FinTech Knowhow #1
Last week saw significant steps taken by the FCA, who have established a firmer stance on the regulation of cryptoassets in UK markets. In late July, the SEC approved a regulated token offering for the first time. These are two simple examples of big shifts in the world of cryptoassets, feeding into one of the current buzzwords of corporate practice: FinTech.
Most readers will know that FinTech is the Financial Technology used in the financing sector, and that this ranges from instantaneous communication tools to complex intangible assets such as cryptocurrencies. We can all have a vague, abstract understanding of transformative technology changing the landscape in legal practice and financial markets. But do we really have any idea what we’re talking about? Students are often duped into dropping blockchain into conversation as a term they think makes them look informed and up-to-date, without really having any conceivable knowledge of the technology they’re discussing. Whilst I wouldn’t expect most readers to be able to code these constructs for themselves, having a basic awareness of how relevant technology works will help to think through any associated problems with development, application and regulation of FinTech, whether academically or in practice.
This is going to be the first in a short series of blogs building up some basic FinTech knowledge and following current FinTech trends. The aim is not to spoon-feed readers. Instead, hopefully this can be a platform from which to gain the basic information needed to more easily facilitate independent investigation and touch on some of the most current FinTech applications, controversies and developments, whether you’re a FinTech beginner, or would consider yourself fairly fluent in this area of law and commerce.
Defining FinTech: Distinguishing AI and Blockchain
Blockchain and AI form the two main pillars of FinTech development. They’re on the lips of lawyers, politicians, academics, bankers, insurers, investors and innovative start-up leaders. We see AI in every spell check, Google search and Amazon purchase. We see blockchain increasingly in contract law, asset migration and the development of new, intangible assets. FinTech feels like the latest zenith of financial development, whilst also central to our abilities to work efficiently and effectively at almost any task we undertake.
AI and blockchain can easily be confused. AI speeds up that which humans have historically done in its ability to learn from ongoing patterns and identify anomalies. This manifests itself in familiar but fundamental ways: spell-check, in-document word search, predictive text, search analytics. We take these things for granted, but technological progression has transformed legal practice and the corporate industry. Take due diligence tasks, for example. The digitalisation of documents and development of AI allows for relevant information to be found much more quickly, by far fewer humans, than has traditionally been the case. Searches are increasingly international, as documents from across the globe can be stored in data rooms and accessed in a matter of seconds, improving efficiency, accuracy and cross-border advising.
Blockchain is a kind of Distributed Leger Technology (DLT). A ledger is a record book, and that’s what blockchain offers, at a very basic level – a transparent, immutable, unchangeable open book of every decision made in relation to a specific subject matter. Whilst, like AI, there is an input of information, blockchain takes that information and rather than merely report on it, the technology acts on it. Blockchain works on a very simple ‘when X then Y’ formula so that when certain events occur, there is an automatic action which is triggered by the technology, independently of human action. For example, insurance and compensation contracts are increasingly using blockchain-based smart contracts to orchestrate automatic, independent deposit of compensation to customer accounts where flights are delayed beyond a certain time limit.
AI isn’t being replaced by blockchain. These two technologies have different functions, applications, and work in different ways.
Explaining FinTech: How do these technologies work?
Unless this is your specific area of expertise, I wouldn’t expect readers to know the intricate details of how this technology is able to function. For example, I can’t code and, whilst I’m sure it may be a useful skill, especially if smart contracts continue to take off, I wouldn’t consider it necessary right at this moment for readers. Rather than being able to produce this technology, I would suggest that having a basic understanding will be sufficient. This will help a lot when it comes to discussing applications, benefits and concerns of these two technologies.
Most users are sufficiently familiar with AI to know that once it has been sufficiently programmed and ‘trained,’ software will analyse data it is given and highlight any discrepancies. This is a simplistic summary, but it’s all we need right now. Blockchain is different and often less understood. Since it reaches a judgment, there has to be a mechanism by which to make a decision, rather than simply report objective reality. The process is outlined below in the context of a transfer of cryptoassets.
Image: Financial Times
Remember that a blockchain is an open record book of decisions. Working off the diagram above, if A wants to send B some cryptoassets on a blockchain platform, the transaction is represented as a ‘block.’ To be legitimate, a series of ‘nodes’ – computers which form a network, often across the globe – need to approve that transaction. Once a majority of the nodes have assented that the transfer is legitimate and has happened, it is added to a chain of transactions – hence, it’s a chain of blocks, a blockchain. Once the ledger is updated, the transaction is complete and the cryptoasset is transferred.
If we take the earlier example of a smart contract automatically executing upon a delayed flight, we see the same pattern. Where a provision in a smart contract allows for this automated compensation, if the flight is delayed beyond a certain time and this is verified by majority consensus, money will be transferred to the delayed flight passenger.
Agreed condition - Event - Majority Consensus - Update to Ledger
I personally quite like a visual image and the clearest blockchain explanation which has resonated with me went something like this… Imagine if five people (A, B, C, D and E) live on a desert island where rocks are currency. Each of the five members of the island community has a mental register of which rocks belong to which people. Let’s say that one day A decides to buy C’s guitar for ten rocks. Each of the people on the island are called together as C passes over his guitar and A outlines which rocks now belong to C, as a result of the exchange. If a majority of the five people on the island are happy with the transfer, it can be added to a record. Each of the five people will update their mental register of who owns what, following the new piece of information they have received. Only then is the transfer complete.
If this isn’t clear, definitely check out videos and other blogs, there are lots of resources to help you understand the basic gist of how blockchain works and I promise it’s not complicated once you get into the swing of it. The key aspects to remember are that:
Blockchain reaches decisions in a decentralised manner – since there is no central authority, there has to be a consensus mechanism to make a judgment.
Blockchain works on majority rule.
Blockchain takes the occurrence of events and turns this into automatic execution of events in an‘if X then Y’ manner.
Describing FinTech: How are these technologies applied?
Since AI and blockchain are fundamentally different, we can expect them to have different uses and roles. That’s not to say that there aren’t some hefty areas of overlap between the two. Both intend to improve efficiency, for example. AI does this by reducing the work a human has to do in any given matter. A variety of applications of AI have already been referred to throughout this essay,
AI isn’t just being used by law firms, however. Look at double- and multi-sided platforms like Google or Amazon; these firms utilise AI to analyse the huge caches of data they collect (dubbed the ‘new oil’ in the current market) and observe through movement on their sites. As data becomes of increasing value, this technology increasingly fuels business models. A site like Amazon can monitor how long your mouse hovers over a prospective product, previous purchases, repeated or similar product searches and much more. This information then feeds into Amazon’s business strategy for what products it sources to sell, and what it produces in its ‘Amazon Basics’ range. The allegation goes that this could potentially be anticompetitive. More will be written on this in future blogs, but if you’re interested in further reading, Lina Kahn is currently the face of academic writings on Amazon in the US context. For an EU perspective, a good place to start for Amazon-specific content are reports by or about the Bundeskartellamt (the German competition law authorities), which has already conducted preliminary investigations into Amazon.
Blockchain gains attention as the technology supporting cryptoassets such as Bitcoin. It is also the technology which fuels smart contracts. These are each relatively simple applications to understand, with much available material online to further your curiosity and understanding. These are also two areas which have attracted a lot of attention as concerns regulation. States are increasingly firming up their positions on whether DLT-based transactions are legally binding, and the legal certainty around cryptoassets. We’ll look more at regulation of Fintech in a future blog, but for those interested, you can look at recent FCA publications for a UK position, SEC decisions for a US perspective, works by and for the EU Blockchain Observatory for the EU approach and specific legislation such as the relatively recent Italian Law No 12/2019 which has been one of the first to define and give legal effect to DLT-based agreements such as smart contracts. Much regulation you’ll find is a working progress but is steadily emerging.
Other applications being explored, or in place, include:
Supply chain auditing
Governance (for example, the Boardroomapp)
Land title transfer
Academics are discussing blockchain in areas as far from corporate law as citizenship, so this technology really has permeated deep into the profession and spread across a variety of practice and research areas. Wherever your interest is, you’re almost certain to come across FinTech in some capacity of practice and academia over the coming years.
Researching Fintech: Good sources to follow independently
Some of the best ways I have found to stay up-to-date with FinTech developments and learn more are:
Linklaters FinTech Blog(UK and US updates)
Cleary Gottlieb FinTech Blog(predominantly US updates)
ScienceDirect.com – this one perhaps seems rogue, but the site offers a real range of up-to-date research articles on technology. It can be more academic in nature, but articles are typically short, accessible and specific.