Fintech innovation has continued apace over the last year across multiple fronts. As one lawyer told us: “The nature of fintech work is quick, with hot topics of the month.” Below, we identify the key topics in the fintech market. The technology that has taken centre stage is blockchain, with its immensely diverse range of applications for the corporate world. Despite, and perhaps because of, its versatility, it has run up against challenges in implementation, and as such has some practitioners questioning whether the bubble will burst in the near future, should these challenges continue. Elsewhere, PSD2, also known as open banking legislation, came into effect at the beginning of the year, and the payment service data it provides offers the tantalising prospect of an explosion in retail banking innovation in Europe and beyond. Finally, the prominence of new AI technologies and digital currencies or “tokens” cannot be ignored in the fintech space.
One of the major trends highlighted by fintech practitioners across the world this year is “the rise of private blockchains” used by corporate clients, which is attracting significant investment. This has reached to the point where “blockchain seems to be overshadowing fintech work”.
There are three primary types of blockchain in use in the market today. The first is “public blockchain”, the original variant of this technology. Public blockchains operate on P2P networks, which simply means that any computer with an internet connection can act as a virtual leger for any data a corporate entity wants to store. The public blockchain rose to fame as the network of choice for virtual currencies like bitcoin.
At the other end of the blockchain spectrum there are private blockchains, now popular among corporates. This takes the fundamental concept of public blockchains but closes the network to only selected members under the control of a single entity. Many therefore question the viability of private blockchains, for the security offered by blockchain networks comes from the anonymity and the low network-density of public blockchains, whereby even if one member’s ledger is compromised many others are still safe. If a single member of a private blockchain has their ledger compromised, the entire network is also effectively compromised. As such, some implementations of blockchain technology that run on purely private networks have been criticised as neutering the security benefits of the original technology.
This criticism has given way to a middle way: the “consortium blockchain”. This network structure is still essentially a private network controlled by a single actor, but it ensures that more than one corporate entity is part of the network and stores the information of others. It is this type of private blockchain that is beginning to feature in supply chain technologies and finance projects.
Nonetheless, there is a clear tone of scepticism surrounding the real-world applications of blockchain technology. Some sources report that “we are going to see again what happened back in the dotcom bubble, as blockchain has been hugely hyped and attracted a lot of investment”, with many pilot projects in progress. However, sources told us that these pilots “are not being scaled up into large projects”, which indicate a lack of commercial viability at present. This has led some to predict that “in 2019 a lot of blockchain projects will be shut down” as the bubble surrounding it bursts. Whether this comes to pass remains to be seen.
Virtual currencies such a bitcoin and ethereum have featured prominently in financial news cycles in recent years, largely because of their volatile market values. At the time of writing in November 2018, the price of bitcoin is a mere 21 per cent of its value in December 2017 (a figure that will no doubt be outdated within days of publication). However, this has not deterred investors totally from digital currencies. Practitioners report that “financial institutions, telecoms companies and start-up clients are all handling some kind of virtual currency”. In particular, there appears to be “a lot of clients interested in setting up digital token exchanges”, as well as “a big trend in the asset tokenisation of gold and other precious metals”. For example, sources told us that “a number of fund managers are looking for advise on digital tokens; instead of selling units in their fund they are selling tokens that represent these units”.
Perhaps unsurprisingly, this poses a number of interesting regulatory questions. Most jurisdictions have not yet developed laws that account for digital tokens. Legislatures have been scrambling to amend anti-money laundering legislation to include digital tokens – the EU did so in early 2018 by amending Directive 2009 to include “virtual currencies”. However, other governments have not been as quick to follow, leaving significant loopholes in countries such as Singapore, for example, where there are no “know your customer” laws in relation to digital tokens as of yet. This has made the virtual currency market a fast-moving and changeable one to operate in and advise on, and in such a market “lawyers add value in trying to predict what regulators will make a priority and making clients aware of the risks”.
Away from digital currencies, AI technology continues to be implemented in a variety of fascinating ways within the financial services industry as it becomes more sophisticated. Sources reported increased used of deep-learning AI technology to provide highly accurate market predictions and optimise investments across a huge variety of markets. However, there have been several notable false-starts for AI as well. After little over a year, UBS decided to shelve its “SmartWealth” AI adviser for clients outside the high-net worth band, with the explanation that its “near-term potential was limited”. It remains clear that AI will form an important part of the future, but there may be a few backward steps along the way.
On 13 January 2018, the EU’s Second Payment Services Directive (PSD2) or Open Banking Directive came into force across Europe. This directive was designed to promote competition and transparency among payment service providers, which will hopefully foster innovation in an industry dominated by large retail banks. The practical effect of this has seen retail banks have to organise their payment service data into a universal format and make it accessible to authorised third parties in the market. Many fintech practitioners have highlighted open banking as the source of the next wave of digital banking innovation, with “lots of clients taking forward open banking projects” and applying to bodies such as the UK’s Financial Conduct Authority for access to this data. It is, after all, with such open-source data that companies like Uber have managed to disrupt traditional industries. This presents significant challenges to the established retail banks, as their profit margins are eaten into by new companies that offer cheaper, faster and more convenient payment service technologies. However, the exact form these projects will take is unclear: it is such a wealth of information that it will take some time for innovators to identify where to make inroads.
As illustrated above, the fintech sector is seeing several different technologies developing rapidly across the international market. As a result of this, sources report that “the legal market is quite fragmented, to the point where you do not see people practising across all these technologies”. Furthermore, such is the hype surrounding fintech and the rapid proliferation of players in the market, that law firms are rushing to establish fintech practices. Some specialists note that this has led to “more and more firms are saying that they have fintech teams, but this is usually a marketing device”. It is also stressed that one firm’s fintech practice may not fit all types of clients and their needs, as the needs of large corporate banks and start-ups in the space are very different, as are the legal and commercial challenges they face. Therefore, those looking for legal advice in the fintech world need to be discerning when it comes to choosing who advises them. To that end, it has become noticeable that some law firms are establishing fintech funds in order to meet the demand in the market.
As the year draws to a close, legislators, legal specialists and market players of all sizes wait to see what innovations and opportunities open banking gives life to. It is no exaggeration to state that the way consumers handle their money may be about to fundamentally change as a result of this legislation. Given the hot-topic nature of current fintech practice, activity will probably rotate between technologies such as blockchain, various forms of AI and tokenisation. As far as the legal market goes, it seems that as the fintech sector becomes more established, law firms will assign more expertise and resources to establishing or augmenting fintech practice groups, a trend that is now well under way. Finally, it seems that increasing regulation is inevitable as legislatures catch up with technological innovation in the never-ending game of cat-and-mouse between innovators and regulators.