How are banks future-proofing themselves?, The race for central bank digital currencies, Which tech is transforming Insurance? --Autonomous ?NEXT #154

Hello and welcome to Fintech Focus --

It's good to be back after a month away. We are busy attending the DeFi Summitin London, if you are there be sure to say hi. As always, we would like to remind you that should you ever wish to refer back to previous newsletter entries, you can find them on our website HERE.

If you have any questions, comments, or suggestions regarding the content and/or structure of the newsletter, feel free to reach out to me directly on LinkedIn, Twitter, or via my email. I look forward to hearing from you.

Our top 3 thoughts for this week are:

1. ONLINE BANK: Just how are the US incumbent banks using Fintech to future-proof themselves? 
2. CRYPTOCURRENCY: The race for Central Bank Digital Currencies is more heated than you may think
3. INSURTECH: Breaking down how technology seeks to transform the $5 Trillion Insurance industry

Our artist of the week is Andy Bauch's 'Dogecoin initially valued at $10'. This piece forms part of a collection merging art and crypto with works using abstract patterns constructed in Lego. Each piece visually represents the private key to a crypto-wallet, and anyone can steal that digital cash—if you can decode them.

ONLINE BANK: Just how are US incumbent banks using Fintech to future-proof themselves?

It's without a doubt that the global banking industry is undergoing a digital renaissance. Digitally native neobanks are serving customers at a third of the cost of incumbent banks, leveraging modern core technology architectures to innovate faster and operate more efficiently, and earning them a significant chunk of market share. Fintech companies are building solutions around lucrative niches in the value chain. A good example of this is payments unicorn Stripe, valued at a cool $22 Billion, recently announcing it will be offering loans to online businesses to support their growth ambitions. In contrast, incumbents are subjected to the limitations of their core architectures and the resultant slow rate of change to innovate and adopt operational efficiencies necessary to retain their market share.

In the US, incumbent banks are actively investing in Fintech companies as a means to "future-proof" themselves. By "future-proof" we mean three things: (1) increasing the potential for high returns in the short-to-medium term leveraging the benefits stated above -- take Goldman Sach's investment in digital lender Better Mortgage. (2) Gain exposure to emerging sub-industries, as well as, utilize new Fintech platforms to enable rapid scaling and less expensive development of ecosystems and ancillary services -- take Wells Fargo's investment in OpenFin, who is now used to help modernize the bank's software for front-and-back-office functions. (3) Lastly, reduce spending on IT by leveraging the structures of Fintech companies such as the removal of technical debt, leveraging the economies of scale of cloud-based services, and using development tools that support automation (DevSecOps).

We recently came across CB Insights' latest Fintech trends report which notes that in 2019 YTD, US banks have participated in 24 equity deals to Fintech companies -- approximately 54% of the record 45 deals in 2018. Unsurprisingly, Goldman Sachs, Citigroup, and JP Morgan Chase were noted to be the most active US incumbent bank investors in Fintech. Since 2016, Goldman Sachs has primarily invested in Real estate and data analytics Fintech companies which compliments their current strategy, Citigroup has focused on payments & settlements and Blockchain Fintechs providing evidence of a potential Banking-as-a-service platform in the near future, and lastly JP Morgan Chase has prioritized investment in capital markets and accounting & tax Fintechs in hopes of strengthening its payments play.

For those incumbents averse to Fintech partnerships, McKinsey outlines three options for replacing the core to their next generation platform. The costliest ($100M to $500M+) and most time consuming option being a full replacement of the core with "new" traditional tech platforms. Opposite to this is the cheapest ($50M to $100M) and arguably the most value-add option of migrating the bank's core onto a "greenfield" tech stack -- essentially a modular and API-first cloud-native architecture. RBS' Bó, National Australia Bank's launch of unsecured lending solution QuickBiz, and Goldman Sach's Marcus are all examples of the greenfield approach. As noted by the Economist Intelligence Unit, the greenfield approach was considered the most sought after bank innovation strategy by 36% of the 400 banking respondents, a close second was to invest in Fintech start-ups with 31%. 

We have noted it before and we will note it again, greenhouse approaches are only effective when the incumbent acknowledges digital as more of a transformation strategy than a channel -- case in point is JP Morgan Chase's failed digital bank Finn. The financial initiatives of Chinese tech companies such as Alibaba and Tencent, for example, serve as a powerful representation of how a core tech chassis serving e-commerce can translate to the physical world leveraging a digital value proposition across its front, middle and back ends. This is why we still believe to see more Fintech mergers and acquisitions beyond the current industry aggregate deal value for 2019 -- more than twice the aggregate of the same period in 2018.

Source: CB Insights (Fintech Report Q2 2019), McKinsey (Next-generation core banking platforms: A golden ticket?), The Economist Intelligence Unit (A whole new world: how technology is driving the evolution of intelligent banking)

CRYPTOCURRENCY: The race for Central Bank Digital Currencies is more heated than you may think

While we were away, the month of August saw some significant announcements in the realm of international cryptocurrencies -- whether it was Binance launching their stablecoin project: Venus, Walmart developing its own Blockchain, Telegram launching its Gram cryptocurrency, and Japanese e-commerce giant Rakuten unveiling its digital currency exchange, these all instantiated the notion that cryptocurrency is rapidly progressing. Additionally, the continuation of the debate amongst regulators over whether stablecoin project Libra ("Facebook's" cryptocurrency) should become the holy grail to banking the unbanked globally. However, as you may recall earlier this year France's finance minister, Bruno Le Maire, stressing that “it is out of question’’ that Libra be allowed to “become a sovereign currency. It can’t and it must not happen.”

What has happened since the launch of Libra, is the warming of Central Banks, once thought to be antagonists of cryptocurrencies, into the crypto fray, with several announcing that they are exploring or experimenting with Distributed Ledger Technology (DLT), and the prospect of central bank crypto- or digital currencies is attracting considerable attention. This is, in part, fueled by the the underlying motivation for issuance (e.g. decline in the use of cash), possible design features (e.g. 24/7 availability, anonymity) and to some extent technical experimentation (involving DLT). Similarly, concerns regarding CBDCs are focused around the fundamental impact they could have on the current financial ecosystem, ultimately questioning the role of banks in financing economic activities, and making their issuance unlikely in the short run.

The People’s Bank of China (PBoC) recently announced that it was placing the finishing touches on its very own CBDC, placing it at the forefront of 44 other central banks who are researching the issuance of a CBDC. Some examples of CBDCs already under development include: Dubai’s emCash, The Bank of Thailand’s Project Inthanon, The Bank of Lithuania’s Digital Collector Coin, The UAE Central Bank and The Saudi Arabian Monetary Authority’s Project Aber, The Marshall Island’s Sovereign (SOV), The Central Bank of Iran’s Crypto-Rial, Uruguay’s e-peso, and The Swedish Riksbank’s e-Krona. According to a report by the Bank for International Settlements (BIS) Central Banks are also increasingly collaborating with each other to carry out proof-of-concept work. Collaborations include Project Stella by the ECB and the Bank of Japan, as well as a joint project by the Bank of Canada (BoC), the Monetary Authority of Singapore (MAS) and the Bank of England (BoE).

Question is, do we really need a CBDC? To answer this it is important to note that CBDCs are predominantly digital twin of traditional printed fiat currency, and are therefore to be fully regulated by the state and not decentralized. Given this, CBDCs hold two notable benefits: (1) they alleviate the costs related to printing fiat currency, maintaining its usability and security, providing infrastructure to store and move it, and distributing it. (2) CBDCs improve overall accessibility and usability of currency, this is because printed fiat currency imposes large costs on those that wish to use it -- whether its making a cash deposit into a bank account (requiring access to ATMs or branches) or safekeeping large amounts of it (requiring a secure storage mechanism i.e. a safe). Realistically, such use cases only speak to states in which the use of printed fiat currency is high, and thus the cost benefits of introducing a digital currency are significantly high i.e. Emerging Market Economies (EMEs).

The BIS report does a great job to sum up the current state of CBDC projects, noting that "At this stage, most central banks appear to have clarified the challenges of launching a CBDC but they are not yet convinced that the benefits will outweigh the costs. Those that do see clear benefits are predominantly from EME jurisdictions. This seems to be because financial inclusion projects create a clear mandate for central bank action, and a lack of current infrastructure limits the disruption a CBDC could create while simultaneously encouraging the use of new technology." Whilst a CBDC provides users with less costs incurred to use and store paper fiat currency, it will also mean a reduction in deposits with commercial banks. In turn, the resultant competition for deposits among such banks will likely increase deposit rates, driving new innovations to encourage saving and borrowing behavior -- which is good!

Source: Bank for International Settlements (Proceed with caution - a survey on central bank digital currency)

INSURTECH: Breaking down how technology seeks to transform the $5 Trillion Insurance industry

When it comes to insurance, the $5 Trillion global industry is often deemed to be a slow-moving conservative sector resistant to change. Innovation is thought to be achieved by merely repackaging existing products into flavorsome marketing wrappers with re-bundled cost structures. Breaking down the variables that impact the need for change such as changing demographics and consumer behavior, enhanced connectedness through digital mediums, the emergence of the shared economy, and shift from asset ownership into renting or fractal ownership, we see a profound effect on the sector as a whole. These variables are enabled by the likes of artificial intelligence (AI) applications, internet of things (IoT) ecosystems, and decentralized ledger technologies (DLT) which help accelerate the insurance sector to respond to new trends, the streamlining of operations, reduction in costs, creation of new revenue models and evolution in innovative products and solutions across the value chain. Let's take a look at some examples.

The core to any insurance product is the back-office process of underwriting, which is leveraging AI to extract insights from various data sources, using IoT devices as the collection mediums, and cloud infrastructure to instantaneously update data to models used to improve risk profiling and thus pricing. US-based Flyreel developed an AI-enabled underwriting system replacing the need for professional insurance inspections. It achieves this via an app on a mobile device which is used to scan a property. The image content is then run through computer vision algorithms to automatically identify items relevant to the customer's policy, enabling property owners to improve underwriting efficiency. Very cool.

The reduction in fraudulent claims losses -- estimated to run the US $80 billion per year -- and improving claim settlement efficiency are crucial areas in which technology is sought to address. Inscribe.ai is a San Francisco-based fraud documents detection platform that uses a combination of natural language processing (NLP) and computer vision to scan documents to identify fraudulent claims. In terms of improving claim settlement efficiency, State Farm is testing a permissioned DLT powered by smart contracts in auto claims subrogation -- a process by which insurers settle claims losses amongst each other -- to significantly speed up the process with immediate automatic payment disbursement as soon as liability determination is completed. 

Lastly, a combination of DLTs, advanced driver-assisted systems (ADAS) or other telematics installed in consumer's vehicles to collect real-time data on driver behavior and driving patterns have been essential to create more accurate real-time dynamic risk assessments and pricing models. These include pay-as-you-drive (PAYD), pay-how-you-drive (PHYD), and on-demand just-in-time insurance pricing models, spearheaded by insurers such as Cuvva, Trōv, Metromile, Insure the box, Root Insurance. On the topic of auto insurance we would be remiss if we ignored self-driving cars. Although the argument is that such vehicles will potentially reduce insurance premiums by 85-90%, new risks such as software and hardware failure, as well as cyber attack will play a major part in formulation of new premiums. Needless to say that startups such as Avinew are already offering policies to cover semi autonomous vehicles using telematics, AI, and machine learning to help build comprehensive risk assessments and policy pricing models.

It is without a doubt that not that far in the future, we will see the emergence of decentralized autonomous insurance organisations that will leverage IoT, AI, and DLTs to enable Peer-To-Peer (P2P) insurance and eliminate the need for middle men. We will see a state of the industry in which customer engagement, policy underwriting, claim filing, inspection, claim settlement, payments are customized and fully automated. And we cannot wait.

Source: Flyreel, Forbes (State Farm And USAA See Stark Increase In Efficiency When Testing Blockchain Subrogation), Trōv, Insure the box, Avinew

FURTHER READING:

• Numerai’s prediction marketplace Erasure arrives on Ethereum
• Four Out of Five Top Bitcoin QR Code Generators are Scams: Report
• Hybrid Security Tokens – What are they and What are they not?
• Brazil’s leading payment processor begins accepting bitcoin

• European banking app Monese partners with deposits marketplace Raisin
• That Apple Card may not be as private as you think
• Digital banks on track to treble customers in next year but profits remain elusive

• WeChat restricts controversial video face-swapping app Zao, citing “security risks”
• Facebook teams up with Microsoft and MIT to fight deepfakes
• Fighting Chinese Artificial Intelligence with lasers and American Crypto with European Central Banks
• This is Your Brain on Neuralink

• Beware of hidden fund mgt businesses from Big Tech companies
• AlgoTrader and Avaloq team up for digital asset management push
• Migrating market data to the cloud

• Is Virtual Reality the Future of Democracy?
• iOS 13 Code Suggests Apple Testing AR Headset With 'StarBoard' Mode, 'Garta' Codename
• North Focals add tighter Android notification integration

We put this together at Autonomous NEXT, where we love Fintech, Crypto and our community. Contact us with questions and ideas.

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Thanks for reading!  

Best,

Matt