Category Archives: Aid:Tech

24/2/17: Distributed ledger technology in payments, clearing, & settlement

A new research paper from the U.S. Federal Reserve System, titled “Distributed ledger technology in payments, clearing, and settlement” (see citation below) looks at the rapidly evolving landscape of blockchain (distributed ledger technologies, or DLTs) in the financial services.

The authors note that DLT “is a term that [as of yet]… does not have a single definition”. Thus, the authors “refer to the technology as some combination of components including peer-to-peer networking, distributed data storage, and cryptography that, among other things, can potentially change the way in which the storage, record-keeping, and transfer of a digital asset is done.” While this definition is broader than blockchain definition alone, it is dominated by blockchain (private and public) typologies.

Impetus for research

Per authors, the impetus for this research is that DLT is one core form of financial sector innovation “that has been cited as a means of transforming payment, clearing, and settlement (PCS) processes, including how funds are transferred and how securities, commodities, and derivatives are cleared and settled.” Furthermore, “the driving force behind efforts to develop and deploy DLT in payments, clearing, and settlement is an expectation that the technology could reduce or even eliminate operational and financial inefficiencies, or other frictions, that exist for current methods of storing, recording, and transferring digital assets throughout financial markets.” This, indeed, is the main positive proposition arising from blockchain solutions, but it is not a unique one. Blockchain systems offer provision of greater security of access and records storage, higher degree of integration of various data sources for the purpose of analytics, greater portability of data. These advantages reach beyond pure efficiency (cost savings) arguments and go to the heart of the idea of financial inclusion - opening up access to financial services for those who are currently unbanked, unserved and undocumented.

In line with this, the Fed study points that the proponents “of the technology have claimed that DLT could help foster a more efficient and safe payments system, and may even have the potential to fundamentally change the way in which PCS [payments, clearance and settlement] activities are conducted and the roles that financial institutions and infrastructures currently play.” The Fed is cautious on the latter promises, stating that “although there is much optimism regarding the promise of DLT, the development of such applications for PCS activities is in very early stages, with many industry participants suggesting that real-world applications are years away from full implementation.”

Per Fed research, “U.S. PCS systems process approximately 600 million transactions per day, valued at over $12.6 trillion.” In simple terms, given average transaction cost of ca 2-2.5 percent, the market for PCS support systems is around USD250-310 billion annually in the U.S. alone, implying global markets size of well in excess of USD750 billion.

DLT Potential

Fed researchers summarise key (but not all) potential (currently emerging) benefits of DLT systems in PCS services markets:

Reduced complexity (especially in multiparty, cross-border transactions)
Improved end-to-end processing speed and availability of assets and funds
Decreased need for reconciliation across multiple record-keeping infrastructures
Increased transparency and immutability in transaction record-keeping
Improved network resiliency through distributed data management
Reduced operational and financial risks

One of the more challenging, from the general financial services practitioners’ point of view, benefits of DLT is that it is “essentially asset-agnostic, meaning the technology is potentially capable of providing the storage, record-keeping, and transfer of any type of asset. This asset-agnostic nature of DLT has resulted in a range of possible applications currently being explored for uses in post-trade processes.”

The key to the above is that blockchains ledgers are neutral to the assets that are recorded on them, unlike traditional electronic and physical ledgers that commonly require specific structures for individual types of assets. The advantage of the blockchain is not simply in the fact that you can use the ledger to account for transactions involving multiple and diverse assets, but that you can also more seamlessly integrate data relating to different assets into analytics engines.

Due to higher efficiencies (cost, latency and security), blockchain offers huge potential in one core area of financial services: financial inclusion. As noted by the Fed researchers, “financial inclusion is another challenge both domestically and abroad that some are attempting to address with DLT. Some of the potential benefits of DLT for cross-border payments described above might also be able to help address issues involving cross-border remittances as well as challenges in providing end-users with universal access to a wide range of financial services. Access to financial services can be difficult, particularly for low-income households, because of high account fees, prohibitive costs associated with traveling to a bank. Developers contend DLT may assist financial inclusion by potentially allowing technology firms such as mobile phone providers to provide DLT-based financial services directly to end users at a lower cost than can (or would) traditional financial intermediaries; expanding access to customer groups not served by ordinary banks, and ultimately
reducing costs for retail consumers.”

Lower costs are key to achieving financial inclusion because serving lower income (currently unbanked and unserved) customers in diverse geographical, regulatory and institutional settings requires trading on much lower margins than in traditional financial services, usually delivered to higher income clients. Reducing costs is the key to improving margins, making them sustainable enough for financial services providers to enter lower income segments of the markets.

Incidentally, in addition to lower costs, improving financial inclusion also requires higher security and improved identification of customers. These are necessary to achieve significant gains in efficiencies in collection and distribution of payments (e.g. in micro-insurance or micro-finance). Once again, DLT systems hold huge promise here, including in the areas of creating Digital IDs for lower income clients and for undocumented customers, and in creating verifiable and portable financial fingerprints for such clients.

The Fed paper partially touches this when addressing the gains in information sharing arising from DLT platforms. “According to interviews, the ability of DLT to maintain tamper-resistant records can provide new ways to share information across entities such as independent auditors and supervisors.” Note: this reaches well beyond the scope of supervision and audits, and goes directly to the heart of the existent bottlenecks in information sharing and transmission present in the legacy financial systems, although the Fed study omits this consideration.

“As an example, DLT arrangements could be designed to allow auditors or supervisors “read-only access” to certain parts of the common ledger. This could help service providers in a DLT arrangement and end users meet regulatory reporting requirements more efficiently. Developers contend that being given visibility to a unified, shared ledger could give supervisors confidence in knowing the origins of the asset and the history of transactions across participants. Having a connection as a node in the network, a supervisor would receive transaction data as soon as it is broadcast to the network, which could help streamline regulatory compliance procedures and reduce costs…”

Once again, the Fed research does not see beyond the immediate issues of auditing and supervision. In reality, “read-only” access or “targeted access” can facilitate much easier and less costly underwriting of risks and structuring of contracts, aiding financial inclusion.

Key takeaways

Overall, the Fed paper “has examined how DLT can be used in the area of payments, clearing and settlement and identifies both the opportunities and challenges facing its long-term implementation and adoption.” This clearly specifies a relatively narrow reach of the study that excludes more business-focused aspects of DLTs potential in facilitating product structuring, asset management, data analytics, product underwriting, contracts structuring and other functionalities of huge importance to the financial services.

Per Fed, “in the [narrower] context of payments, DLT has the potential to provide new ways to transfer and record the ownership of digital assets; immutably and securely store information; provide for identity management; and other evolving operations through peer-to-peer networking, access to a distributed but common ledger among participants, and cryptography. Potential use cases in payments, clearing, and settlement include cross-border payments and the post-trade clearing and settlement of securities. These use cases could address operational and financial frictions around existing services.”

As the study notes, “…the industry’s understanding and application of this technology is still in its infancy, and stakeholders are taking a variety of approaches toward its development.” Thus, “…a number of challenges to development and adoption remain, including in how issues around business cases, technological hurdles, legal considerations, and risk management considerations are addressed.” All of which shows two things:

Firstly, the true potential of DLTs in transforming the financial services is currently impossible to map out due to both the early stages of technological development and the broad range of potential applications. The Fed research mostly focuses on the set of back office applications of DLT, without touching upon the front office applications, and without considering the potentially greater gains from integration of back and front office applications through DLT platforms; and
Secondly, the key obstacles to the DLT deployment are the legacy services providers and systems - an issue that also worth exploring in more details.

In both, the former and the latter terms, it is heartening to see U.S. regulatory bodies shifting their supervisory and regulatory approaches toward greater openness toward DLT platforms, when contrasted against the legacy financial services platforms.

Mills, David, Kathy Wang, Brendan Malone, Anjana Ravi, Jeff Marquardt, Clinton Chen, Anton Badev, Timothy Brezinski, Linda Fahy, Kimberley Liao, Vanessa Kargenian, Max Ellithorpe, Wendy Ng, and Maria Baird (2016). “Distributed ledger technology in payments, clearing, and settlement,” Finance and Economics Discussion Series 2016-095. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2016.095.

23/9/16: Two Major Partnerships for AID:Tech

AID:Tech CEO, Joseph Thompson presented at the Techstars Demo Day earlier this week.

Here is the video of his excellent talk about AID:Tech-powered technology promise to the aid and development sector: https://techstars.wistia.com/medias/fi4q9e0zkf delivered in front of some 600 top European technology VCs and business development specialists.

As a part of the Demo Day, AID:Tech also made two new partnerships announcements. Details are here:

As a board member and an adviser to the company, I am proud of what the team led by Joseph have been able to achieve within a span of just few months. The importance of blockchain-based solutions in providing greater efficiencies, better security and higher degree of transparency to payments in the international aid and development area is matched by the blockchain potential to revolutionise key development sub-sectors of micro-lending and micro-insurance. AID:Tech are clearly positioned to lead fintech innovation in these market niches.

3/9/16: Fintech, Banking and Dinosaurs with Wings

Here is an interesting study from McKinsey on fintech role in facilitating banking sector adjustments to technological evolution and changes in consumer demand for banking services:
http://www.mckinsey.com/business-functions/risk/our-insights/the-value-in-digitally-transforming-credit-risk-management?cid=other-eml-alt-mip-mck-oth-1608

The key here is that fintech is viewed by McKinsey as a core driver for changes in risk management. And the banks responses to fintech challenge are telling. Per McKinsey: “More recently, banks have begun to capture efficiency gains in the SME and commercial-banking segments by digitizing key steps of credit processes, such as the automation of credit decision engines.”

The potential for rewards from innovation is substantial: “The automation of credit processes and the digitization of the key steps in the credit value chain can yield cost savings of up to 50 percent. The benefits of digitizing credit risk go well beyond even these improvements. Digitization can also protect bank revenue, potentially reducing leakage by 5 to 10 percent.”

McKinsey reference one example of improved efficiencies: “…by putting in place real-time credit decision making in the front line, banks reduce the risk of losing creditworthy clients to competitors as a result of slow approval processes.”

Blockchain technology offers several pathways to delivering significant gains for banks in the area of risk management:

It is real-time transactions tracking mechanism which can be integrated into live systems of data analytics to reduce lags and costs in risk management;
It is also the most secure form of data transmission to-date;
It offers greater ability to automate individual loans portfolios on the basis of each client (irrespective of the client size); and
It provides potentially seamless integration of various sub-segments of lending portfolios, including loans originated in unsecured peer-to-peer lending venues and loans originated by the banks.

Note the impact matrix above.

Blockchain solutions, such as for example AID:Tech platform for payments facilitation, can offer tangible benefits across all three pillars of digital credit risk management process for a bank:

Meeting customer demand for real-time decisions? Check. Self-service demand? Check. Integration with third parties’ platforms? Check. Dynamic risk-adjusted pricing and limits? Check
Reduced cost of risk mitigation? Yes, especially in line with real-time analytics engines and monitoring efficiency
Reduced operational costs? The entire reason for blockchain is lower transactions costs

What the above matrix is missing is the bullet point of radical innovation, such as, for example, offering not just better solutions, but cardinally new solutions. Example of this: predictive or forecast-based financing (see my earlier post on this http://trueeconomics.blogspot.com/2016/09/2916-forecast-based-financing-and.html).

A recent McKinsey report (http://www.mckinsey.com/industries/financial-services/our-insights/blockchain-in-insurance-opportunity-or-threat) attempted to map the same path for insurance industry, but utterly failed in respect of seeing the insurance model evolution forward beyond traditional insurance structuring (again, for example, FBF is not even mentioned in the report, nor does the report devote any attention to the blockchain capacity to facilitate predictive analytics-based insurance models). Tellingly, the same points are again missed in this month’s McKinsey report on digital innovation in insurance sector: http://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/making-digital-strategy-a-reality-in-insurance.

This might be due to the fact that McKinsey database is skewed to just 350 larger (by now legacy) blockchain platforms with little anchoring to current and future innovators in the space. In a world where technology evolves with the speed of blockchain disruption, one can’t be faulted for falling behind the curve by simply referencing already established offers.

Which brings us to the point of what really should we expect from fintech innovation taken beyond d simply tinkering on the margins of big legacy providers?

As those of you who follow my work know, I recently wrote about fintech disruption in the banking sector for the International Banker (see http://trueeconomics.blogspot.com/2016/06/13616-twin-tech-challenge-to.html). The role of fintech in providing back-office solutions in banking services is something that is undoubtedly worth exploring. However, it is also a dimension of innovation where banks are well-positioned to accept and absorb change. The real challenge lies within the areas of core financial services competition presented (for now only marginally) by the fintech. Once, however, the marginal innovation gains speed and breadth, traditional banking models will be severely stretched and the opening for fintech challengers in the sector will expand dramatically. The reason for this is simple: you can’t successfully transform a centuries-old business model to accommodate revolutionary change. You might bolt onto it few blows and whistles of new processes and new solutions. But that is hardly a herald of innovation.

At some point in evolution, dinosaurs with wings die out, and birds fly.

2/9/16: Forecast-based Financing and Blockchain Solutions

As the readers of this blog know, AID:Tech (https://aid.technology/) is a new venture I am involved with that uses blockchain platform for provision of key payments facilitation services for people in need of emergency and continued assistance (refugees, international aid recipients, disaster relief aid and general social supports payments). As a part of the market analysis and strategy, we have encountered an interesting, rapidly evolving services segment relating to disaster relief: the concept of Forecast-based Financing (FBF) worth highlighting here.

Under FBF, aid providers release humanitarian aid-related funding ahead of the adverse event taking place, based on forecast information that aids in predicting the severity, timing and impact distribution of the disaster (natural or man-made). This approach to aid delivery aims to:

Reduce key risks (e.g. assuring that delivery is timed in line with the adverse shock, focused on key geographic and demographic audiences, uses pre-disaster - and thus more efficient - supply chain networks, etc),
Enhance preparedness and response (by increasing quality of aid targeting and allowing to concentrate resources in the areas where they are needed most and ahead of the actual disaster impact), and
Make disaster risk management overall more effective by assuring that aid resources are present at the time of the disaster and after the disaster impact, thus reducing losses and delays in delivery of aid that may arise as the result of the disaster (e.g. destruction of roads and disruptions in power supplies, etc).

In general, FBF framework is open to several questions and objections, all requiring addressing.

How does FBF work?

A humanitarian aid agency and stakeholders (e.g. meteorological services and communities at risk) jointly create a contingency plan, outlining key actions to be taken ahead of the probabilistically likely disaster or shock. They also set out specific metrics that define the trigger for aid pre-delivery, based on a model risk forecast reaching a specific threshold of probability. Linked to severity of forecast shock, specific budgets are set aside for activation. Once the risk probability threshold is breached, aid is delivered to the location of possible disaster, using pre-disaster supply chain management structures before these get disrupted by the event.

Forecast errors: are these really costly?

Probabilistic forecasts are never 100% accurate, which means that in some instances, aid will be delivered to the communities where the adverse event (a shock) might end up not materialising, despite probability models generating high likelihood of such an event. In a way, this is the risk of aid agencies providing disaster relief “in vain” or “wasting” scarce resources. It is worth noting that probabilistic errors of “wastage” can be significantly over-estimated, as some disasters can be relatively well forecast in advance (http://www.nat-hazards-earth-syst-sci.net/15/895/2015/nhess-15-895-2015.pdf). Quality of forecasting will, of course, co-determine losses in the system.

To achieve system-wide efficiency and secure gains from implementing an FBF programme, one has to be able to counter-balance the benefits of early response,including those arising from more efficiency in accessing supply chains pre-disaster and reducing the cost of disaster, against the likelihood of a loss due to probabilistic basis for the action. This can be done via two channels:

Assuring that during planning, the cost of acting pre-emptively, including the cost of probabilistic ‘waste’, is factored into planning for which forms of aid should be pre-delivered and on what scale; and
Assuring that aid supply chain and forecasting models are optimised to delver highest efficiencies possible.

Over time, development of FBF will also require changes in supply chain management to mitigate losses due to “wastage”. For example, putting more emphasis on local (or proximate) sources for supply of critical aid can reduce “wastage” by lowering cost of deliveries and by closely anchoring pre-disaster deliveries to existent markets for goods and services (so at least some pre-delivered aid can be returned into local markets in the case if probabilistically likely disaster does not materialise).

In other words, aid agencies and potentially impacted communities need to have access to timely and accurate information on which resources are needed in responding to a specific disaster, on what scale and, crucially, which resources are already available in the supply chain and in the local or proximate markets. The key element to this is ability to track in real time supply chains of goods and services accessible at differential cost to specific communities in cases of specific disaster events. The agreed (in advance) standard operating procedures (SOPs) that are set between the aid providers and the recipient communities must be both realistic (reflective of measures necessary in the case of specific disaster) and effective (reflective of the balance of cost-benefit).

Put differently, the process of FBF is the process of, first and foremost, planning and data relating to supply chain management.

Are there any tangible experiences with FBF?

One early example of FBF implementation is the case of the Red Cross Red Crescent Movement that has field-tested an FBF programme Uganda and Togo. This project bridged financial and technical support from the German government and Red Cross, and used technical support from the Climate Centre.

Another case is of FoodSECuRE initiative by the World Food Programme that is currently in planning stages. In this programme, private sector partners (aviation services providers, insurance companies etc) are engaged in FBF planning for alleviation of potential flooding due to El Niño effects in Peru (http://www.climatecentre.org/downloads/files/FbF%20Brochure4.pdf and http://www.climatecentre.org/programmes-engagement/forecast-based-financing). Both of these experiences show also the importance of setting aside sufficient response funds for FBF delivery.

Further afield, FBF pilots are being run or planned by the WFP and other organisations in Bangladesh, the Dominican Republic, Haiti, Mozambique, Nepal and the Philippines.

Note: the above cases were provided by the UNFDP research.

Overall, FBF is becoming one of the cornerstones of the global disaster aid delivery programmes and was endorsed by UN OCHA and the IFRC. FBF was also included in the International Federation’s special report ahead of the World Humanitarian Summit in Istanbul. The report included a pledge to facilitate a doubling of FbF within the Movement by 2018.

However, despite the aid agencies enthusiasm, the key problem relating to FBF remains largely unaddressed: currently, with some 20 percent of disaster aid being lost due to insufficient supply chain management, fraud and theft, delivering properly structured FBF requires exponentially greater exposure to data collection and analysis, as well as to strengthening of real-time supply chain visibility systems.

As AID:Tech example shows, these objectives can be supported via private and semi-private blockchain solutions.

20/6/16: Aid:Tech in Techstars 2016

So it is now official: AID:tech (https://aid.technology/) is one of 11 companies selected for the Techstars 2016 programme: http://www.techstars.com/content/accelerators/announcing-11-companies-summer-2016-techstars-london-class/

AID:tech is the largest blockchain player in the market for providing payments facilitation, data collection and analytics; and assets / supply chain management company for international NGOs and State organisations providing aid and social welfare supports around the world. The company has fully-developed, field-tested suite of solutions allowing it to assist NGOs and governments in:

Reducing risk of fraud in international aid and social welfare payments by digitalising their payments processes;
Transmit a payment to the end recipient of aid, instantaneously verifying identity of the recipient, receipt of funds, and confirming the use of funds in the case of aid-related purchases
Substantially (by a factor of up to 3 times) reduce the cost currently charged by less secure platforms that generally offer lower degree of tractability of transactions.

Today there is a lack of transparency and accountability in the distribution of funds by NGO's and governments.

Of the $360bn transferred each year by NGO's, only $90bn is currently delivered via transparent systems and these systems are extremely expensive to administer. By utilising private blockchain technology, AID:tech enables all international aid to be accounted for, including the distribution of assets such as medicine, food and other essentials. The platform also offers add-ons such as smart contracts and instant micro-insurance, as well as advanced data analytics that help organisations to better plan and execute aid deliveries.

AID:tech is finalist in the Irish Times Innovation Awards (http://www.irishtimes.com/business/irish-times-innovation-awards-finalists-original-thinkers-from-all-sectors-1.2663210 and http://trueeconomics.blogspot.ie/2016/05/30516-aidtech-through-to-irish-times.html) and is shortlisted for the ‘Best Humanitarian Tech Startup’ for The Europas European Tech Startup Awards https://aid.technology/aidtech-shortlisted-for-the-europas-european-tech-startup-award/.

Disclosure: I am very proud of being involved with the company as an adviser and shareholder.