TheFutureofFinance:DigitalCapital,BlockchainandBeyond

Robert RuttmannUniversity of St. Gallen

@RRuttmann

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Agenda

2November2016

1 Thefinancialservicessectorisinthemiddleofafundamentaltransformation

2 Blockchain andcryptocurrencyarekeytocreatinggreaterwealth

3 Whatareblockchain technologyandcryptocurrency?

4 Howwillblockchain challengetoday‘sbusinessmodelfundamentally?

5 Whataretheimportantusecasesofblockchain?

The financial services sector is in the middle of a fundamental transformation

4November2016

We are losing confidence in our financial leaders

1.5milliondepositaccountsand565’000creditcardaccountsopened

– WITHOUTCUSTOMERPERMISSION!!

Music News Books TELCO Movies Travel Retail Automotive Banking Insurance Pharma

Implications for the financial sector are immense

5November2016

It is not a matter of “if”, it is a matter of “when”

“If banks don’t change, we will change banks.”Jack Ma,CEO, Alibaba

Emerging innovations are accelerating a change in consumer behavior

6November2016

New disruptors threaten existing business models

P2P lending

Crowd-funding

Seamless digital

payment

Crypto-currencies

Block-chain

Reg-Tech

Tech-Giants

Roboadvisory

Incumbent

Technology empowering customers

Radical transparency

Demand for hyper customization

Wealth shift to tech-savvy millennials

New realities

Increasing regulatory burden

”Banks are good at creating pain points. Silicon Valley is great at getting rid of them.”

---- Jamie Dimon, CEO of JP Morgan Chase & Co

September21,2016 7FutureofFinance:Banksand

Fintech

Physical branch networks are falling fast, while Fintech investment is booming

8November 2016

A shift to a digial arena where innovation drives demand

0

10

20

30

40

50

60

2005 2010 2015 2020 2025

Commercial Bank Branches per 100k Adults By Region

East Asia & Pacific Euro areaLatin America North AmericaNordics Switzerland

In Switzerland, commercial bank branches are set to fall by 50% in just 10 years

1.8 2.1 2.44.0

12.0

19.0

0

5

10

15

20

2010 2011 2012 2013 2014 2015

Over USD 19 billion invested globally in Fintechs in 2015

Fromthreat

toopportunity

Switzerland (-45-50% by 2025)

CAGR=67.74%(2012-2015)

CAGR=10.06%(2010-2012)

Over 14‘000 fintechs globally aiming to simplify and revolutionize financial services

Source: World Bank, HSG, post 2014 data are estimated by ICI-HSG Source: CB Insights, ICI-HSG

World’s top 10 Unicorns (2015)

9

ANT FINANCIAL

$ 60 BOnline payments

provider for individuals and

businesses

LUFAX

$ 19 BChinese peer-to-peer

lender

MARKIT

$ 5.1 BFinancial information

and data provider

STRIPE

$ 5 BOnline payment

processing

LENDING CLUB

$ 4.7 BAmerica’s biggest

peer-to-peer consumer loans

platform

ZENEFITS

$ 4.5 BFree HR software for

small businesses

SQUARE

$ 4.3 BSmartphone card

readers, small business loans, and

online payments

CREDIT KARMA

$ 3.5 BFree credit scores

ADYEN

$ 2.3 BOnline payment

processor

KLARNA

$ 2.25 BOnline payment

processing

Technology giants take part in the game

September21,2016 FutureofFinance:Banksand

Fintech

10

Company No. of Users (2015)

Business Model

FinanceProducts

Volume (2015)

c.a 200 mnmonthly unique users

data monetization

(2011) (2015)

• c.a 20mn devices have Google Wallet installed in the US

• 1-2mn active users of Android Pay in the US

800 mn (iTunes users)

data, sotfwareand hardware

(2014)

• c.a 24mn ApplePay compatible devices in the US;

• 4mn users have used ApplePay at least once and 1-2mn are active users.

1'550mn data monetization

(2015)

• no data available yet

304 mn E-commerce Amazon lending (2012): loan to sellers

(2007)

• Globally more than 23mn customers (<10% customers) have used the "Pay with Amazon" service since 2013;

• Payment volume from "Pay with Amazon" increased 150% year-over-year in 2015

Source: Company reports

Wealth AdviceBlockchain and Cryptocurrency

Credit and Lending

Payment Systems

11November2016

8 clusters that are set to be transformed

1 2 3 4

Digital Capital Markets RegTech Digital Insurance

5 6 7

Innovation for Social Impact

8

Fintechs are offering simpler, faster, and more innovative payment solutions

12November2016

1. Payment Systems (1/2)

Mobile Payments

Integrated Billing

Streamlined Payments

Next Generation Security

Micropayment

Customers demand payment solutions that are different, cheaper and real-time

1325April2016

1. Payment Systems (2/2)

931 $bn

282 $bn

Alipay total payment volume 3.3 �PayPay (2015)

3.3 �

China: More active users of payment apps than retail customers at banks (mn)

549

350

270

149

465 456

314

63 56 45

Wexin&WeCaht

Alibaba Alipay&Wallet

Yu'e Bao ICBC ABC CCB BoCom CMB CNCB

Source: Company reports, HSG

Payment Apps

Retail Banks

New platforms are simplifying and expanding the lending process

14November2016

2. Credit and lending (1/2)

P2P, P2B Lending

Digital Credit Risk Analytics

Crowdfunding Social Lending

Lean, automated process

Kickstarter is an online crowdfunding platform helping bring creative projects to life

15November2016

2. Credit and lending (2/2)

Moving towards a faster, cheaper and more secure transactions platform

16November2016

3. Blockchain and cryptocurrency

Cryptographic protocols

P2P Transfers

Mobile Money

New Market Protocol/Standard

Online Fixed Income Markets

New players are challenging existing models with cheaper, seamless services

17November2016

4. Wealth advice

Automatedadvice

Sharing Knowhow

Advanced analytics

Natural language

Process-as-a-service

Partner-ships

Redefining the way buyers and sellers are being connected

18November2016

5. Digital capital markets

New Market Platforms Big Data Artificial Intelligence

Automating many outdated compliance and due diligence tasks

19November2016

6. RegTech

Automated Processes

Big Data Analytics

Machine Learnings

Virtual Banking

Sustainability Check

A new degree of personalization and proactive risk management in insurance

20November2016

7. Digital insurance

Disaggregated Distribution

Sharing Economy

Autonomous Driving

Wearables Standardized Platforms

Harnessing financial innovation to allocate capital for social progress

21November2016

8. Innovation for social impact

New Funding Platforms

Empowered angel investors

Mobile Payments

Capability sharing

Social Trading

Banking as a platform (API)

Blockchain and cryptocurrency have the potential to have a big development impact

The worlds‘s biggest problems – The Copenhagen ConsensusThe existence of trade barriers is considered to be the world’s number one problem

23November2016

1Trade barriers

Health2

Education3

Removingtradebarriersis

over30timesmore

effective thananyother

intervention.-- Copenhagenconsensus

Freetrade

Democracy

Freetradeis50timesmoreeffectivethan

democracyatreducingviolentconflict.

-- EconomicFreedomoftheWorld2005

Wealthcreationisthefundamentaldriver

ofindividualandsocialwell-being

Howdowebuildwealth?

How do we build wealth?We build greater wealth by achieving three conditions

1Greatersecurity

ofproperty3

Largereconomic

networks2

Lowertransaction

costs

• Greaterdivisionoflaborandspecialization

• Higherproductivity

• Boosing wealthcreationandstandardofliving

It is critical to secure property rights

27November2016

1. Greater security of property

However, 2/3 oftheworld‘spopulation– 4billionpeople

– arelockedoutofthemainstreameconomy,

i.e.theirpropertyrightsareunsecured.

“Development is very complex. But if you do not have an order that tells you who owns what, none of the rest works.”

— Hernando de Soto, economist

Low transaction costs are the fundamental driver of economic growth

28November2016

2. Lower transaction cost

A mere 0.1% reduction in transaction costs quadruples a country’s wealth— the difference between Argentina and Switzerland.

USD548

bn

USD701

bnUSD152.98bn

+USD3’558per

personperyear

Source:Kovak and Spruck,Institutional development,transaction costs and economic growth:evidence from across-country

investigation�Journalof Institutional Economics,September2015,pp.1–31,

http://journals.cambridge.org/abstract_S1744137415000077

3. Greater economic networkAbout 53% of world‘s adults – or 2.45 million -- are still unbanked

Thistechnology

iscryptocurrencies

What if we could develop a technology that • secures property rights • reduces trading costs • integrates people into the global economy?

What is a cryptocurrency?

What is blockchain?

Cryptocurrecy is also known as digital currency or virtual currencyBitcoin is the first decentralized “cryptocurrency”

0

200

400

600

800

1000

1200

1400

Jan-09 Nov-09 Sep-10 Jul-11 May-12 Mar-13 Jan-14 Nov-14 Sep-15 Jul-16

MarketPrice (USD)

OneBitcoinisworthoverUSD700today(November12,2016)

0

50

100

150

200

250

300

Jan-09 Nov-09 Sep-10 Jul-11 May-12 Mar-13 Jan-14 Nov-14 Sep-15 Jul-16

DailyTradingVolume (millionUSD)

DailytradingvolumeofBitcoinaveragedabove16mn USDinOctober2016

Source:https://blockchain.info

November2016 32

Transaction with cryptocurrency is cheaper, faster and safer

33November2016

Cryptocurrency is a currency created & transferred by cryptographic means

Bitcoinwallet

(digitalcurrency)

Jenny’sBitcoinaddress

Mike Jenny

5Kb8khDgzW933jdyhKelghw3Au72

Mike’sprivatekey(signature)

A blockchain consists of multiple blocks with data recorded within each

34November2016

Blockchain is essentially a form of a distributed ledger

�n

Ethereum allows a network of peers to administer their own “smart contract“

35November2016

Ethereum blockchain: an alternative to Bitcoin blockchain

• Smartcontracts(alsocalled self-executingcontracts, blockchain contracts,or digitalcontracts)aresimplycomputerprograms thatactasagreementswherethetermsof

theagreementcanbepreprogrammedwiththeabilitytoself-execute andself-enforceitself.

Traditional contractsTraditional contracts Smart contracts Smart contracts

36November2016

Smart contract: an example

1 A”smartcontract”

betweenpartiesis

writtenascodeinto

theblockchain.The

partiesmayremain

anonymous,the

contractisthepublic

ledger.

2 Atriggeringevent

likeanexpiration

dateandstrikeprice

ishit(i.e.the

predetermined

criteriaaremet)and

thecontract

executesitself

accordingtothe

codedterms.

3 Regulatorscan

retrievethedata

recordedinthe

blockchain anduse

themtounderstand

theactivityinthe

marketwhile

maintainingthe

privacyofindividual

actors’positions.

37November2016

Two types of blockchain: public versus private blockchain

Publicblockchain(Permission-less)

Privateblockchain(Permissionrequried)

• Anyone can read or write data from or to the ledger

• A public blockchain is a transparency engine.

• Degree of security is higher than private blockchain

• Participants are known a priori and have permission to update the ledger

• Transaction speed of a privately-run blockchain can be faster

• Privacy is obviously more assured

• Banks can still protect their underlying product from disruption by using private blockchains

How will Blockchainchallenge today‘s business model in the financial services sector?

6 key value drivers of blockchain technology

Operational

simplification1

Reducingmanualeffortsrequiredtoperformreconciliationand

resolvedisputes

Regulatoryefficiency

improvement2

Enablingreal-timemonitoringoffinancialactivitybetween

regulatorsandregulatedentities

Counterpartyrisk

reduction3

Challengingtheneedtotrustcounterpartiestofulfillobligations

asagreementsarecodifiedandexecutedin”smartcontracts”

Clearingand

settlementtime

reduction

4Disintermediatingthirdpartiesthatsupporttransaction

verification/validationandacceleratingsettlement

Liquidityandcapital

improvement5

Reducinglocked-incapitalandprovidestransparencyinto

sourcingliquidityforassets

Fraudminimization6Enablingassetprovenanceandfulltransactionhistorytobe

establishedwithinasinglesourceoftruth

November2016 39

40November2016

3 characteristics of blockchain that challenge today’s business model

Immutablerecordoftransactionhistory1

Reconciliation Auditing

• Eliminatestheneedforreconciliation

• Providesasingleversionofthetruth

Radicaltransparency2

Asymmetric

information<

Central

authorities

Regulatory

burdens

• Eliminatesimbalanceofinformationamong

marketparticipants

• Enablesreal-timemonitoring

• Increasescooperationbetweenregulatorsand

regulatedentities

Aninnovation intrust3

Intermediaries Oversight

• Ensuresagreementsareexecutedtoagreed

uponbusinessoutcomes

• Disintermediatessupportingentities

establishedtoresolvedisputes

What are the importantblockchain use cases in financial services sector?

Blockchain makes cross border transactions easier, faster and cheaper

42November2016

Use case 1: Global payments

Whatarethepainpoints? Howcanblockchain help?

• Expensive totransfermoneyacrossthe

border:costtomoneysenderaveragesat

7.7%oftheamounttransferred(World

Bank,2016)

• Crossbordertransactionsareoften

circuitousandslowduetotheinvolvement

ofmultiplecorrespondentbanks

• Thevalidation&consensusmechanismsof

blockchain disintermediatecorrespondentbanks,offeringmuchfaster andmuchlesscomplextransactionsolutions.(Companyexample:Ripple)

• Withfewerparticipantsandmoreefficient

operation,blockchain reducestransactioncostssignificantly.(Companyexample:Monetas)

Blockchain can automate processing, improve assessment and reduce cost & fraud

43November2016

Use case 2: Insurance

Whatarethepainpoints? Howcanblockchain help?

• Difficult-to-understand insurancecontractandcomplexclaimprocess(forcustomers)

• Smartcontractscanautomateclaimsprocessing,managingitinatransparent,responsiveandirrefutablemanner.

• Ever-tighterregulationandgrowingthreatoffraud (forinsurers)

• Blockchain enablesinstanttracking&sharingclaims

data,preventingduplicateclaimsandreducingfraud.

• Expensive documentmanagement(for

insurers)

• Blockchain reducesoperatingcoststhroughprocesssimplification

Blockchain facilitates automated compliance of KYC

44November2016

Use case 3: Compliance -- Know Your Customer (KYC) as an example

Whatarethepainpoints? Howcanblockchain help?

• Expensivetomaintainglobaleffortstoprevent

moneylaunderingandfinancingofterrorism:

globalspendingonAnti-Money-Laundering=

USD10bnin2014(KPMG,2014).

• Blockchain enablesreal-timemonitoringofhistoricaltransactiondata storedonblockchain isparticularlyusefulforidentifyingfraudulent/suspiciousbehavior.

• Ever-stringentKYCrequestsentailhighcostsforbanks,candelaytransactions,andfailureincompliancemeanslargepenalties.

• Blockchain couldunlockadvantagesbyautomatingprocessesandthusreducingcomplianceerrors.Italsoenablesencryptedupdatesofclientdetails tobedistributedtoallbanksinnearreal-time.

Blockchain can automate processing, improve assessment and reduce cost & fraud

45November2016

Use case 4: Post trade

Whatarethepainpoints? Howcanblockchain help?

• Humanerrorsintradingactivitiesarehardtoavoidandposttradeprocessingcanbetimeconsuming andsettlementcanbedelayed

• Smartcontractscansimultaneouslytransfersecuritiesandcashinrealtime,reducingthelikelihoodoferrorsimpactingsettlement

• Slowclearingandsettlementprocessincreasescounterpartyrisk,resultsinpoor

liquiditymanagementandhighcosts.

• Blockchain automatestheposttradeprocess.Thisenablesfasterrecirculationofthecapitalbacktothemarkets,reducescounterpartyrisksandthus,also

reducesmargin/collateralrequirements

Blockchain also has enormous potential in health, public, media and other sectors.

46November2016

Other non-financial use cases

• Digitalidentitymanagement:Permissionedmutualdistributedledgers

couldbeusedtostoreverifiedhealthrecords,passportdata,etc.inan

encryptedformat.

• Supplychainmanagement:Blockchains canbeusedtoshare

provenance,demandandinventorydatamoreefficientlybetweenthe

differentpartiesinasupplychain.

• Recordvotesinelections:Thiscouldbeassimpleassettingupatoken-

basedblockchain witheverycitizeninthecountrybeingassigneda

token.Eachvotecastwouldbeatransactionconstitutingthecitizen

sendingthetokentohis/herpartyofchoice.

• Musicdistribution:Ablockchain couldbeusedtostoreacryptographic

‘hash’oftheoriginaldigitalmusicfile,ensuringthatcopyrighttheftand

illegalfile-sharingbecomeallbutimpossible.Thesmartcontractcan

defineexactlyhowtheartistswouldbecompensatedforthemusic.

Summary

47November2016