Chapter 1.

Reshaping the Financial Order

Handbook of Blockchain, Digital Finance,
and Inclusion
1.1 Megatrends and New Alternatives
• How technology has shifted consumer preferences
and opened new doors for greater competition?
– Information technology and mobile connectivity have
changed everything.
– The boundaries between the virtual and physical
worlds continue to blur.
– Smartphone technology has fundamentally changed
consumer behavior.
– E-commerce is rapidly eclipsing face-to-face
transactions, growing three times faster than
traditional commercial activities.
1.1 Megatrends and New Alternatives
• How technology has shifted consumer preferences
and opened new doors for greater competition?
– Any consumer or business product can be equipped
with sensors and wireless connectivity features.
– Anything can be made to communicate and interface
with anyone or anything else through, what is called,
the Internet of Things.
– Digital payments need to be integrated into these
networks for it all to be commercially viable.
1.2 Digital Implications
• Consumers demand ever-higher levels of
responsiveness, immediacy, convenience and
customization.
– Instantaneous access to information, entertainment
and services,
– Interacting and engaging with customers requires a
much more integrated and digital approach.
1.2 Digital Implications
• The survival of incumbent firms depends on three
essential factors
– Assets that are vital to ensuring scale and relevance
as an organization steps into the digital domain.
– Critical capabilities that enhance and augment these
core assets.
– Collaboration and securing where one operates in an
ecosystem.
1.3 Historical Context
• 1950s and 60s
– credit cards
• 1970s
– A nationwide credit system became possible
– Visa and MasterCard emerged
• 1980s
– Electronic funds transfers (EFT) became mainstream
– ATM machines and debit cards made their debut
• 1990s
– In 1998 the popularity of debit cards reached a tipping
point in which they were used considerably more often
than checks
– prepaid gift cards
1.4 E-commerce and P2P
• New entrants from outside the traditional banking
– Non-traditional non-bank P2P payment methods.
– P2P payment methods relied on cash or wire-transfers
through companies like Western Union.
– These methods were inconvenient for e-commerce
activities, like participating in eBay’s online auction
house.
– PayPal answered this demand by easing the risks and
costs of online transactions between buyers and
sellers.
1.4 E-commerce and P2P
• Non-bank intermediaries did not engage in fractional
reserve banking and were therefore not subject to the
same stringent financial regulation as banks.
• In the mid-2000s commercial banks and non-bank
intermediaries expanded their payments capabilities by
developing applications for customers to manage
accounts and make transactions on mobile devices.
1.5 The Rise of M-commerce
• Tech companies and traditional payments companies
begin to partner in 2010s.
– Smartphone manufactures began installing network
approved near field communication (NFC) chips for
contactless payments onto all of their phones.
– Digital wallets were mobile device applications that
make use of NFC or other communication
technology to make wireless transactions.
– Mobile phone is transformed into an open loop
prepaid card.
• Apple Pay
1.6 Weapons of Mass Consumption
• Cash is expensive to manage and access to a digital
payments network unlocks new markets and increases the
velocity of money.
• Emerging market countries often consider digital payment
networks as co-infrastructure in their development strategies.
• Alibaba in China: it has empowered millions of SMEs to act
globally by linking buyers and sellers from all over the
world. Facilitating all these transactions is a digital payments
network.
• In almost every market, smartphone penetration is nearly
complete.
– Consumers that were previously unbanked can now
receive banking services through their smartphones.
1.6 Weapons of Mass Consumption
• Merchants and consumers that rely only on cash are
penalized to just one, single limited form of payment.
• However, cash does have certain advantages. It is
universally accepted (practically), anonymous and
versatile.
• The peer-to-peer sharing economy is quickly making
traditional corporate models obsolete.
– Crowdfunding (Kickstarter), ridesharing (Uber),
apartment/house sharing (Airbnb), co-working (The
Coop), reselling and trading (Craigslist), knowledge
and talent sharing (TaskRabbit)
– These companies are transcending national
boundaries and innovating faster than regulation can
contain them.
1.7 Banking 2.0
• Inclusive business models are the new frontier in banking
– More than two billion people in the world remain
unbanked or under banked.
– Traditional banks have been reluctant to cater to this
segment.
• Unknown risk profile, low income, limited wealth
and geographic dispersion of their potential
customers.
• They are simply too expensive to service, the
returns are too low.
• FinTech is disrupting the established regime.
• The market potential is huge, and it’s not limited to
emerging markets.
1.7 Banking 2.0
• Inclusive business models are the new frontier in
banking.
– By ignoring those neglected by the financial system,
banks have made room for tech companies.
– Thus, the Internet companies, telecoms and start-ups
(not banks) that were among the first to seize the
opportunity and develop alternative, more efficient
systems to provide banking and financial services at
scale to the un-banked.
– Starting with payments, they have moved into other
financial services like savings, loans and
investments.
1.8 Understanding the Model
• The LASIC model of FinTech disruptors
– Low margin
• Revenue stream for FinTech alternatives has been based on
small facilitation fees.
– Asset light
• They do not engage in fractional reserve banking.
• The capital requirements imposed by Basel III does not apply
to them.
– Scalable
• Inherent scalability with no need for brick and mortar
branches, these reduced costs can be multiplied and passed on
to millions of previously untapped consumers.
– Innovative
– Compliance easy
• Alternative banking and financial services have far fewer
compliance obligations.
1.8 Understanding the Model
• The LASIC model of FinTech disruptors
– FinTech companies attract more capital.
• They grow by reaching out to the masses, diversifying
service offerings and disrupting further up the value chain.
– Alibaba
• Offer low-cost loans to merchants for years.
• They have since branched out into micro-loans for
consumers.
• Because transactions between buyers and sellers take place
through an e-wallet like Alipay, Alibaba is able to quickly
assess a company or individual’s cash cow in real time.
• Low-interest rate loans of 30 days to a year are approved
within 24-hours. A traditional bank would struggle to do
that.
1.8 Understanding the Model
• The LASIC model of FinTech disruptors
– Service can be quickly scaled when they run on servers and
software
• In 2013, Facebook bought the start-up messaging service
WhatsApp, with its 400 million active users, for US$22
billion, despite the acquired company earning a net loss of
US$138.1 million that same year. However, this also
represents 400 million users that could potentially be
integrated into a FinTech platform.
• On Nov 11, 2014, Alibaba recorded sales of more than US$9
billion in that one day, over half of which was facilitated by
Alipay.
– Overall, what has happened is that profit margins are so low that
potential competitors find no incentives to go after new entrants.
– With negligible margin cost, these disruptors grow the business
exponentially with a very light balance sheet of liabilities and
assets.
1.9 The Democratization of Banking and Finance
• Technology is making centralized organizations obsolete
• Lending Club
– Online peer-to-peer (P2P) lending platform headquartered in
San Francisco.
– Facilitates direct lending between individuals.
– Offers unsecured personal loans up to US$35,000.
– Focuses on making borrowing accessible and straightforward.
– Initially launched on Facebook.
– Started as a social networking service for lending.
– Originally matched lenders and borrowers based on social
affinity.
– Considered factors like education, geography, professional
background, and social media connections. volved to include
traditional financial metrics.
1.9 The Democratization of Banking and Finance
• Lending Club
– Current default rate stands at 3.39%. Slightly higher than the
U.S. average consumer loan default rate of around 2%.
– Despite higher default risks, reports solid returns. Lenders
benefit from diversified investments and risk management.
– Compliance costs are low.
– The lending process has been democratized.
– Borrowers get access to credit within hours and lenders earn
returns in excess of most coupon rates.
– This has proved to be an attractive model for capital
investment.
– In December 2014, Lending Club raised US$900 million in
the largest tech IPO of 2014.
– In 2015 the company signed a partnership agreement with
Google to expand lending services to small companies using
Google’s business services.
1.10 The Incumbents
• In 2013 Visa, MasterCard and American Express began co-
developing a new technology to supplement digital
payments security
– ‘Tokenization’ as it is called replaces a payment cards
16-digit number with an encrypted digital proxy, or
token, that adds an additional layer of security that
shields the personal account number.
– It allows payment issuers to directly send account
credential (tokens) in real time to customers through any
device or application through any means of connection to
make payment.
– This technology enables partners and clients to secure
payment authorization over the cloud through the device.
1.10 The Incumbents
– What is different about tokenization is that digital
payments companies are opening up their networks to
app developers.
– In the past, these networks have been closed.
– This means that people around the world can develop
applications and services with tailor-made payment
experiences that utilize an established global payments
network.
– This is a clear signal that the traditional network payment
companies are preparing for the total pervasiveness of
the Internet.
– The most successful players will be the ones that dream
big and create new solutions that impact the lives of
billions of consumers and merchants around the world
that leverage the scale, reliability and network security.
1.11Cryptocurrencies and Blockchain
– In a Blockchain, a transaction is transparently recorded
simultaneously across an automated peer-to-peer
computer network.
– Transactions take place across numbered accounts, which
are public.
– Every transaction is verified through a distributed
process that records the date, time, account number and
amount for the transaction, where each network node
(and there are thousands), contains a full copy of the
ledger.
– A transaction is only approved once the nodes reach a
consensus on the state of the ledger. This keeps the
system synchronized, and – in all practical terms – it is
almost impossible to defraud.
1.11Cryptocurrencies and Blockchain
– Blockchain based cryptocurrency can also be
programmed to represent anything of value
• a company share
• tax
• environmental credits
• vouchers
• cash
• Votes
– Embedded instructions can be programmed to perform
any transaction determining how, when and where a
transaction can take place
1.11Cryptocurrencies and Blockchain
– Critical importance in building the necessary
infrastructure to support the Internet of Things.
– It also has extraordinary implications for banking
systems, including the potential to better automate
processes and thereby reduce operational and
compliance costs.