from https://ripple.com/insights/mckinsey-cutting-noise-around- fintech-2 [9] Ripple Website, https://ripple.com/ [10] Times of India, July 28th, 2016, “RBI fines 13 Banks for KYC, FEMA Violations.” [11] World Economic Forum( 2016) , The future of financial infrastructure – An ambitious look at how blockchain can reshape financial services, Retrieved from https://www.weforum.org/.../the-future- of-financial-infrastructure-an-ambitious-look http://www.iaeme.com/IJM/index.asp 351 editor@iaeme.com