1

INTRODUCTION – WHAT IS FINTECH?

Jelena Madir

A. INTRODUCTION 1.001 7. Blockchain 1.026

B. WHAT IS (AND ISN’T) NEW ABOUT D. HOW SHOULD REGULATORS RESPOND
FINTECH?1.003 AND WHY SHOULD LAWYERS CARE
C. KEY PLAYERS, PRODUCTS AND TRENDS1.009 ABOUT FINTECH? 1.044
1. Mobile payments and e-wallets 1.012 1. Distributed ledgers and data privacy
2. Open banking/APIs 1.014 1.046
3. Artificial intelligence (AI) and big 2. Rules governing ownership and
data1.020 contractual rights and obligations 1.047
4. Machine learning 1.022 3. Regulatory sandboxes 1.049
5. Biometrics 1.024 4. RegTech 1.052
6. Robo-advice 1.025 E. CONCLUSION 1.059

A. INTRODUCTION

Largely shrouded in hype and obscured by hyperbole, the word ‘FinTech’ is 1.001
simply a combination of the words ‘financial’ and ‘technology’. It describes the
use of technology to deliver financial services and products to consumers. This
could be in the areas of banking, insurance, investing – anything that relates
to finance. Increasingly, FinTech is coming to represent technologies that are
disrupting traditional financial services, including mobile payments, money
transfers, loans, fundraising and asset management. Yoshi Kawai, General
Secretary of the International Association of Insurance Supervisors, a member
organisation of the Financial Stability Board, offered a working definition of
‘FinTech’ as follows: it is a ‘technologically enabled financial innovation. It is
giving rise to new business models, applications, processes and products. These
could have a material effect on financial markets and institutions and the pro-
vision of financial services’.1

1 International Association of Insurance Supervisors Newsletter (June 2016), at 2.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

1.002 This chapter proceeds as follows: Part B describes the development of FinTech
and its key features, Part C describes key players, products and trends, Part D
analyses regulatory responses to FinTech and the impact FinTech will have on
the legal practice. Part E concludes.

B. WHAT IS (AND ISN’T) NEW ABOUT FINTECH?

1.003 While some financial industry observers argue that FinTech has been
around for decades and forms the lifeblood of all financial institutions (think
ATMs), others posit that this time is different and that FinTech represents
a phenomenon distinct from earlier eras of innovation. Both camps agree
that it is the rapid evolution of FinTech over the past decades that has been
transformational for the financial sector. A number of factors have conflated
to turn FinTech into the poster child that continues to grab the headlines.
First, following the 2008 global financial crisis, the brand image of banks was
severely shaken. Such scandals as the LIBOR-fixing and foreign exchange
price manipulation did not do banks any favours in terms of restoring public
trust in the banking industry. For example, a 2015 survey reported that
Americans trusted technology firms far more than banks to handle their
money.2 In addition, the global financial crisis damaged bank profitability and
competitiveness, and the ensuing regulation drove compliance costs to record
highs while simultaneously lowering credit growth. Requirements regarding
ring-fencing, the preparation of recovery and resolution plans, and the per-
formance of stress testing only contributed to increasing bank costs. The crisis
further led to large-scale redundancies, leaving many professionals seeking to
apply their skills to new outlets.3

1.004 This, in turn, coincided with the rapid rate of technology development, high
level of smart phone penetration and genuine sophistication regarding APIs,
which have enabled service improvements, especially faster payments.4 In
today’s digital age, people are seeking easy access, convenience, efficiency and
speed. They want to conduct transactions via mobile technology platforms and
applications, and such activities include managing their financial lives – from
tracking their overall spending to applying for a loan and optimising their

2 Banktech, Survey Shows Americans Trust Technology Firms More Than Banks and Retailers (25 June
2015).
3 Douglas W. Arner, Janos Barberis and Ross P. Buckley, FinTech and RegTech in a Nutshell, and the Future
in a Sandbox, CFA Institute Research Foundation (2017), at 6.
4 OECD, Digital Disruption in Banking and its Impact on Competition (2020), at 9.

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 B.  WHAT IS (AND ISN’T) NEW ABOUT FINTECH?

investment strategies.5 Given the level of service expectations from customers,

there is no excuse for businesses not to embrace the latest technologies – and
those who refuse will certainly be losing business.6 Moreover, the widespread
adoption of mobile and internet technology is being driven by a change in
demographics in emerging markets with a more technology savvy and con-
nected generation of middle-income investors. Investors between the ages of
18 and 34 are more likely to be internet and smartphone users and to partici-
pate in social media networks, compared to those aged 35 and older.7 As the
income of this younger generation increases over time, it is expected that it will
further drive the market size for FinTech.8

Importantly, not only is more information stored online, but the pace of 1.005
data-creation and its rapid availability to those seeking it has accelerated expo-
nentially. For example, unlike in earlier decades, where information on under-
lying loans or mortgage-backed securities were sourced through central nodes
of information, like credit rating agencies or conventional news organisations,
the production of digital data is often decentralised, and emerges from a variety
of websites, social media outlets and various types of news sources and databas-
es.9 Collectively, these developments are enabling the production of not only
more data than in the past, but also new kinds of meta and secondary data not
previously accessible. FinTech firms can scour the internet, including social
media and mobile phone records for insight into customers. The cloud can
help create secondary data based on the analysis and mining of original data.10

Closely related to the above is growing disintermediation driven by technology 1.006

and the internet. For example, Tripadvisor combined with online travel agen-
cies is disintermediating physical travel agencies, Amazon is disintermediating
bookstores, iTunes is disintermediating CDs, Airbnb is disintermediating
hotels, and Uber is disintermediating holders of official taxi operating licences.
Similarly, innovative FinTech business models are disintermediating certain
regulated activities. For instance, online equity crowdfunding platforms are
disintermediating stock exchanges and underwriters and banks, peer-to-peer
lending platforms are disintermediating banks and other lenders, and

5 Ibid.
6 See Jennifer Lund, How Customer Experience Drives Digital Transformation (4 November 2020).
7 See Pew Global Research, Smartphone Ownership and Internet Usage Continues to Climb in Emerging
Economies (2016).
8 Ibid.
9 Chris Brummer and Yesha Yadav, FinTech and the Innovation Trilemma, 107 Georgetown Law Journal 235
(2019), at 267.
10 Ibid.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

robo-advisors are disintermediating traditional financial advisers.11 Advances

in big data and machine learning have made it easier than ever for firms to cull
information from traditional as well as alternative data sources, and develop
new infrastructures designed to render irrelevant or bypass certain services of
intermediaries like banks or securities underwriters. By harnessing big data,
algorithms and AI, firms are increasingly linking services and products directly
with consumers, whether they are investors, entrepreneurs needing capital or
borrowers.12

1.007 FinTech firms have attracted substantial investment in recent years, while
public interest has grown significantly. Most firms have remained small –
reflecting their knowledge-based business model, but investment in them has
risen substantially. Moreover, COVID-19 has significantly accelerated digital
trends. The rapid demand for and use of digital platforms, digital banking,
no-touch payments and other FinTech-related services in every region of the
world has driven many financial services companies to increase their FinTech
investments.13 Further, the pandemic has encouraged digitally non-savvy retail
customers to consider new payment methods, with 38 per cent of consumers
reporting having discovered a new payment provider during the lockdown.14

1.008 Nevertheless, looking at the sector as a whole, it is yet to deliver on its promise
of profitability. Bank of England estimates that pre-COVID-19, up to 80 per
cent of UK FinTech companies were loss making.15 Since then, the pandemic
has placed additional strains on some business models and restricted the avail-
ability of funding, which could call into question the viability of some FinTech
companies down the line.16

C. KEY PLAYERS, PRODUCTS AND TRENDS

1.009 When people think of FinTech, they often focus on start-ups that are breaking
into areas that banks and other legacy financial institutions have dominated.

11 OICU-IOSCO, IOSCO Research Report on Financial Technologies (FinTech) (February 2017), at 7.

12 Brummer and Yadav, supra note 9.
13 KPMG, Pulse of FinTech H1 2020 (September 2020).
14 Capgemini, World Payments Report 2020 (October 2020), at 7.
15 Tom Mutton, Director, FinTech, Response, and recovery: fintech during the COVID crisis and beyond,
speech (25 October 2020).
16 Ibid.

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

However, as illustrated in the Figure 1.1, the ecosystem of FinTech companies

is considerably broader and covers:

● incumbent, well-established financial institutions such as HSBC, Barclays,

Bank of America and Allstate, which are acquiring or working with
FinTech start-ups and building their own innovative solutions;
● big technology companies that are active in the financial services space but
not exclusively so, such as Apple, Google, Facebook, and Twitter;
● companies that provide infrastructure or technology that facilitates finan-
cial services transactions, such as MasterCard, Fiserv, First Data, various
financial market utilities, and exchanges such as NASDAQ; and
● disruptors – the fast-moving companies, often start-ups, focused on a par-
ticular innovative technology or process, such as Stripe (mobile payments),
Betterment (automated investing), Prosper (peer-to-peer lending), Moven
(retail banking), and Lemonade (insurance).17

Figure 1.1 FinTech players

As an umbrella term, FinTech covers many technological disruptions related 1.010

to finance. They can be classified in several categories: payments, insurance,
investment advice, securities clearance and settlement, and alternative funding
platforms, all of which are enabled by cross-cutting technologies such as data
analytics, distributed ledger technology/blockchain and cybersecurity. Table
1.1 lists key technologies and real-life examples associated with each of these
categories.

Let us look more closely at some of these: 1.011

1. Mobile payments and e-wallets

Mobile payments and e-wallets have made a huge impact on how people 1.012
transact. Most mobile payment systems are based on a prepaid balance that is
transferred by SMS, near-field communication, or using codes, but post-paid
or real-time payments are also possible. As distinct from some other forms

17 PWC, What is FinTech? (2016), at 2.

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 Table 1.1 Real-life examples and technology disruptions related to finance
Chapter 1

Category Key technologies Real-life examples

FINTECH USE CASES
Payments Mobile payments, smartphone wallets, digital Apple Pay, Android Pay, PayPal Mobile Express
wallets, acceptance devices, Central Bank issued Checkout, Venmo, Square, Wise
digital currencies
Insurance Online insurance platforms, online brokers, Insureon, Knip, Oscar, Slice, Cuvva
peer-to-peer insurance
Investment advice Robo-advisory, digital wealth management, Motif, Wealthfront, Nutmeg, Juntos
digital investment tools, tailored financial
messaging
Securities clearing and settlement Digital assets, DLT-based solutions Australian Stock Exchange (ASX) DLT settlement

6
system, Hong Kong Exchange and Clearing
INTRODUCTION – WHAT IS FINTECH?

Limited (HKEX)
Alternative funding platforms Equity-based crowdfunding and P2P lending GoFundMe, Kickstarter, Lending Club,
platforms Funderbeam, Zelle, Crowdcube, Kabbage, Funding
Circle
CROSS-CUTTING ENABLING TECHNOLOGIES
Data analytics Big data, artificial intelligence, machine learning Equifax NeuroDecision credit scoring, Credit
Benchmark, Bloomberg Social Sentiment
Analytics, Solovis, Kreditech
Distributed ledger technology/blockchain Private key encryption, proof-of-work, Bitcoin, Ethereum, Ripple Payment Network,
proof-of-stake (and other protocols), Coinbase
cryptocurrencies, smart contracts
Cybersecurity Encryption, authentication, biometrics Diebold iris-scanning ATM, Mastercard
Biometric Card, TeleSign, Experian CreditLock

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

of electronic banking, the transferred money is available immediately and,

depending on the system, a bank may not need to be directly involved.18

A natural extension of mobile payments, mobile wallets let users store money 1.013
and credit cards on their mobile devices and transact through their phones
without ever opening their actual wallet. Google’s Android pay and Apple’s
Apple Pay are two of the most well-known mobile wallets. Paypal has been
considered as one of the pioneers of the digital payments industry. After its
acquisition by eBay, Paypal payments rapidly gained popularity and became
the choice of payment method for the majority of eBay users. This led to
a chain effect, giving rise to a whole new segment concerned with digital pay-
ments – payment gateways, security companies and fraud detection software,
to name a few.

2. Open banking/APIs

Open APIs are perceived by a number of institutions (particularly in the 1.014

European Union in view of the PSD2) as an opportunity to bring more
tailored products to customers and offer new propositions. Through open
APIs – software applications that enable computer systems to communicate
with each other and exchange data, customers can share their bank data with
other parties and to initiate payments from their bank through third-party
apps.19 Admittedly, it is yet unknown to what extent customers will consent
to share their personal financial data with third-party providers. Moreover,
sharing data across multiple providers could be impractical if consumers have
to provide consent every time some of their account information is used, or if
they had to submit data histories to multiple providers to get the best quotes
on financial products and services.20

Recognising a number of potential risks that open APIs pose to consumers, 1.015
the European Banking Authority has developed regulatory technical stand-
ards, specifying the requirements for strong customer authentication, the
requirements with which security measures have to comply to protect the
confidentiality and the integrity of payment service users’ personalised security
credentials, and the requirements for common and secure open standards of
communication.21

18 See Robert Bosch, Who will be the winners in the mobile payments battle?, BearingPoint.
19 Greg Chen and Xavier Faz, Open Data and the Future of Banking (23 October 2019).
20 Ibid.
21 European Banking Authority, Final Report, Draft Regulatory Technical Standards on Strong Customer
Authentication and common and secure communication under Article 98 of Directive 2015/2366 (PSD2)
(23 February 2017).

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

1.016 Mobile access and the internet have been transformational, allowing the gains
from technological progress to be shared directly with billions of individual
consumers whose mobile devices are now portals for accessing a full range
of financial services, and can be extended by third parties via APIs.22 This
massive decentralisation is opening the door to crowdfunding platforms that
disintermediate banks and directly connect those looking for financing with
potential investors.23 As described in more detail in Chapter 3, crowdfunding
now means that one can raise money quickly and cheaply from people all over
the world that one has never met. It has democratised the process of finding
start-up capital and shortened the timeline from perhaps months of meetings
to as little as a few weeks.24

1.017 In addition, it is now also easier than ever for small businesses to accept pay-
ments. Even farm stands in remote locations can accept credit and debit cards
with tools like Square. Additionally, companies like Wise are providing ways
to transfer money internationally, disrupting that sector by offering a 90 per
cent discount on traditional bank transfer fees.25

1.018 Another consequence of digitisation is that vast amounts of data now exist
in forms that can be readily aggregated and analysed with computing power.
Online and mobile applications that draw on these data make it possible for
consumers to view banking and other financial account information, often
held at different financial institutions, on a single platform, monitor the per-
formance of their investments in real-time, compare financial and investment
products, and even make payments or execute transactions.26 Applications can
also assist with automatic savings, budget advice, credit decisions, and fraud
and identity theft detection in real-time.27

1.019 In short, digitised record-keeping and its applications have significantly

improved a consumer’s ability to make financial decisions. They have given
rise to a new sector of non-bank financial institutions focused on products and
services using data aggregation, based on data obtained with the consumer’s
consent. Naturally, however, the emergence and growth of such financial

22 IMF, FinTech and Financial Services (June 2017).

23 Ibid.
24 Bernard Marr, The Complete Beginners’ Guide to FinTech Everyone Can Understand (10 February 2017).
25 Ibid.
26 See Letter from the Center for Financial Services Innovation to the Bureau of Consumer Financial
Protection, CFPB-2016-0048 Request for Information Regarding Consumer Access to Financial Records
(21 February 2017).
27 Ibid.

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

institutions raises questions regarding the way in which they operate and are
currently regulated.

3. Artificial intelligence (AI) and big data

Artificial intelligence (AI) and big data can dissect and analyse large databases 1.020
through advanced algorithms to derive patterns used to predict behaviour and
prices, and ultimately even mimic human judgement in automated decisions.
Related applications can automate credit approvals or advice, facilitate regu-
latory compliance and fraud detection, and automate the trading of financial
assets.

Unsurprisingly, a report by the Joint Committee of the European Supervisory 1.021

Authorities has found that big data brings many benefits for the financial
industry and consumers, such as more tailored products and services, improved
fraud analytics or enhanced efficiency of internal organisational procedures.
On the other hand, consumers should be made particularly aware of some of
the risks posed by big data. The risks identified include the potential for errors
in big data tools, which may lead to incorrect decisions being taken by financial
service providers. In addition, the increasing level of segmentation of custom-
ers, enabled by big data, may potentially influence the access to and availability
of certain financial services or products.28

4. Machine learning

A sub-category of AI, machine learning is a method of teaching computers 1.022

to analyse data, learn from it and then make a determination or prediction
regarding new data. Rather than hand-coding a specific set of instructions to
accomplish a particular task, machine learning essentially uses algorithms to
allow a system to learn from data. Machine learning algorithms could be more
accurate than humans in some respects, but their outputs come with limited
reasoning attached.

Institutions and relevant service providers have already started using machine 1.023
learning for a variety of purposes, such as credit scoring, for which machine
learning could improve services and pricing customisation, given its ability to
process significantly larger amounts of data input than classic statistics analy-

28 Joint Committee of the European Supervisory Authorities: Joint Committee Final Report on Big Data (15
March 2018), at 14.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

sis.29 For example, a number of new entrant FinTech firms are capitalising on
this opportunity by leveraging on large amounts of data to produce challenger
credit scoring models that assess creditworthiness faster and supposedly more
accurately, and possibly also in cases where conventional data is not available.30

5. Biometrics

1.024 Biometrics identifies individuals through unique physical characteristics, such

as facial recognition, fingerprint and iris verification, as well as behavioural
patterns, such as voice identification. Biometric authentication gives finan-
cial institutions independence from passwords, PINs, and tokens, which are
susceptible to attack, and can offer significant opportunities, ranging from
security to mobile payment solutions.31 Notably, however, biometrics is not
fool-proof and consequences of any security breach involving biometric infor-
mation are likely to be much more serious than a security breach involving
a password or a PIN.

6. Robo-advice

1.025 Described in more detail in Chapter 16, robo-advice is an online service that
uses algorithms to automatically perform many investment tasks done by
a human financial adviser. Initially offered by start-ups, robo-advice is now
part of the suite of services offered by major financial institutions such as
Vanguard, Schwab and Fidelity.32 Since they are less expensive than a human
adviser, they democratise access to financial advice – they can take on cus-
tomers with few savings since adding one more person will not cost much
more. While an automated advice model could help mitigate some of the risks
associated with human advisers and managing a large salesforce, ultimately the
design of the robo-advice model is crucial and a poorly designed model could
lead to systemic mis-selling. Managing risks is ultimately the responsibility of
the individual firm and its senior management.33

29 European Banking Authority, Report on the Impact of FinTech on Incumbent Credit Institutions’ Business
Models (3 July 2018), ¶ 83.
30 Ibid.
31 Ibid., ¶77.
32 The Rise of the Robo-advisor: How Fintech Is Disrupting Retirement, Knowledge@​Wharton (14 June
2018).
33 See Robo Advice: an FCA Perspective, a speech by Bob Ferguson, Head of Department, Strategy &
Competition Division, Financial Conduct Authority (11 October 2017).

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

7. Blockchain

As described in Chapter 6, blockchain is a unique type of computerised ledger, 1.026

which relies on cryptographic techniques and new methods for consensus to
capture and secure the data. It is designed to be read by a computer, rather than
by the human eye. The following traits characterise blockchain:

● the ledger is shared among and worked on by multiple participants, none of

which has a single point of control over it;
● an ever-growing chain of ledger entries (‘blocks’) links the entire history in
such a way as to prevent tampering with or rewriting past records; and
● digitally signed transactions or instructions indicate intent to record or
modify data, or to transfer digital assets.34
Blockchain technology offers a commonly agreed record of truth to multiple, 1.027
mutually distrusting participants in an economic system. It uses a decentral-
ised, peer-to-peer network comprised of many users, which maintains a ledger
of transactions and relies upon multiple users to confirm the veracity and
authenticity of such transactions using cryptography. Blockchain essentially
provides a ‘record book’ of each component of a transaction and this record
book is maintained and instantaneously authenticated on a network that is
shared between a theoretically infinite number of computers. When all the
members of the network approve a transaction, that transaction is added to the
record book and such a transaction cannot be tampered with or altered.

A research report from Goldman Sachs offers a concise summary, explaining 1.028
the core concept of how the consensus mechanism functions in a blockchain:

(1) It is a database containing transactions between two or more parties,

where the copies of this database are replicated across multiple locations
and computers being the nodes.
(2) This database is made of ‘a chain of blocks’, with each block containing
data such as details of the transaction – the seller, the buyer, the price, the
contract terms and other relevant details.
(3) The transaction information contained in each block is validated by all
nodes in the network via an algorithm called ‘hashing’. The transaction is
valid if the result of hashing is confirmed by all nodes.35

34 Michael Casey et al., The Impact of Blockchain Technology on Finance: A Catalyst for Change, Geneva
Reports on the World Economy (2018), at 1.
35 Goldman Sachs, Blockchain – Putting Theory in Practice (2016), at 8.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

1.029 For most financial data, however, the world still relies on central intermedi-
aries such as banks, accounting firms and governmental entities to create and
maintain centralised, private databases, which keep track of such data and the
transactions they comprise. In many cases, these databases are powered by
obsolete, legacy computer systems that are inefficient, slow, costly and incom-
patible with other legacy systems.36 For most financial institutions, improving
the customer experience has been their number one priority. Unfortunately,
while the vast majority of banks and credit unions aim to compete and win new
business by offering a personalised digital consumer experience, existing bank
infrastructure built on legacy systems may make this difficult.37

1.030 A centralised database managed by one entity is susceptible to cyberattack and

error, and in some parts of the world, is affected by political and state manipu-
lation. Effectively, the central intermediaries, through their own private data-
bases, determine: (i) the status of each transaction; (ii) the ownership of certain
goods; and (iii) the speed at which a transaction is completed.38 By contrast,
the possibility of recording data and transferring value without the mediation
of trusted third parties means that the speed of such matters can be increased,
while the costs are reduced by not just avoiding transaction fees, but also, for
instance, the costs of security, supervision and enforcement.39

1.031 As described in more detail in Chapter 6, most blockchain platforms that are
being developed for use in financial services are ‘permissioned’, both in terms of
who can access the network and who can update it. This means that access to
the network is restricted to a list of known and approved parties, for example,
banks who already trade with each other. The use of permissioned platforms
might be preferable in some cases because financial institutions handle sensi-
tive data and need to know who they are dealing with on the platform. There
are also practical benefits to permissioned networks: If only known and trusted
users are admitted to the network, the consensus mechanism used can be
exponentially faster and more energy- and cost-efficient than in permissionless
systems. Nevertheless, permissioned systems do not achieve the full potential
of decentralisation that can be achieved through permissionless systems.

1.032 Many have recognised potentials of blockchain to, among other things,
enhance transparency and reduce transaction costs by better managing data

36 Ryan Middleton: Why bankers and lawyers need to understand blockchain and smart contracts (15 June
2018).
37 Ibid.
38 Ibid.
39 Ibid.

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

and streamlining processes, improve supply chains, enable the tracking and
management of intellectual property, improve reliability and traceability of
records, reduce speed and cost of settlement, facilitate copyright and patent
protection, and improve efficiency using automated reporting and smart
contracts.

Yet, there are still significant challenges to broad application of blockchain: 1.033

First, performance (particularly transaction capacity and scalability) of block- 1.034

chain is still an issue – no blockchain has yet been able to process billions of
transactions in a second in a way that the current banking payment systems
can.40

Second, there are concerns about privacy and security, with some stakeholders, 1.035
particularly in the law enforcement and regulatory sectors being concerned that
the pseudonymous nature of blockchain-based records obscures the identity of
actors. Moreover, as described in more detail in Chapter 11, the fact that data
once stored on the ledger cannot be erased may be at odds with the ‘right to be
forgotten’ granted in some jurisdictions.

As illustrated in Figure 1.2, design choices made by blockchain developers, 1.036

particularly with respect to the degree of data distribution and decentralisation
of control, often lead to inevitable trade-offs that must be made between
performance, privacy and resilience (i.e., the degree of decentralisation).
Hopefully, future technical advancements will alter these trade-offs.

Third, there are challenges relating to the interoperability: (i) between different 1.037
blockchains, (ii) between applications built on the same blockchains, and (iii)
between blockchain and legacy systems.41 For example, in the potential area of
application for post-trading settlement, it will be important to ensure interop-
erability among the systems of all current market participants (brokers, issuers,
investors, trading venues and financial market infrastructure operators).42

Fourth, there are concerns about the theft or loss of private keys, which allow 1.038
the owners to control their digital assets and, if lost, the owners will lose such
control. Private keys have been stolen in various high profile incidents. For

40 House of Commons Treasury Committee, Crypto-assets, Twenty-Second Report of Session 2017–19

(September 2018), para 22.
41 See, e.g., European Parliament, Distributed Ledger Technologies and Blockchain: Building Trust with
Disintermediation, P8_TA-PROV(2018)0373, para 40.
42 European Central Bank, The potential impact of DLTs on securities post-trading harmonisation and on the
wider EU financial market integration (September 2017).

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

Source: HM Treasury, Financial Conduct Authority and Bank of England: Cryptoassets Taskforce: final
report (October 2018), at 26.

Figure 1.2 Trade-offs in blockchain design

example, hackers managed to steal nearly USD 500 million worth of Bitcoin
from Mt. Gox in 2014 without breaching the Bitcoin blockchain protocol,
which eventually led to the collapse of this Bitcoin exchange.43

1.039 Fifth, as described in more detail in Chapter 9, there are trade-offs relating to
the governance of blockchains, particularly with regard to software updates:
While in a centralised environment, some trusted authority controls much
of the governance of a system and is responsible for software updates, in the
blockchain context, for certain software updates, there must be a consensus
among a distributed network, for which there is no controlling entity.

1.040 Sixth, for blockchain technologies to reach their potential, they must be fully
brought within public policy and legal frameworks. Only with clear rules will
there be broad adoption of blockchain technologies.44

1.041 Seventh, as with the application of other new technologies, firms’ use of block-
chain may also raise a number of competition questions. For example, if a per-
missioned blockchain network developed to become essential infrastructure

43 OICU-IOSCO, supra note 11, at 61.

44 Casey et al., supra note 34, at 10–13.

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 C.  KEY PLAYERS, PRODUCTS AND TRENDS

(for example, in clearing and settlement), there could be competition concerns

around access.45

While it is still early days, several authorities have issued views on blockchain. 1.042
For example:

● In 2016, the French Parliament voted a law (Law n°2016-1691 (art 120)),
which authorised the French government to determine, by an ordinance,
the rules that could allow for the holding and transfer of non-listed securi-
ties via a blockchain system.
● In 2016, Japan enacted amendments to the Payment Services Act, which
came into force on 1 April 2017 and introduced the registration require-
ment for operators of ‘virtual currency exchange businesses’ (defined as
businesses involving the exchange of virtual currency to legal currency or
another virtual currency). In order to prevent money laundering and the
financing of terrorism, a registered operator of a virtual currency exchange
business is required to implement certain identity verification procedures,
among other steps.
● In 2018, 26 EU Member States and Norway agreed to sign a Declaration
creating the European Blockchain Partnership and cooperate in the estab-
lishment of a European Blockchain Services Infrastructure that will support
the delivery of cross-border digital public services, with the highest stand-
ards of security and privacy.46 Further, in 2020, the European Commission
adopted a comprehensive package of legislative proposals for the regulation
of cryptoassets and creating a legal framework for regulatory sandboxes of
financial supervisors in the EU for using blockchains in the trading and
post trading of securities.47
In addition, international organisations such as the International Organization 1.043
of Securities Commissions, the Financial Stability Board, the Bank of
International Settlements, the World Bank Group and the International
Monetary Fund (IMF) are observing the developments of FinTech under
their respective objectives. For example, in October 2018, the World Bank
and the IMF launched the Bali FinTech Agenda, which offers a framework
for the consideration of high-level issues by individual member countries,

45 HM Treasury, Financial Conduct Authority and Bank of England, Cryptoassets Taskforce: Final Report
(October 2018), ¶ 3.12.
46 See Digibyte, European Countries Join Blockchain Partnership (April 2018), available at: https://​ec​.europa​
.eu/​digital​-single​-market/​en/​news/​european​-countries​-join​-blockchain​-partnership.
47 European Commission, Proposal for a Regulation of the European Parliament and of the Council on
Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (24 September 2020).

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

including in their own domestic policy discussions.48 After all, the fast growth
of FinTech products is an international phenomenon and is becoming an
important component of the global financial system. As a result, regulators
and standard-setting bodies are increasingly focusing their efforts on building
a regulatory framework to support these new products, services and processes.

D. HOW SHOULD REGULATORS RESPOND AND WHY SHOULD LAWYERS

CARE ABOUT FINTECH?

1.044 Evidently, FinTech offers wide-ranging opportunities, which national author-

ities are keen to foster. It promises to reduce costs and frictions, increase effi-
ciency and competition, narrow information asymmetry and broaden access to
financial services – especially in low-income countries – although the benefits
of technological change may take time to fully materialise.

1.045 At the same time, however, national authorities are rightly concerned about
potential risks posed to the financial system and to its customers in terms of
consumer protection, the clarity and consistency of regulatory and legal frame-
works, the adequacy of existing financial safety nets, and potential threats to
financial integrity. As technology changes financial service features and market
structure, financial regulation must adapt to remain effective. In turn, regula-
tion could also have an important influence on the development of technology.
The following are some of the key issues that emerge:

1. Distributed ledgers and data privacy

1.046 Spreading data over multiple nodes may facilitate access to private data, which
in turn could violate data protection laws. While many GDPR compliance
issues may be alleviated by a permissioned blockchain, fitting the pre-defined
roles of controller and processor into a decentralised blockchain ecosystem is
far from easy, as described in more detail in Chapter 11.

2. Rules governing ownership and contractual rights and obligations

1.047 Digital transformation of the economy and financial services requires

wide-ranging changes to the regulatory system. For example, there is a need
to modernise regulations for digitally communicating with consumers. Other
regulations that should be implemented are discussed throughout this book

48 The Bali FinTech Agenda, available at: https://​www​.imf​.org/​en/​Publications/​Policy​-Papers/​Issues/​2018/​

10/​11/​pp101118​-bali​-fintech​-agenda.

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 D.  HOW SHOULD REGULATORS RESPOND AND WHY SHOULD LAWYERS CARE?

and include: updating regulations to better facilitate secure access to digitised

data; authentication of digital identity; and support for core financial service
activities such as lending, payments, and investment advice.49

Moreover, DLT records the transfer of ownership of ‘digital tokens’, which are 1.048
essentially units on a ledger. They can either have intrinsic value themselves
(e.g., a ‘native asset’ like Bitcoin), or be digital representations of a physical or
digital asset that exists outside the ledger. The legal status of a digital token
and the legal effect of its transfer are not clear. For example, would the transfer
of an asset-backed token (e.g., representing a security) on a ledger transfer legal
ownership of the security, or would registration outside the ledger (e.g., in
a corporate share registry) still be required? Jurisdictions are trying to develop
answers to these questions but country practices differ, and will therefore
require thought from policymakers.50

3. Regulatory sandboxes

As described in more detail in Chapter 14, regulatory sandboxes are testing 1.049
grounds for innovative products, services and business models that can be
tested without immediately being subject to all of the regulatory requirements.
A regulatory sandbox provides valuable insights to policymakers in under-
standing new technologies and their applications, but is not a substitute for
effective, permanent regulatory frameworks that will eventually need to be put
in place.51 For example, the UK Financial Conduct Authority (FCA), which
was one of the first regulators in the world to introduce a FinTech sandbox,
requires prospective participants to demonstrate that the product: offers
genuine innovation – either ground-breaking or significantly different offering
in the marketplace; creates a measurable benefit to consumers – either direct
or indirect; is intended for the UK financial services market; needs to be tested
in the sandbox alongside the FCA; and is ready to test (e.g., testing plans are
well developed with clear objectives, parameters and success criteria; some
preliminary testing has been concluded to date; the company has the tools

49 Capgemini, supra note 14.

50 International Monetary Fund Staff Discussion Note, Fintech and Financial Services: Initial Considerations,
SDN/17/05 (June 2017), at 17. See also The UK Law Tech Delivery Panel, Legal statement on cryptoassets
and smart contracts (November 2019), helpfully clarifying that, under English law, cryptoasset constitutes
property and, specifically, either a thing in action in the broader sense, or alternatively, it falls within the third
category of personal property of being neither a thing in possession nor a thing in action.
51 International Monetary Fund Staff Discussion Note, Fintech and Financial Services: Initial Considerations,
SDN/17/05 (June 2017), at 17.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

and resources required to enable testing in the sandbox; and the company has
sufficient safeguards in place to protect consumers).52

1.050 Arguably, the greatest tangible benefits to sandbox firms are contacts with the
regulator and the credibility that the participation in the regulator’s sandbox
gives them vis-à-vis customers and financiers. On the flipside, one might
argue that regulatory sandboxes create a ‘two-tier’ system of start-ups, where
those that are selected in the sandbox are given a (possibly unfair) advantage.
Moreover, one could also question if regulators have the requisite skillset to
determine whether a business concept is innovative. Rather than imitating
the model of corporate innovation accelerators, regulators may instead want
to engage in a more open dialogue with all (or at least a less exclusive group)
of innovative start-ups that need assistance navigating the maze of regulatory
requirements. This is partly achieved through ‘innovation hubs’. These are
essentially schemes set up by competent authorities to enable firms to engage
with the authorities on FinTech-related issues and seek clarification on licens-
ing and regulatory requirements.

1.051 In China, which has quite a permissive regulatory framework and therefore,
arguably, does not need a regulatory sandbox approach, authorities have
introduced a range of regulatory pilot projects tied to liberalising the country’s
financial markets and improving financial access. For example, the China
Insurance Regulatory Commission (CIRC), the country’s insurance regulator,
introduced a two-year pilot project designed to give insurance companies
the regulatory room to offer services and products across city and state lines.
The pilot illustrates the regulator’s attempt to test-run regulatory innovations
within a controlled setting.53

4. RegTech

1.052 As described in Chapter 12, RegTech is generally defined as the adoption of

new technologies to facilitate more efficient and effective delivery of regulatory
requirements. Over the past ten years, financial institutions have faced an
ever-increasing regulatory burden. The cost of compliance has skyrocketed

52 See FCA, Applying to the Regulatory Sandbox, available at: https://​ www​ .fca​
.org​
.uk/​
firms/​
regulatory​
-sandbox/​prepare​-application; see also FCA, Regulatory Sandbox Lessons Learned Report (October 2017),
available at: https://​www​.fca​.org​.uk/​publication/​research​-and​-data/​regulatory​-sandbox​-lessons​-learned​
-report​.pdf.
53 See, e.g., China, Pilot programme for insurance company and agency cross-regional business, available at:
https://​www​.lloyds​.com/​market​-resources/​market​-communications/​regulatory​-communications/​regulatory​
-communications/​regulatory​-news​-articles/​2017/​03/​china​-pilot​-programme​-for​-insurance​-company​-and​
-agency​-crossregional​-business, and Brummer and Yadav, supra note 9, at 46–7.

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 D.  HOW SHOULD REGULATORS RESPOND AND WHY SHOULD LAWYERS CARE?

for many financial institutions, particularly global institutions needing to

comply with regulatory requirements across jurisdictions (particularly since
the introduction of such financial regulations as GDPR, PSD2, the Markets
in Financial Instruments Directive II/Markets in Financial Instruments
Regulation).54

Most existing RegTech solutions operate along one or both of these dimen- 1.053
sions: reducing the cost of compliance via automation, or leveraging technology
to increase the effectiveness of compliance (e.g., by accessing broader data sets
or employing better data analytics). According to the Institute of International
Finance, this wave of RegTech innovation ‘stands out from other software
solutions by linking advanced models and algorithms, machine learning and
advanced analytics, and real-time capabilities’.55 Moreover, unlike FinTech’s
inherently financial focus, RegTech’s applications span many regulatory
contexts, including monitoring companies’ compliance with environmental
regulations and real-time tracking of the location of airlines, to name but two
simple examples of how technology could be used to improve not only regula-
tion but also the regulated industry itself.56

In addition to helping companies with their compliance processes, RegTech 1.054

solutions can also help regulators explore leveraging new compliance software
and surveillance tools to evaluate compliance with regulatory requirements.
Increasingly, regulators are also starting to embrace the notion that block-
chain has wider applications than cryptocurrencies, including the potential to
provide greater transparency, innovative ways to solve problems and increased
access for citizens. Particular areas of regulatory focus include developing new
ways to manage and track physical and digital assets, record internal transac-
tions and verify identities.

Excessive or indiscriminate reliance on RegTech solutions may, however, 1.055

create new problems and could potentially cause system-wide disruptions. For
example, if multiple financial institutions rely on a single firm providing such
solutions or on a single regulator to aggregate the data, this entity could be
subject to a cyberattack or a malfunctioning of the underlying technology.57

54 KPMG, The Pulse of FinTech 2018, Biannual global analysis of investment in fintech (July 2018), at 6.
55 Institute of International Finance, RegTech: Exploring Solutions to Regulatory Challenges, 29 October
2015, available at: https://​www​.iif​.com/​topics/​regtech/​regtech​-exploring​-solutions​-regulatory​-challenges.
56 Arner et al., supra note 3, at 10.
57 International Monetary Fund Staff Discussion Note, Fintech and Financial Services: Initial Considerations,
SDN/17/05 (June 2017), at 18.

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 Chapter 1 INTRODUCTION – WHAT IS FINTECH?

1.056 In sum, the pace of technological development and its applications to financial
services have increased dramatically. It is critical that financial regulators stay
abreast of developments and establish mechanisms for adopting appropriate
regulation and guidance accordingly without stifling innovations that require
time to mature. Regulators must be more agile than in the past in order to
successfully uphold their missions without creating unnecessary barriers to
innovation. This requires principles- and performance-based regulation that
enables the private sector to adopt innovative, technology-based compliance
solutions.58 The right regulation promotes stability, protects consumers and
fosters competition, thereby supporting entrepreneurs and innovators, while
at the same time giving consumers confidence, trust and encouragement to try
new products and services.59

1.057 As FinTech continues to blossom, its impact will arguably creep into various
legal disciplines, just as the internet became an integral part of the modern-day
law practice. As is happening now, more and more clients will demand sophis-
ticated legal advice related to their complex use of FinTech products to evolve
their businesses.60 Moreover, as described in Chapter 18, it is quite possible
that the software and database tools that lawyers use in their practices will
incorporate blockchain technology, so the way that legal services are provided
will inevitably change. For example, drafting of contracts with a simple ‘if
this, then that’ logic may be somewhat displaced by blockchain-based smart
contracts. In addition, lawyers may soon be confronted with more clients with
issues arising from the use of blockchain. The creation of courts such as the
Intellectual Property Enterprise Court and the Technology and Construction
Court, both in the UK, demonstrates the need for lawyers with specialist
knowledge to respond to the growing number of technology-related disputes.61

1.058 Finally, as described in Chapter 19, lawyers will likely be required to work
more closely with technologists and/or have some basic understanding of pro-
gramming skills in order to be able to verify that contractual terms expressed
in a computer code accurately reflect the natural language contract. This trend
is already evident with law firms around the globe developing innovation labs

58 US Department of the Treasury, A Financial System That Creates Economic Opportunities: Nonbank
Financial, Fintech, and Innovation (July 2018), at 170–71.
59 Mutton, supra note 15.
60 International Bar Associate Legal Policy & Research Unit Legal Paper, Rule of Law Versus Rule of Code:
A Blockchain-Driven Legal World (November 2017), at 42.
61 Ibid., at 38.

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 E.  CONCLUSION

and in-house technology for the legal sector in order to boost their competitive
advantage against other firms.62

E. CONCLUSION

There is a lot of hubris when it comes to FinTech. After all, it erodes inter- 1.059
mediation and financial supply chains, introduces a cast of new characters and
leaves familiar financial functions to be performed by sophisticated algorithms.
Advocates believe that FinTech will fundamentally change and improve
finance. One very obvious improvement, which every industry disrupted by
technology has seen, is the lowering of costs and enhancement of services.
The other improvement that we are likely to see is better, data-driven decision
making. Technology companies are able to identify better loan prospects based
on algorithms driven by millions of data points. This is effectively able to
overcome human bias and prejudice.

FinTech is still in its nascent stages, however. The disruptions caused by 1.060
FinTech in the banking and finance sector pose a substantial risk to incumbent
banking and finance service providers, but where there is risk there are also
opportunities. The way regulators respond will have a significant impact on the
shape of FinTech in the years ahead. In-house legal departments will need to
cast a gimlet eye on the intricate requirements and jurisprudential uncertainty
that attend this infant dynamic. The industry is changing rapidly, and shrewd
businesses and lawyers alike will want to remain informed in order to stay at
the forefront of their markets. Those that do not will lose out on opportunities,
customers and market share.

62 See, e.g., Allen & Overy, Second Group of Tech Companies Confirmed to Join Fuse in May (April 2018),
available at: https://​www​.allenovery​.com/​en​-gb/​global/​news​-and​-insights/​news/​second​-group​-of​-tech​
-companies​-confirmed​-to​-join​-fuse​-in​-may.

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