Are Crypto-Currencies more Democratic?

The internet, as I’m sure you know, is formed of millions of connections between nodes, or access points for all its users.

Concurrent with, or alongside, this network a new network has sprung up, consisting of the Bitcoin miners and its payment system. This is supposedly money at its most ‘democratic’ because supposedly no one entity can gain control of a majority of the miners on which this consensus rests.

(for an explanation of the Bitcoin creation mechanism, see https://jessking1311.wordpress.com/2015/10/01/what-is-the-real-problem-with-bitcoin/  )

A fintech explosion

Goldman Sachs’ widely read ‘Future of Finance’ report cited three trends which two of its authors, Heath Terry and Ryan Nash on the Global Investment Research team, expanded on further in a podcast. These were: regulation, technology, and changing consumer habits.

The financial crash and ensuing regulation “effectively created a greenfield opportunity during the recovery… following Facebook’s IPO in 2012, a lot of opportunists asked themselves, ‘What sectors don’t have a Facebook, a Google, an Amazon yet. And financial services was the only one of those.”

A friendly credit environment also contributed to the exponential growth in ‘shadow banking’, – here defined more narrowly than the Fed which has tracked a recorded $15 trillion in liabilities by non-bank lenders like private debt funds – as so-called P2P or marketplace lenders.

The Goldman Sachs analysts predict $10-12 billion could move out of the traditional sector and into shadow banking. Marketplace lenders have been quick to adopt innovations like risk pricing algorithms, and analytics to predict consumer demand for loans. Thus they benefit from ‘lower cost of customer acquisition’ and ‘efficient delivery channels’, where banks are hampered by due diligence restrictions which give loans applicants offputting mountains of paperwork.

The third factor cited is regulation. Where Basel III imposed rigid capital adequacy ratios, the Dodd-Frank stress test limits made bank lending even more restricted, because they needed to consider also the value at risk of certain assets under stress scenarios. This severely limits the type of assets they can hold on balance-sheet.

Finally, the Credit Card Accountability Responsibility and Disclosure Act of 2009, or Credit CARD Act of 2009, created a unified pricing standard which also meant credit providers’ losses were absorbed to some extent. And profits in the industry as a whole became more attractive, spurring innovation and start-ups to capitalise on the benign regulatory environment.

Crypto-currencies are more ‘democratic’ than fiat currencies

Bitcoin is a new currency but unlike sterling or the dollar it is not controlled by a national government, which can intervene to buy and sell the currency to preserve its value. And which are traded on mass by foreign exchange funds.

This means Bitcoin’s value depends almost entirely on how much it can be exchanged for in terms of goods and services on the internet. Or, to be more accurate, what people believe these items to be worth in Bitcoin at any given time. Which depends on the amount of Bitcoin in circulation.

For an explanation of the historic issue of the ‘capacity crunch’ and the competing plans to increase the size of transactions and transfers to scale up the payment system, again see my previous post on the issue.

But more important in revolutionising the way money is lent in the modern world is the Distributed Ledger Technology used to record Bitcoin transactions. Everyone in the Bitcoin network has access to this record, and its only alterable by mutual consensus or agreement.

So no one can fraudulently claim they have made or recorded a transaction, because the online ledger called the blockchain shows exactly who had made and received the transaction. Many companies and governments, like that of Estonia, are adapting this technology because it is a secure way of record-keeping for other purposes, such as health records, marriage and birth certificates, taxes and property.

The new distributed ledgers would have different rules. For example, there would likely be an administrator who would have overall control over access and permission to transact. Each system would also have its own encoded rules of conduct.

Some Real-life Examples

Some payment systems like Coinify already use the blockchain to enable consumers to make guaranteed payments, via small businesses which act as merchants.  Within some payment networks, such as Lending DApp (see https://jessking1311.wordpress.com/2016/01/13/back-to-the-future-bitcoin-blockchain-and-how-marketplace-lenders-are-using-technology-to-overtake-banks-in-the-race-to-attract-new-lenders/), ordinary people can act as intermediaries to guarantee that the terms of a contract have been fulfilled. Or the computer programme can be designed such that it recognises e.g. when a certain number of hours have clocked on a timesheet.

It occurs to me that this could be the solution to many of the problems in the banking system. Processing payments by the big banks like HSBC, RBS, Barclays et al. can take several days, even need, your money right away. Because they have to comply with so many regulations, banks have to do a lot of checks to make sure the payment is for legitimate activity and by a legitimate entity.

Alternative, more immediate providers like Paypal charge a transaction fee for every payment they process. But a pretty insignificant one. And Paypal seems to be cornering the market in micropayments. What does blockchain and DLT have that existing providers don’t?

It struck me the other day that the systems in place to connect us with the money we have earned or need to conduct our life and business are grossly inefficient.

I was waiting for a sum of money I had collected from a crowdfunding platform, Indiegogo. But when I tried calling HSBC, I had to wait on hold for 20 mins. When I finally got through to someone, he did not speak enough English to process my request. Three times I told him I was waiting for a transfer to my account and if he could put me through to whoever was responsible for bank checks, that maybe the depositor was concerned it was an individual not a business account.

Three times he asked me ‘If I would like to make a transaction’? When I tried to contact Indiegogo to ask the same question, initially I couldn’t find the contact form. Eventually I got a response, and my money, after I Twitter-bombed the crowd-funder. But the point is that I couldn’t access my money when I needed it. I had to pay it out of my own pocket and then be tardily reimbursed.

Now I’m not saying we need to overhaul the entire financial system, but if the service is flawed it would make sense to encourage competing providers, like those using the blockchain network, to let individuals like you or me moderate payments for a fee that corresponds with their efficiency and success rate at doing so.

And I’m not the only one this thought has occurred to.

Marketplace Lenders Leapfrog Lumbering Dinosaur Banks in Big Data Usage

 14/12/15

While banks excel at writing in-depth research papers about the necessity of institutional investors better leveraging their disparate databases, consensus holds they have not embraced the new science of data analytics to as great an extent as the marketplace lenders.

An article on Finextra.com by Jon May, who writes for KYC.com (Know Your Client), a new Markit and Genpact-sponsored venture to universalise identifiers for legal, tax and margin essentials pre-trade, explains how banks are hampered in their ability to process new credit applications by the seemingly endless checklist of their due diligence process:

“Processes that lead to being compliant are complex, inefficient and fragmented. Data is often sitting within silos across different parts of an organisation. Regulatory, tax and margin changes also mean that banks are obliged to ask customers more questions they weren’t asking before…. there is no standardisation.”

(http://www.finextra.com/blogs/fullblog.aspx?blogid=11634)

Hire Someone Else To ‘Know Your Customer’

When sourcing institutional buyers for a debt issue, the market research techniques that credit funds use, particularly for private debt, are heavily reliant on inter-personal connections. The infamous ‘black contact book’ is favoured over a more scientific data-based approach.

Dave Hunter, a partner with investment sales and marketing consultants First Avenue Partners, which uses social media analysis metrics on industry community forums like Mallow Street, admits that “What we do is still not really enough – and we’re told we’re above market.”

Some believe there is too great a reliance on existing relationships among placement agents. They are essentially, says one industry insider, “hired because they are people who know people, often former brokers.” Coming from this background, he claims, they are more comfortable in the role of ‘salesman’ than ‘data cruncher’.

Although the important firms have proprietary databases and have a policy of profiling contacts to enable better targeting, in many cases the systems are “fragmented and not properly integrated, and there is insufficient training in their usage. Either that, or a reluctance to fully embrace it.”

Gaining Advantage with Strategic Alliances

In contrast, marketplace lenders such as Credibility Capital have formed strategic partnerships with global technology companies and database providers. Credibility Capital has FIS Global source loan originators, a company self-described as “the world’s largest global provider dedicated to banking and payments technologies, with over 39,000 employees serving more than 14,000 institutions in over 110 countries.”

The lender is also partnering with UK-based credit information provider Dun & Bradstreet, which gives an additional layer of information beyond that provided by Experian; to include details on major shareholders in the company, any relevant sanctions, persons associated with it (to identify conflicts of interest), as well as the consumer credit rating of the company directors and management.

Previous bankruptcies and county court judgements are included as a matter of course. The D&B credit database is marketed as a source of comprehensive company research, on anything which may impact a borrower’s credit, or ability to repay debt in the future. Whereas a company like Experian will focus only on their credit record.

Funding Circle provides another illustrative example of the level of analysis many marketplace lenders put into processing credit applications. It claims to take over 20000 factors into account when assigning a risk band, and uses industry standard Experian as well as a variety of other sources.

It will analyse the workings of the business, incorporating factors like commercial invoice payment performance, and profit and loss account over the course of the business’s life. Thus it assesses its durability, while simultaneously factoring for macro trends within that industry; and probability of capturing market share within that region, to assess its future prospects. It will also look at how the loan will be used to advance the business.

Because these are small business loans, the company director has a disproportionate amount of power over whether it is profligate or thrifty. This is why the director’s personal credit, consumer and commercial record is scrutinised so intensely. Banks focus on a client’s due diligence record because their primary concern is violating AML rules; or complying to strict margin requirements on derivative trades.

If banks have any concern that the borrower might default on a loan, they will likely deny the applicant. It seems the marketplace lender’s approach is to use the data to actually get to know their clients, and customers, a little better.

 

To illustrate the importance of having up-to-the-minute systems – or of hiring a specialised data provider – we leave you with some telling stats from both D&B’s own data, and the UK’s Sales & Marketing Institute:

• Up to 96% of email addresses and contact data within customer files and CRMs are inaccurate.
• CRM degradation is approaching two percent per month
• Within a 30-minute period the following changes occur:
• 120 business addresses
• 75 business telephone numbers
• 15 company names
• 30 new businesses formed
• 10 businesses close
• 20 CEOs to leave their jobs