EFPA Digitalization Handbook

Introduction

Preamble

The financial services industry stands at a pivotal crossroads, where traditional banking practices intersect with revolutionary technological innovations. This transformation is not merely about digitizing existing processes—it represents a fundamental reimagining of how financial services are conceived, delivered, and consumed. The emergence of fintech has catalyzed changes that ripple through every aspect of the financial ecosystem, from how advisors serve their clients to how institutions manage risk and compliance.

This book arrives at a crucial moment when financial professionals must navigate an increasingly complex landscape of technological innovation, regulatory requirements, and evolving client expectations. As artificial intelligence, blockchain, and other emerging technologies reshape the industry's foundations, financial advisors and planners find themselves at the forefront of this evolution, tasked with bridging the gap between traditional financial expertise and digital capabilities.

The chapters that follow offer a comprehensive exploration of this new financial paradigm, structured across four key dimensions. Part I lays the groundwork by examining the foundational technologies driving innovation, from artificial intelligence and machine learning to blockchain and tokenization. Part II addresses the critical regulatory and compliance considerations that accompany digital transformation. Part III deals with the implications of new technologies in business transformation. Part IV delves into practical applications and real-world use cases, demonstrating how these technologies are already transforming financial advisory services, while Part V examines the changing dynamics of market behaviour and client expectations in this digital age.

Drawing on the expertise of leading practitioners, regulators, and academics, this volume provides financial professionals with both the theoretical understanding and practical insights needed to thrive in an increasingly digital financial world. Whether you are a seasoned financial advisor adapting to technological change, a fintech entrepreneur seeking to understand the regulatory landscape, or a student preparing for a career in financial services, this book offers valuable perspectives on the intersection of finance and technology.

As we witness the continued evolution of financial services, one thing becomes clear: the future belongs to those who can effectively combine human expertise with technological innovation. This book serves as your guide to understanding and navigating this transformation, ensuring you remain at the forefront of the financial services industry's digital revolution.

Patrick Levaldaur

General Secretary.

EFPA Luxembourg

Fintechs and Digital Transformation: A New Era for Financial Advisors and Planners

Digitalization is not just an option—it is the new fabric of finance. The convergence of technology and finance has brought about unprecedented opportunities, reshaping the industry from its core. There is no future in finance without embracing digitalization. Financial advisors and planners are now standing at the forefront of a transformation that will define their future and the future of their clients. This book, written by several co-authors and organized by EFPA Luxembourg, is designed to provide you with insights into the powerful changes driven by fintechs and digital transformation, and how they will revolutionize the way financial advice is delivered.

For financial advisors and planners, digitalization offers much more than just automation of routine tasks. It is a gateway to a more efficient, client-focused future, where time and human capital can be redirected from repetitive, administrative activities to more meaningful, value-added services. The introduction of advanced technologies, such as artificial intelligence (AI), machine learning (ML), blockchain, and robo-advisors, has already begun to free up significant resources in the back and middle offices, allowing staff to be redeployed to roles where their skills can make a greater impact. No longer confined to administrative duties, professionals will be better equipped to engage with clients, offering more strategic, personalized advice.

Digitalization is about enhancing human capabilities rather than replacing them. The future will bring us better bankers and advisors, not merely because they are more efficient, but because they are augmented by technology. Machines will process data faster, provide more accurate insights, and identify opportunities previously unnoticed by human eyes. As a result, the time spent with clients will be more productive, enabling financial advisors and planners to focus on truly understanding their clients' goals, risks, and financial well-being. With better data, advisors will deliver higher-quality advice, improving outcomes and trust. In a sense, we are stepping into an era where the advisor-client relationship is enhanced by a partnership between human intuition and technological intelligence.

Fintechs ‒ innovative companies that leverage technology to offer financial services—are at the forefront of this transformation. They are not only enhancing traditional financial services but also opening new doors and exploring uncharted territories. With fintech solutions, advisors will be able to explore new possibilities, providing services that go beyond the traditional scope of financial planning. Automated financial advice, real-time analytics, personalized investment strategies, and blockchain-enabled transactions are just a few of the new frontiers being pioneered by fintech companies. Advisors who embrace these innovations will find themselves on the cutting edge of the industry, equipped to meet the evolving needs of tech-savvy clients.

This new landscape is not without its challenges. The collaboration between banks and fintechs is crucial to unlocking the full potential of digital transformation. While banks have the regulatory infrastructure, trust, and client relationships, fintechs bring agility, innovation, and technological expertise. For financial advisors, understanding how these two worlds can work together is key. New bridges will need to be constructed, and traditional borders will have to be crossed. Advisors will need to navigate a more complex ecosystem, learning to integrate the strengths of both fintech and traditional banking to deliver comprehensive, future-ready solutions for their clients.

Innovation, however, comes at a price. The rapid pace of technological advancement introduces new risks—risks that financial advisors must be prepared to manage. Cybersecurity threats, regulatory changes, data privacy concerns, and the potential for technological obsolescence are just a few of the complexities that will accompany this new era. As advisors, it is crucial to remain vigilant and informed, not only about the benefits of digitalization but also about the associated risks. With great opportunity comes great responsibility, and the financial industry will need to develop new strategies to ensure that innovation does not outpace regulation.

Despite these challenges, the need to adapt is not optional—it is imperative. The financial industry has always evolved, and human beings are uniquely capable of embracing change. As history has shown, those who can adapt to new realities are the ones who thrive. For financial advisors, embracing digital transformation is not just about survival; it is about seizing an opportunity to enhance your practice, better serve your clients, and stay ahead in an increasingly competitive market. The ability to adapt to change will be a defining characteristic of successful advisors in the years to come.

Education and continuous learning are the enablers of this transformation. Staying current with the latest technological developments, understanding how to integrate fintech solutions into your advisory practice, and enhancing your digital literacy will be crucial for success. EFPA Luxembourg, as a certifying body for financial advisors and planners, recognizes the importance of ongoing education in ensuring that professionals remain fit for the future. This book is part of that effort, providing you with the knowledge and insights you need to embrace digitalization confidently and effectively.

Of course, with rapid change comes the risk of obsolescence. As new technologies emerge, those who fail to adapt may find themselves left behind. However, for those who view digitalization as an opportunity rather than a threat, the possibilities are limitless. The advisors who can harness the power of technology, who see fintechs not as competitors but as partners, will be the ones who thrive in this new landscape. The sky is the limit for those who are willing to invest in their own growth and in the growth of their clients.

In conclusion, digital transformation is not just a trend; it is the future of finance. Fintechs are reshaping the way we think about financial services, and for financial advisors and planners, this presents a unique opportunity to enhance your practice, provide better advice, and deliver higher levels of client satisfaction. By embracing technology, learning continuously, and building bridges between traditional finance and fintech innovations, you will position yourself as a leader in this new era. This book is designed to help you navigate that journey, offering insights from experts across the field and equipping you with the tools you need to succeed in the age of digital transformation.

Welcome to the future of finance—a future where digitalization and fintechs are not just tools but partners in building a more efficient, responsive, and innovative financial advisory practice. Let this book guide you as you embrace the changes ahead, preparing you for a world where the only constant is evolution, and the opportunities are endless.

Roger H. Hartmann

Chairman.

Board of Directors

EFPA Luxembourg

Part I

Foundation Technologies and Innovation Drivers

Chapter 1

Some Fintech Technologies

1.Blockchain and Cryptocurrencies

1.1.In-depth explanation of blockchain technology

In 2008, the academic paper authored by an individual under the pseudonym Satoshi Nakamoto Bitcoin: A Peer-to-Peer Electronic Cash System. was published.¹ The paper introduced an innovative and groundbreaking method for the transfer of monetary value, which was encapsulated in a protocol referred to as Bitcoin. The foundational technology that facilitated this system is referred to as Blockchain. While the overarching technology, Distributed Ledged Technology (DLT), refers to a decentralized database spread across multiple users; blockchain is a subset of DLT that uses cryptographic and algorithmic methods to create and verify an append-only sequential chain using hash links. This technology is considered revolutionary due to its potential for innovation and implications for the future of financial transactions and beyond. Currently, it is being developed for the financial sector, but due to its nascent and ambitious growth, both scholars and lawyers envision a future where DLT might pave the way for progress of human rights law and advance democratic functions.²

Whereas traditional approaches to recording and sharing data rely on a centralized entity that records every transaction, DLT leverages on a distributed network of computer servers. The two core attributes of DLT-based structures are: (i) the capacity to record information in digital form across different participants without relying on a central record-keeper and (ii) the ability to ensure that the same asset cannot be sent to multiple parties (so called double-spend problem).³ In fact, before the development of DLT, it was not possible to record information through a decentralised set of participants without running into the double-spend problem.

The creation and verification process relies on the sharing of information across all members of the network (called nodes), with each node storing a replica of the ledger records of the entire blockchain thus ensuring immutability, non-repudiation and due authorisation of transactions made at any point in time. Continuous synchronisation between nodes ensures that each node has always the latest information, making DLT a trustworthy and transparent solution for handling data.⁴

Each block is comprised of a certain number of records having occurred on the network and irreversibly encrypted onto the shared ledger after having been validated and confirmed by specific nodes of the network. Such nodes proceed through a consensus operation to verify whether the transactions meet the conditions set out by the algorithm defining the blockchain and approve (or reject) each transaction. As a result, the encryption of transactions onto the blockchain does not always require a unanimous decision from all nodes, which could have hindered its efficiency. Consequently, the construction of the chain relies entirely upon the nodes’ protective role, without any central authority’s approval required. The linking of one block to the one before through hash function⁵ ensures integrity of the data through cryptography, with each block containing information tracing it back to the one it binds with.

The consensus principle is essential for determining whether a new transaction or record on the blockchain is legitimate, making it a core aspect of the functioning of all blockchain protocols. However, consensus can be reached through different methods in accordance with the algorithmic design of the blockchain, which depend on the blockchain’s nature, purpose, and underlying asset(s). Comparing different blockchain platforms, two main approaches on how to reach consensus prevail (although other consensus methods exist): the proof-of-work and the proof of stake. Proof-of-work ‒ the most traditional approach ‒ relies on the participation of actors validating the transactions, who are known as miners. Miners validate the transaction by solving a computational challenge they then get rewarded for. On the other hand, in the proof of stake method, transactions are performed through the involvement of validators, who are owners of the blockchain-native digital currency and who put some of their currencies at stake so that they may participate in the consensus mechanism. It is worth mentioning that the proof of stake method counters one of the main drawbacks of blockchain technology, its large energy consumption when performing transactions.⁶

Within this DLT framework emerged a great variety of platforms with different levels of accessibility. Blockchains can either be private or public, the former allowing only authorised and identified users to access the ledger, the latter being open to anyone. Additionally, a distinction must be made between permissioned blockchains, which allow only specific users, both authorised and identified, to perform transactions on the network, and permissionless blockchains on which anyone can join the network and perform transactions. The validation process can also be modulated within restricted blockchains and unrestricted blockchains; allowing to further restrict or broaden the access rights of a participant on an individual or case-by-case basis.⁷

Considering the decentralised nature of blockchain and the eradication of a centralised authority, protection of the code administering any blockchain network is integral, specifically when it comes to more open structures such as public permissionless blockchains. Therefore, each blockchain network must define its own protocols aligned with its own features to ensure efficiency when changing or updating its rules. When sponsored by a consortium⁸, a blockchain will often be managed and supervised by multiple committees to execute those changes, and more generally, to monitor streams and risks or review the architecture of the system.

Accessibility of the DLT raises the question of the identification of the people processing transactions for their own account. Within the decentralised environment of DLT, each user has control over its own identity information within the network without relying on the control of any central authority as is the case in traditional finance. Therefore, users can be identified on the network through private keys, non-transferable tokens, whitelisting, or on-chain identities, all operating under a veil of privacy through cryptography to guarantee that the real-word owner is the only one trading their assets on the platform.

1.1.Role of DLT in decentralizing financial processes

Despite its revolutionary innovation, DLT is often associated with cryptocurrencies and, sometimes, with speculation or illicit activities. This is, however, a misconception of a sophisticated and developing technology whose potential applications in the realm of processing records in a decentralised manner seem quasi-limitless and unchartered (DLT has even been explored to facilitate digital identity products such as national ID and civil status records). DLT has proved to be a particularly valuable tool to modernise the financial system, by introducing new forms of disintermediation like decentralised autonomous organizations (DAOs) or accompanying market infrastructure dealing with post-trade processes.

DLT has indeed triggered the emergence of new forms of decentralised entities and DAOs are one of the most notable examples on this perspective. DAOs are organisations managed, in whole or in part, by a decentralised computer program, with no single centralized entity with default validation powers.⁹ Whereas other decentralised organisations function on a peer-to-peer network, with users interacting with each other using self-executing and protocolled computer programs (smart contracts ‒ whose notion will be addressed below), DAOs functioning relies on code.¹⁰ What distinguishes a decentralized autonomous organization from a decentralized organization is its autonomous capability: whereas decentralised organisations still need, to a minor extent, human intervention, DAOs are designed to run autonomously.¹¹

The advantage of self-execution of targeted steps of trading and post-trading activities through DLT and smart contracts, with high potential for automation and non-discretionary tasks, challenged the traditional role of financial institutions in trading, which triggered a profound redesign of their place on the financial infrastructure. This shift is particularly important with regard to its application to post-trade processes. In fact, the smooth functioning of capital markets relies not only on trading but also on an accurate and traceable recording of ownership transfers and holdings in securities. In this context, financial instruments' registers and records are critical for establishing ownership. The evolution of rules and regulations governing these transfers reflects decades of development and refinement, but the overall structure, made of different levels of custody or safe keeping, has proved to be costly and, to some extent, even inefficient.¹²

DLT addresses some of the inefficiencies of traditional post-trading structure (which can be further optimized depending on its design): it can enable real-time monitoring of securities ownership and, by leveraging on self-execution codes, decreases instances of human errors and accelerates transaction execution. It simplifies the transaction process, by cutting out several intermediaries of the chain and reducing structural costs.

This is another reason why blockchains and DLT projects in the capital markets space are currently blossoming and financial institutions are launching their own platforms facilitating specific steps of the capital markets value chain.¹³ However, depending on the assets traded on the platform, each network relies upon a specific computer program which causes interoperability issues between different platforms. Standardising code and smart contracts to allow blockchains to communicate and exchange information with one another would be taking decentralisation to a higher level and could trigger a massive adoption of DLT for trading purposes.

From a technical point of view, interoperability allows networks to exchange data and to coordinate the execution of a transaction on a blockchain with data stored on another blockchain. However, some organizations aimed at global interoperability like the Distributed Ledger Technology Group¹⁴ stress that exchanges of information between networks can only work when intermediated, as direct messaging between blockchains is impossible. Therefore, even if DLT becomes widely adopted, financial institutions would still be required to intermediate transactions and explore new ways of relaying information.

2.Tokens and Smart Contracts

2.2.Definition and the relationship with blockchain technology

By allowing assets to be virtually traded and represented as tokens, blockchain is a revolutionary step. The Regulation on markets in crypto-assets published 9 June 2023 (MiCAR), partly reflecting the previous surge promoted by both academics and legislators, clarified this evolving framework by setting out three exclusive categories of crypto-assets. MiCAR precisely distinguishes (1) the electronic money token (EMT) which refers to a type of crypto-asset that maintains a stable value by referencing its value against an official currency (e.g. in 2018, Circle launched USD Coin whose value is based on the United States dollar); (2) an asset-referenced token (ART) which is a non-EMT crypto-asset that maintains a stable value by referencing another value or right or a combination thereof, including one or more official currencies (i.e. in 2019, the Paxos Trust Company launched Pax Gold tokens, backed by gold kept in London Bullion Market Association vaults) and (3) crypto-assets other than ARTs or EMTs, including utility tokens and more broadly crypto-assets that do not qualify as financial instruments under Directive 2013/65/EU dated 15 May 2014 on markets in financial instruments, as amended (MiFID II). Though MiCAR brought clarification, it failed to cover all types of crypto-assets and most notably non-fungible tokens (NFTs), (i.e. tokens that are unique and not interchangeable with other crypto-assets).

Tokenised assets can be safeguarded by financial institutions who act as custodians, minimizing risk, and ensuring confidence and safety to their beneficiaries. In this regard, DLT provides enhanced security, transparency, and efficiency as it can reduce time-consuming tasks with automation. This is particularly interesting in relation to post-trade activities. Custodians in the post-trade phase act at the forefront, securing asset owners from the risk of loss or theft, as in this configuration, liability rests upon custodians.

Smart contracts refer to the encryption into the blockchain and self-execution of certain clauses of an agreement between parties (including transfer, payment, and issuance restrictions) rather than a properly defined legal concept. Once the conditions encrypted in the blockchain are met, the transfer occurs automatically, lowering human error and limiting counterparty risk.

Despite a misleading name, it is currently still up for debate whether smart contracts can qualify as contracts. National jurisdictions have followed different approaches on the matter. In this context, it is interesting to highlight the fact that the Italian legislator has introduced a legal definition of smart contracts as "a computer program which leverages on technologies based on distributed ledgers and whose execution is automatically binding for two or more parties on the basis of predefined effects". For Luxembourg law, no legal