Through Fintech (Financial Technology) various technologies have emerged over the decades to take the guess work out of financial decisions. Algorithmic trading and analytics (we know as Big Data analytics) has been employed in the financial markets for a very long time. Predictive analytic programs to assist financial decisions based on long-term data gathering for many types of data plotting graphs and charts based on previous traded history. This is one example of Fintech! There are many others that are part of the overall finance technology employed (settlements with payment mechanisms that settle the trades purchased or sold, as another example).
The current trend is more of a decentralisation of access to create opportunities all of the banking environments to interact in unprecedented ways.
[easy-tweet tweet=”When we talk about Digital currency the word Bitcoin comes to mind, this is a hot topic. ” hashtags=”fintech, blockchain”]
So, now that we’ve got a base definition of “FinTech”, I should probably elaborate on exactly what it entails with a few examples:
- Digital currency– Bitcoin and others emerging as the de-centralisation of currency transfer and distribution now comes of age
- Peer-to-peer lending– matching lenders to borrowers directly
- Algorithmic asset management or algorithmic trading – Artificial Intelligence using information management techniques to predict future outcomes within financial trading (BlackRock and Two Sigma, hedge funds that hired two former top Google engineers)
- Crowdfunding– raising money/investment from a large number of individuals online
- Payments– Specific forms of payment systems are used to settle financial transactions for products in the equity markets, bond markets, currency markets, futures markets, derivatives markets, options markets and to transfer funds between financial institutions both domestically using clearing and real-time settlement systems and also internationally using the SWIFT network
- Data collection– research and compliance purposes
All of the above build and implement technology that is used to make financial markets and systems more efficient.
In my opinion, the next wave of advances within the “Fintech” space are coming from the above list. When we talk about Digital currency the word Bitcoin comes to mind and this is a very hot topic at the moment. For a decentralised infrastructure that governs/controls anonymous payments is a very difficult thing to do and it’s reliant on systems and infrastructure that need to have rapid connectivity to each system in the chain and to be in synch. Enter a method called Blockchain.
Digital Currency, associated infrastructure needed – The Blockchain method!
So what is Blockchain I hear you ask? Well it’s basically made up of 3 concepts (elements):
Sharing a Set of Rules for Updating State via Blocks and a Trust Model for Timestamping. Essentially and originally set up to support Bitcoin, the cryptocurrency, blockchain is a way of sharing a set of rules via a sort of shared ledger system that gets timestamped and logged. Based on the principle of trust (I know, an oxymoron statement in the context of banking) but it’s also based on mathematical probability. If there are many many “nodes” (basically software installations that are connected to the internet) the chances of all of the nodes getting out of synch/changed is very unlikely so the main security is based on trust. With blockchain(s) the blocks contain details of the transaction and as long as more than 50% of the resources/nodes are honest the blockchain continues. Also, it is important to add that this is where the term Miners enters the room. Miners are nodes that find and source bitcoins. Basically, you can have a program running on your computers and as long as you are connected to the internet you have a chance of receiving bitcoins yourself in gratitude, this is why it takes approximately 10 minutes to complete a transaction with bitcoin on the blockchain as miners are sought after to find bitcoins that are available. If you are lucky enough to be at the top of the blockchain you will be awarded 25 bitcoins for assisting with the transaction. Now lets put this into context, if you win the blockchain lottery (that’s what I call it) it will be quite lucrative 1x Bitcoin = £369 (as of time of writing) X 25 = £9,225! Now if you have an extremely high powered computer network of miners you stand a better chance of being at the top of the blockchain. It’s interesting to see that we have to create incentives to decentralise the control of the currency, however, this commission/lottery ticket value will go down to 12.5 bitcoins every 10 mins around October time due to changes in the regulation of payments. I’m not sure what effect this will have on the currency but one thing is for sure is that you will need an extremely fast network of compute, power and processing to stand a chance of winning!
Peer to Peer lending
Essentially peer to peer lending is a marketplace that directly matches lenders to borrowers via an online platform. In this way a fee or commission is made, a sort of finder’s fee if you like, that is usually taken from the lender and the borrower. Credit scoring is key to the process and quite often other 3rd parties are linked in the chain. With this said it is a very effective way of getting a loan and when compared with the risks of a bank taking on this role of lending money no capital is needed with little or any liability.
Algorithmic asset management or algorithmic trading
This has been around for quite a while, however with the increased developments for connectivity and speed to execute, this is now very competitive. Speaks for itself really.
A new way to raise capital for that cracking idea you have that will make you billions. There are many crowdfunding platforms out in the market that will allow you to donate/pay to be a piece of your success.
This is a massive subject and warrants its own document really. However, I will list out a few examples:
Paypal, ApplePay, Transferwise are good examples of payment mechanisms that are widespread and familiar to you. Transferring money to overseas has never been cheaper due to the emergence of the new technologies available. Opensource software has been a massive catalyst for this and startups are rife in this industry at the moment. New and improved ways to authentication, new and improved ways of quickly transferring/settling a monetary transaction are springing up monthly.
Also, this extends to the financial trading world too. Fast execution, fast settlement and cheaper overheads. This maybe to the reason why banks and others are trying to implement the blockchain infrastructure but are concerned about the regulatory requirements for data protection and security.
Data collection and manipulation within the finance markets has been happening for decades. Recording stock market prices on a daily basis to then implement within each respective banking system of choice (banks even do this internally for their own in-house written apps and databases). Now we can take Big Data analytics to a new level and run rule set algorithms (complex queries) against existing data so that the bank can now accurately tell when you may require any other product they want to sell you (pension, insurance, saving schemes etc). This can also be referenced against social media data and even take into consideration sentiment analysis. Imagine you post on twitter/facebook that you have just won using a lottery ticket, your bank can find this out and the same day call you offering a wonderful investment opportunity! This is available now and will increase 10 fold in the future.
[easy-tweet tweet=”Data collection/manipulation within the finance markets has been happening for decades.” hashtags=”fintech, blockchain”]
Fintech Users and uses
Who uses fintech?
- B2B (business to business) – for banks their business clients, this is a very large arena and will be broken down further later
- Banks as consumers – what technology they consume?
- Consumers of banking technology – other banks or partners (broker dealers, asset managers or portfolio managers)
- B2C for small businesses and consumers – tech that’s used to link to banking systems, online payment mechanisms etc.
Banking specifically explained
Banking and finance is such a large market vertical. To really understand Banking Technology you really need to understand how the banking system works and the differing types existing today. In essence, there are two main types of banks, Retail and Investment (possibly a third if you count central banks such as the Bank of England etc).
Industry models, types of financial firms and how they function – Enter the Buy and Sell side (Finance industry slang)!
The Sell Side
Acts as an intermediary between the client and the market. Its regulated to perform trading activity and they are paid commission for the process of transacting business on behalf of their client.
- Research driven Broker-Dealers
This type of broker-dealer conducts research on companies and sector and advises clients on what investment choices they should make. In exchange for this advice the clients channel their trading activity through the broker-dealer paying them for their research in dealing commission.
The Buy Side
- Fund managers/Institutions/Insurance companies.
This is the most important element of the market in that it’s this investment that underpins the market. By institutions we mean the pension funds and investment funds. This has traditionally been the largest trading block in the market.
- Hedge funds.
Hedge funds are a relatively new addition to the market. They attract vast sums of money from the institutions and adopt investment strategies that are higher risk and less opaque than normal. They charge high fees and in return aim to deliver higher returns. Currently, they operate in a loose regulatory environment that allows them this freedom this also includes private wealth management and retail.
Note: This is trading by or on behalf of the public.
Buy side vs. Sell side
Why do we have the distinction? The buy-side deals with clients in the form of the public or public money or, in the case of insurance companies, to leverage premiums and the sell side deals with the market.
Note: The aim of having the distinction is to make the entire process more transparent and to prevent illegal collusion between the market and investment managers or traders.
Bids and Offers
Bids and Offers is the accepted terminology applied to trades in the market.
Client Broker Market
Sell Buy – Sell Bid
Buy Sell – Buy Offer
The above table shows the chain of events from client to market in a transaction.
Retail banks are much easier to describe, we all have an account with one of them – Barclays, Lloyds, Santander etc. Salaries get paid into various types of accounts held from current accounts to savings (if you are lucky enough not to rely on a salary to pay the bills).
Most retail banks use similar IT infrastructure as investment banks, in fact most are a hybrid of both these days offering similar investment products and stock purchasing etc.
Investment banks provide services to other banks and institutions (also to corporates). Investments banks normally consist of trading (requiring trading and settlements technology), research on stocks (research distribution mechanism both writing and publishing) and mergers and acquisitions (technology that enables due diligence as well as corporate valuations).
A typical Investment bank would normally look something like this:
Front office trading department – Traders and brokers alike that fill orders based on the type of stocks and shares they predominantly focus on (yes each bank can specialise in certain stocks and shares). Complex trading systems software is in use that allows the “order book” to be propagated and logged based on what financial instruments they are trading (foreign exchange currency, commodities – metals, energy etc). They will also offer loans (millions) to firms that prefer debt as a means to raise money, manage pension funds and offer advice on investments and corporate acquisitions.
So with all of the above services going on, what technical infrastructure is utilised?
A front office trading system – This needs to be very resilient and fast. Typically insourced from a major vendor in the market (E.g Fidessa – for equities). Database management is also very key and many banks have their own in-house developed infrastructure that they rely on that is fed from market data providers that can populate their own “trading database” however this is costly and can be very complicated due to the regulatory requirements imposed.
As you can see banks have complicated technical infrastructure (and I haven’t even discussed the specific elements of the tech and systems). With the rise of Opensource and decentralised infrastructure concepts such as blockchain, I feel we may be some time away from productionised implementations of this into the large banks although they are playing with the tech now.