Financial Innovation and Technology

Course Code: Fin565

COMSATS University Islamabad

Reading Material

Not Limited to These…

• Fintech in a Flash_ Financial Technology Made Easy-De Gruyter (2024)
• The Cryptocurrency Phenomenon. The Origins, Evolution and Economics of
Digital Currencies-Routledge (2024)
• Fintech in Investment Management, CFA (2018)

COMSATS University Islamabad

Class ecosystem

Some Ground Rules For The Class…

COMSATS University Islamabad

Course Outline:
Pay Tech:
• Current practices in payments & capital transfer
• Front-end innovation e.g., digital wallets and payments ecosystem
• System-wide innovations
Cryptofinance:
• Introduction to distributed-ledger technology
• Blockchain as an asset: market for cryptocurrency
COMSATS University Islamabad
• Blockchain as a business: existing uses & launching new business
ideas
Course Outline:
CreditTech:
• The evolution of credit and lending
• Peer-to-peer lending and equity crowdfunding
• Crypto-based fundraising: ICO, STO, IEO
• Banking-as-a service
InvestTech:
• Robo-Advising
COMSATS University Islamabad
• AI-based stock selection and asset management
• Big data in investing, and wealth management
Overall Learning Goals
Know the technology
• Digest key technical aspect of major fintech concepts
• Knowledge of AI, machine Learning, and big data
Know the Business
• Understand the key stakeholders and practices of the ‘disrupted’ industries
• Connect new technological concepts to specific business applications & value
propositions
COMSATS University Islamabad
• Evaluate new fintech business models
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Learning Objective's
• Explain how current payment systems operate.
• Describe inefficiencies in current practices in the processing of payments.
• Relate new technological innovations to current inefficiencies.
• Build value propositions for new technologies in the payment space.
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A Brief Historical Perspective:

• It is difficult to pinpoint when financial technology emerged, but the 1950s are a good

reference point.

• The 1950s saw the introduction of credit cards. Instead of carrying cash, people used

these cards to pay for their purchases. ATMs were introduced in the 1960s, meaning

people no longer had to visit bank branches for certain transactions.

• In the 1960s, banks started using mainframe computers for record-keeping and data

storage.

• In the 1970s, firms began to trade stocks electronically.

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A Brief Historical Perspective:

• In 1981 the first IBM PC was invented, ending the dominance of time-sharing terminal

computing.

• In the 1980s, electronic trading continued to evolve, and algorithms began to transform

the way markets operated.

• In the 1990s, e-commerce business models and the internet thrived. Because of this,

retail investors could experiment with online stock trading.

• During the 2000s, the emergence of mobile technology and the proliferation of the

internet worldwide led to the rise of online banking, mobile payment systems, and peer-

to-peer lending platforms.

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A Brief Historical Perspective:

• The financial crisis of 2008 also spurred innovation in fintech, as new regulatory

challenges and mistrust in traditional banking institutions created opportunities for

disruptive start-ups.

• In the 2010s, blockchain technology and cryptocurrencies emerged, offering new ways of

securing transactions and creating value.

• AI and machine learning started to be utilized in financial services for fraud detection,

risk management, and customer service.

• Fintech incubators and accelerators became commonplace, fostering innovation across

various segments of the industry.

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A Brief Historical Perspective:

• Incubators focus on building the foundational elements of a startup while Accelerators

concentrate on scaling startups by addressing specific growth challenges.

• Currently, in the 2020s, fintech is digitizing retail financial services through

crowdfunding platforms, robo-advisors for retirement and wealth planning, payment

apps, mobile wallets, and the like.

• Emerging technologies like quantum computing, the metaverse and DeFi are also

starting to sound like possible useful technologies.

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A Brief Historical Perspective:

• Emerging technologies like quantum computing, the metaverse and DeFi are also

starting to sound like possible useful technologies.

• Quantum computing is a multidisciplinary field comprising aspects of computer science,

physics, and mathematics that utilizes quantum mechanics to solve complex problems

faster than on classical computers.

• Metaverse is a a highly interactive three-dimensional virtual domain where real-world

conditions can be simulated by combining a multitude of Internet functions.

• DeFi is short for decentralized finance.

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A Brief Historical Perspective:
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What is Financial Technology or FinTech?

• A combination of the words “finance” and “technology”.
• Financial Technology (FinTech) is used to describe new tech that seeks to
improve and automate the delivery and use of financial services.
• FinTech is the catch-all terms that applies to any technology that helps
consumers or financial institutions deliver financial services in a novel, more
convenient way.
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• Some FinTech firms compete directly with incumbents such as banks and insurance
companies, while others have partnered with them or supply them with goods or
services.
• What is clear is that fintech companies are improving the financial services world
through introducing innovative ideas, allowing for speedy delivery, and increasing
competition.
• Broadly:
• Technological Innovation that improve how money and capital are transferred, raised,
and invested.
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• Traditional financial institutions are in danger of being technological

‘leapfrogged’
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• Think about traditional financial Institution. What does a bank do?
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• This is the daily function of the bank, and all involve in capital and money, which is the

core function of the finance is simply moving them around

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• Now to decompose these functions and to show you that today the traditional financial

institutions is being threaten on all these fronts. Not as a whole but piece by piece.
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• How do we get pay & get paid?
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• Summary of Payment Innovations
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The Checking System and the Importance of Financial Intermediation
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The Checking System and the Importance of Financial Intermediation
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• Electronic Fund transfer through Automated Clearing House (ACH) is a

“Modern equivalent of the paper-based checking system”

• Same as bank wire it's a secure electronic messaging system and like checks, it allows transactions to

be initiated by either the sender or the receiver.

• Every time we used direct deposit of our paycheck or use bank account to pay our utility bills online, for

such purpose we used a new payment apps, such as the PayPal and Venmo.

• That's the reason we need to talk about it, because despite being a quote-unquote legacy system, it is

really the bedrock upon which a lot of the new pay tech Innovations are built.

• It is also the “rail” upon which new fintech innovations are built
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• let's take a look at its technical underpinnings and then connect them to the new Innovations.
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• let's get rid of the paper check. We can replace it with the computer.

• The sender's bank is called originating depository financial institution, or ODFI for short and the receiver's bank is called the receiving

depository financial institution, or RDFI.

• Finally, the paper check writing system is replaced by an electronic communications network.
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• Now, let's do a quick transaction and transfer some money. If you have used the system, you'll see

something similar to this form on your bank's website.

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• Remember, this request can go both ways. So, if you have used online bill pay, for example with your

credit card company to pay off your credit card every month, you're sending your bank information to

the receiver and give them the authorization to generate the payment request on your behalf, and they

transmit the request to your bank.

• Either way, the request ends up in the ODFI server. After the OFDI gets the request, you will conduct

some standard intermediation tasks,

• Authenticating the account

• Making sure the request is authorized

• There's enough money to make the transfer

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• After this, the bank will use the payment request information to generate a standard text message file.

• This is the ACH file consisting of all the relevant identifiers and amounts. It's in a standardized format so all banks' computers can easily read

them.

• This text file is the information that will be transmitted over the ACH network to the receiver's bank, the RDFI.

• The bank will then identify the receiving account, and that's when as a receiver you'll get a notification that you have some money coming.

• This completes the information flow of this transaction, and it happens fairly quickly. As you'll see shortly, it's not instantaneous, but is

usually done within the same day.

• Because everything is electronic, there's no paper checks to be routed, so settlement, the actual money flow, can also occur much quicker,

either on the same day or within a couple of days.

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• Advantages of ACH
• The most obvious advantage is that it really cuts down the time lag between the information flow and the money flow.

• In the paper checking system, the information flow is limited by the physical speed that the checks can move. In the ACH
network, the information flows digitally. This would both significantly increase the settlement speed and cut down
potential fraud.
• ACH is extremely cost-effective

• The system is really cheap to use. The average cost per transaction is a fraction of a penny (Average low cost $0.0001 per
transaction). And this low cost is due to the fact that communications in the system is not done in real-time but in a batch
process.
• Bank accumulate ACH files into a batch file
• Transmit to the network at a predetermined time of the day (10:30am and 2:45pm)
• Processing occurs in predetermined batches (intervals) instead of real-time
• Strikes a balance between the need for speed and the need for low cost Therefore

• This really cuts down the infrastructure requirement for the network and that's why so cheap to use. The low cost of
ACH will be a primary reason why most fintech innovators choose to build upon this system
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• Limitations
• Despite the good infrastructure at the back end, the main drawback of the ACH is that it's not very easy to use.

• Not very user-friendly

• The user identifiers, these numbers, take a long time to retrieve and each bank and each receiving merchant usually

have their own different user interface, and some of them are not very intuitive and user-friendly.

• Each institution has its own user interface

• A large proportion of PayTech innovations improves on this aspect

• They are essentially front-end innovations that make the back-end (e.g. ACH) easier to access.
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Pure Digital Wallet

• A digital wallet acts, well just like a wallet, it digitally connects to our bank accounts as the source of

money. Just like we can put cash into our physical wallets, we can transfer actual money in the

connected bank accounts into a virtual balance in the wallet app.

• PayPal is one of the modern fintech companies in the payment space that pretty much popularized the

idea of a digital wallet, which has been further refined by many other fintech companies afterward.

• PayPal was founded in 1998 when, as the company puts it, “money meant paper and coins.” Originally

named Confinity, PayPal developed an early focus on digital payments for consumers and businesses.

Its mission was to create the world's first digital payment platform that would make money work faster

and better.
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Pure Digital Wallet

• let's put that in a familiar five-party graph with the sender and the receiver, their banks and a

conventional payment rail like the ACH. Now, let's give PayPal accounts to both the sender and the

receiver, which will be linked to their respective phone numbers.

• In addition, we're going to need another bank account for PayPal itself. This third bank account serves

as the central conduit of money flow in the system. Note that very importantly, PayPal and most other

digital wallets, they're not banks.

• They don't want the increased regulation with the banking charter. Therefore, to legally hold your

money, the wallet has to first partner with the bank and setup as main bank account there.
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Pure Digital Wallet

• Although this is a PayPal's account, they can not touch this money and use it for other purposes. It

simply hosts that a $100 as a custodian on behalf of the sender. That amount will be linked to the

sender's PayPal account, showing up as a $100 virtual balance in the wallet.

• But now that is in the wallets bank account and designated to the sender, the information flow, which

is now in the form of virtual money balances within PayPal, is decoupled from the traditional payment

rail.

• If for instance, the sender wants to send the $100 to another PayPal user, they simply put in the

receiver's identifiers, the email or their phone numbers, and the virtual balance can be transferred

instantly.
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Pure Digital Wallet

• On the back-end, PayPal does not have to actually move the money. You can simply change a line of

code that moves the designation of this $100 from the sender to the receiver in the software. Now, the

receiver can keep that Virtual balance and use it to pay someone else, and the e-wallet re-designation

process will repeat itself, or they can decide to withdraw, converting the virtual money back into real

money in their bank account.

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• Now, let's take a look at the cost side. This is where not being a bank and not having to develop a

new payment rail, really paid off. By utilizing the existing rails, the main development is on the

software side rather than the hardware side.

• So, the fixed costs are relatively low. Once developed, because the maintenance of the wallet bank

accounts and bank related compliances are the responsibility of the bank partner, the ongoing

costs are mostly related to R and D in software maintenance.

• Therefore, the marginal cost of processing one more transaction or having one more user, is

minimal and the system is easily scalable.

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From Pure Wallet to Payment Ecosystem

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Alipay
• Alipay was founded in 2004 and started expanding business in 2010.
• Alipay beat PayPal become largest electronic payment company.
• Alipay began to encourage users to deposit their money and offer higher
interest rates than banks, this has attracted a large number of loyal users.
• It handles over 100 million transactions every day and has more than 800
million active users each month.
• It’s available in 70 countries and is used by over 3 million merchants
worldwide.
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• Before that, let's talk about Alipay's second Innovation, the expansion of the wallet to offline, face-

to-face commerce settings.

• Soon after the wallet was introduced, the developers realized a big problem. The majority of the

Chinese population have never participated in online transactions before, not to mention online

banking.

• Sure, they have a smartphone, but unless they are a millennial or younger, they haven't really done

much online shopping, and they prefer the more traditional brick-and-mortar stores.

• In these transactions speed is the key, and they're definitely not going to be bothered with finding

and typing in all the stores' email addresses and other identifiers when waiting in line at the

checkout counter, this presents both a challenge and an opportunity.

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Brick and mortar (or B&M) is an organization or business with a physical presence in a
building or other structure. The term brick-and-mortar business is often used to refer to a
company that possesses or leases retail shops, factory production facilities, or
warehouses for its operations.
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• Because of its low cost and convenience this type of arrangement is now ubiquitous all over the

country to the point where cash is often not accepted anymore.

• This simple process innovation is a case to consider for wallet developers, particularly in emerging

markets with a lot of offline transactions and without a robust credit card network.
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General Alipay Statistics
• Surprisingly, the United States leads with about 2.2 million users, making up 21.09% of the total

audience. Alipay is a top payment platform in China.

• Alipay holds about 54% of the market share in China, while WeChat Pay has 42% and UnionPay only has

4%.

• The Alipay website has roughly 190.3 million backlinks, which is a 6.7% increase. There are about 900

million Alipay users in China.

• In the U.S. and Taiwan, 15,552 and 5,150 websites, respectively, accept Alipay as a payment option.

• According to Alipay’s statistics, 45% of adults use the platform every day, and 41% use it weekly.

Around 80 million merchants accept payments through Alipay.

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Market Share of leading third-party online payment providers in Dec 2022
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According to Statista, the total value of digital payment transactions in 2022 was almost $3.5 billion,
and it is expected to grow to $5.2 billion by 2027, with an annual growth rate (CAGR) of 8.25%.
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Social-Network-Based Payment Innovation

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• The third type of digital wallets. Those derived from or embedded in social
networks. Social relationships represent a unique opportunity to grow a
paycheck ecosystem because of the strong network effect and the word-of-
mouth effect.
• If all your friends are using a particular digital payment platform to pay each
other and for other transactions, then you’ll be more inclined to use it as well.
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• The revenue model is almost identical as well, free to use foremost, charging merchants for

transactions and charging for credit card usage.

• The key innovation is that they have combined the social element and the financial element ofa single

financial transaction.

• They started off with the millennial and younger population with the problem of say, splitting a bar tab.

It's usually a somewhat awkward situation. But what Venmo did is turning this into a social network

status update.

• They can broadcast this financial transaction to all their friends into the world, and maybe adding in a

clever joke, some emojis and maybe a selfie.

• The result of this is that the value of the user's social network data is significantly increased.
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• This opens the door fora series of customized financial products based on this insight, particularly in

short-term lending and insurance. Note that data privacy will be an important issue, and any

monetization effort will have to take into account any future regulatory changes.
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Wechat
• WeChat is a China-based social networking platform similar to a combination of Facebook and

WhatsApp. After they're built a large user base, the company started to think about more creative ways

to monetize the network interaction. And one of the ways is to build a payment platform for the

network users.

• User’s identifiers will be their network handles, and as usual, money will flow on traditional rails. But

how do you get people to use it, especially if many of them are already with competitors like Alipay?

WeChat's key innovation is really to focus on the social part with the so-called Lucky Money campaign.
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• WeChat open up a marketplace that’s similar to the Facebook marketplace.

• This allows users to conduct both Venmo-like transactions with friends, as well as e-commerce with

members of their social network.

• All powered by their WeChat wallet. This led to a large number of WeChat-based merchants who

otherwise wouldn't be able to build an online capability.

• And now can sell their merchandise through their public WeChat profiles. This significantly expanded

its reach to the merchant side.

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• And finally, once they have build up the user base, kept them engaged with the marketplace and

attracted enough margin participants, they went outside at the social circle and became a full-fledged

payment platform to compete directly with Alipay, both online and offline.

• This three-step innovation process is informative about growing a paytech ecosystem from within a

social network, which is an important monetization strategy that other social networks like Facebook

are also pursuing.

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Origin of the Credit Card Network

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• Turns out, there's quite a complex series of actions happening in the next couple of seconds that lend

really well to innovation.

• We'll examine exactly what's going on in these couple of seconds, identify the key players involved,

what functions they carry out, and what their respect to the business models look like.

• First, let's go back in time and talk about why and how quite a card came about in the first place.
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Origin of the Credit Card Network

• With the first generation actually called the Diners Club card that are geared toward primarily

business meals and entertainment uses.

• The basic principle is the same such as;

 Bank extends revolving line of credit to customer

 Guarantees real-time availability of funds to merchant

 Build a real-time messaging network to communicate this guarantee

 Bill customer later & bear all default risk

 Charges merchant for these costs

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Origin of the Credit Card Network

• Trust of the bank is paramount in this case, and this again shows the importance of financial

intermediaries.

• After the success of the Diners Club card, Bank of America step into the game and built an alliance of

banks and a communication network which the eventually spun off and became today's Visa.

• A competing alliance of banks in the western states built a competing communication network, The

Master Charge network, which was also eventually spun off and became today's MasterCard.
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Origin of the Credit Card Network
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Credit Card Network-Key Stakeholders and Business Model

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• We'll have four parties involved, the paying consumer, the receiving merchant, network and their

banks.

• We'll call the consumer's bank the issuer because they issue the credit card and the underlying

loan.

• The merchant's bank is called the acquirer and that's where the merchant has their bank accounts

to receive money.

• And in the middle as usual, we'll have an electronic communications network.

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So, the consumer first applies fora revolving line of credit from the bank. And once approved, the bank

will issue them a credit card that has their credit account information, that is the card number, and

the expiration date printed on the card and embedded in the chip and the magnetic stripe.

we're going to need an additional sixth party involved called the processors. They are the providers of

the terminal, the hardware, and the software to capture the card information and send it onward to

the card network. They can be either affiliated within cumbent financial institutions or they can be

fintech startups acting as independent sales organizations or ISOs.

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• The network itself then simply forward the message to the issuer. Different than an ACH Network,

there's no batch processing here and every message is routed through in real time just like a cell

phone network. Once the information gets to the issuer, it'll perform several key intermediation

tasks in quick succession.

• They're going to verify that the consumer has the account, the charge does not exceed the amount

of the available loan, and do a quick risk assessment about how likely this transaction might be

fraudulent, more on this later.

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• As settlement, the actual money flow happens later on other rails either ACH or bank wire. But wait

a minute, each party has to be compensated for making this convenience happen. So instead of

transferring the full $100 to the merchants, each party will take their slice of this pie.

• We'll have a deeper look at how the pie is divided, but for now note that the issuer will take the

biggest piece of the pie for their intermediation tasks. Their compensation is called the interchange

fee and can range up to 2 to 3%depending on the bank.

• In this example, we're using a 2.15% interchange fee.

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The Credit Card Network : Advantages and Inefficiencies

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Credit Card network : Advantages
• Efficient, near – instant transaction clearance
1. Most payment platform cannot match this speed
2. Can be used to process less risky debit & prepaid card transactions
• Value-added services for consumers
1. Dispute – resolution mechanism
2. Advanced fraud detection using machine learning & big data techniques
3. Revolving credit lines providing short term financing when needed
4. Other perks to increase customer loyalty
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Credit Card network : Advantages

Examples of credit card disputes:

• The cardholder didn't authorize the charge because their card was lost or stolen.

• The merchant charged more than the authorized amount.

• The merchant didn't deliver the product or service.

• The product or service received was not as described.

• The cardholder was a victim of fraud by the merchant.

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Credit Card network : Drawbacks
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Credit Card network : Drawbacks
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Credit Card network : Drawbacks
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Credit Card network : Drawbacks
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M-PESA: Paytech in developing markets

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M-PESA
• The pay tech innovations that we have reviewed so far, have mostly be concentrated in more

developed markets with well-established financial infrastructure, such as the well-functioning

interbank payment network and telecommunication structure for credit card transactions.

• These enabled innovators to focus on the front end and develop user interface enhancements that

make these good infrastructure easier to use.

• Hence, the barrier of entry is relatively low and the market is quickly becoming crowded.

Innovators and venture funding have consequently started to look at other less-developed parts of

the world with less competition.

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M-PESA
• In these markets, for instance, developing countries in Africa, a good financial
infrastructure backbone is much less developed. This results in a large number of
potential customers who lack access to the banking or financial system that could
potentially be well-served by new Fintech innovations.
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