Digital Finance PDF

DIGITAL FINANCE  Digital finance is the term used to describe the impact of new technologies on the financial services. Includes variety of products, applications, processes and business models that has transformed the way of providing banking and financial services. Products- electronic m...

DIGITAL FINANCE  Digital finance is the term used to describe the impact of new technologies on the financial services. Includes variety of products, applications, processes and business models that has transformed the way of providing banking and financial services. Products- electronic money, digital wallets, and digital payment platforms, loans, savings, insurance, and investment. Applications- Online and Mobile banking, Funds Transfer, P2P payments, pay bills, cash deposit, ticket booking. Business models- Digital wallets, digital insurance, asset management, credit scoring, P2P lending. TYPES OF DIGITAL FINANCE SERVICES 1. Cards 2. ATMs 3. E-Wallets 4. PoS(Point of Sale) Terminals 5. APIs- Software tool for communication and sharing information 6. Internet and Mobile banking GOALS OF DFS Primary goal is to include all classes of society to recognise the benefits of Digital Finance. This is known as FINANCIAL INCLUSION. Digital Finance can contribute to bring down the national barriers in areas like Online Banking, online payments and transfers, P2P lending, Personal Investment, Capital growth and reducing risks. These services are provided by PROVIDERS such as Banks, other traditional finance service organisations and non banks. BENEFITS OF FINANCIAL INCLUSION Safety and Security- easier to store and manage physical assets in digital form. Speed and Transparency- Overcomes delay, cash leakage, and ghost receivers. Increased Flexibility- Can transfer funds directly to pay bills, fees, savings etc. Credit Histories- E-Payments create records. Tx histories help borrowing loans easier. THE EVOLUTION OF THE DFS ECOSYSTEM The root of the development of the digital financial services ecosystem is, of course, the rapid and wide-spread adoption of mobile phones. Most consumers and small businesses, transact and interact electronically. The rapid spread of the phenomenon of "mobile top ups" - the ability to convert cash into airtime minutes - is known as eMoney. A shift from open loop to closed loop banking system. An ecosystem dependent on networks of agents, branches or ATM's to support "cash-out" and "cash-in” has obvious problems with costs and the management of this infrastructure. Digital liquidity had an obvious appeal. THE DFS ECOSYSTEM DFS Ecosystem depend on two fundamental support structures: an Enabling environment and a solid level of Infrastructure readiness. Infrastructure Readiness consists of Payments Systems available for transaction between and among end users, including consumers, merchants, businesses and governments. These payments systems may be public, semi-public, or private; they may be "closed-loop" or "open-loop". In addition, a certain degree of payments system interoperability among participants in payments is a necessary component. Voice and Data Communication Networks to support financial messaging among end users and providers. Certain levels of communication network quality and security are a necessary component. Identity Systems capable of identifying end users and their providers. Authentication systems capable of recognizing and validating these identities. Eg: national ID's, sectorial ID’s, private sector ID’s. The Enabling Environment consists of Laws and regulations, implementing those laws. These include the basic permissions given to financial institutions in the countries; the authority of financial regulators, and regulation and permissions given to non-bank financial services providers. Standards setting bodies and their standards: These bodies may be specific to one industry group (e.g. EMV) or be more broadly applicable (e.g. ITU, ISO). Industry groups which act on behalf of large numbers of individual providers - these are most typically industry- specific (e.g. GSMA, Mobey Forum). NGO's and Development Organizations working to implement DFS ecosystems (e.g. World Bank, CGAP, UNCAD, the Bill & Melinda Gates Foundation.) The Ecosystem also includes, of course, consumers, businesses, and governments that are involved in the use and provision of digital financial services. This includes: Users - this term is used to include all entities which are users of digital financial services. This includes, consumers; merchants, billers, and other payments acceptors; businesses; governments; and non-profit agencies. DFS Providers - this term is used to include all entities which provide digital financial services to end users. It includes both traditional financial services providers (banks, savings institutions, credit unions, and other chartered financial institutions) and non-bank providers(eMoney operators, postal authorities, and a variety of different commercial providers). Non-Bank providers are constrained by national law and regulation.  DFS Providers Support Services - this term is used to include all entities which provide services to DFS providers. This includes processors, platform providers, and a wide range of software and hardware (e.g. terminals, ATM’s) providers. It also includes agents (who may work on behalf of either bank providers or non-bank providers). A note on providers: any given company or organization active in the digital financial services ecosystem may play multiple roles. For example, an eMoney operator may be both a provider of data and voice services (in “infrastructure readiness") and a direct DFS provider. A card network may be both a provider of a payment system (again, in "infrastructure readiness") and a DFS Support Service provider. Transaction Accounts for the safe keeping of funds: these include both bank accounts and eMoney accounts. Payments Services: the ability to transfer money into or out of an account: this may be done through a variety of different payments systems and providers. Remittances, transfers, merchant payments, bill payments, etc. are all examples of payments. Payments may be domestic or cross-border. RTGS systems, eMoney transfers, and card payments are considered to be digital payments. Use Cases are the situations in which consumers and businesses consume or require digital financial services. Many use cases have two end users: for example, in a “paying bills" use case, both the consumer or business paying the bill, and the biller receiving the payment.  CLOSED LOOP AND OPEN LOOP MODELS Closed loop payments systems connect end parties directly to each other without banks as intermediaries. The end parties, merchants and consumers, join the payments system directly. These became "closed-loop" payments systems, and the general model is often referred to as a “non-bank led model". It is used mostly in cards payments or online payments systems like Paypal. Cryptocurrencies like the Bitcoin operate on closed loop models. One of their main goals is to get rid of banks or any intermediary and allow participants to transact directly among themselves. The system is connected to Banks, Payments Services Providers (PSP) or similar institutions which act as intermediaries. And the banks are connected to end parties, the senders and receivers of funds. So there is no direct connection between end parties and the payments system. These systems are generally considered to be "open-loop" systems, and the general model is often referred to as a "bank-led model". Eg:AePS, ATMs.  CASH-IN AND CASH-OUT (CICO PROBLEM) CICO often goes hand in hand with a Person to Person (P2P) transfer, where consumers would Cash In (CI) at an agent, perform a P2P transfer and the recipient performs a Cash Out (CO) at another agent. Cash in transactions require an eMoney holder to deposit physical cash at an agent. Agent accepts cash and transfers eMoney to user’s eMoney account. A cash-out transaction requires an eMoney account holder to transfer e-money to a participating agent of their joint scheme. The agent receives the e-value and gives the user physical cash. Attributes of successful CICO (ATM) models include: safety (all transactions are PIN based); speed (transaction take place in real-time) Convenience. PAYMENTS SERVICES There are two areas of payments services, of particular importance to the development of the DFS. Merchant Payments- refers to payments made to merchants or other payments acceptors. These payments may be made in person (POS or "proximity payments) or remotely (eCommerce or "mobile" payments) Bulk Payments- refers to payments made to multiple recipients. Typically, these are government payments (benefits, cash transfers, salaries), donor payments or payroll payments. A domestic digital funds transfer is the exchange of funds from one user to another through a DFS provider using electronic means. The regulated environment includes licenced money transfer companies such as banks and post offices, the unregulated environment includes Hawala (trust based) and personal cash transport. This eMoney model is tightly coupled with digital wallet and CICO Services. An International funds tranfers is the transfer sent from a consumer in one country to a consumer in a second country. These transactions are normally cross-currency as well. These transaction requires someone either the sending or receiving party, or the providers who are serving them, to effect the currency exchange. Many DFS Service Providers have built partnerships with the traditional international remittance operators such as Western Union and MoneyGram. THE MAGIC LEDGER What Is Blockchain? Blockchain is a shared, immutable ledger that stores data in blocks that are linked together in a chain. The data is chronological and cannot be deleted or modified without consensus from the network. Applications: Recording transactions for cryptocurrencies Monitoring supply chains Digital IDs Data sharing Copyright and royalties protection IBM, Walmart, Microsoft, FedEx, Carrefour, Alibaba, JP Morgan Chase, Paypal, Ford, Mastercard etc are using blockchain Technology. FOUNDATIONAL ELEMENTS OF BLOCKCHAIN 1. Accounting- A ledger is used to keep track of the transactions, around an organization or system. Every participant maintains his or her own copy of this ledger. Processing & Communications- As trusted third parties, notaries have played an important role in business over time as they act as official, unbiased observers and endorsers to a document's authenticity and validity. Blockchain technology allows the duties of a notary to be written into computer code and performed by the blockchain itself, eliminating the need for a third-party notary. Blockchain can employ many other mechanisms from accounting to update and maintain the ledger referenced above. Through coding, any accounting procedure like financial accounting, tax accounting, auditing, and reporting of activities that occur on the blockchain system can be executed on the chain. 2. Computer Science is one of the fundamental disciplines upon which blockchain technology is based, dealing with how data is best handled, processed, stored, and communicated. Networks consist of two or more connected computers that work together for the purpose of sharing resources. Individual nodes are assigned unique addresses to ensure all messages and connections are properly routed to the intended recipients. Centralized vs Decentralized Networks Accessibility- Public, private, hybrid and consortium. Consortium blockchain networks could be described as semi‐decentralized. Access to the network can only be obtained with permission. However, control over the network is not governed by a single entity but instead by a group of approved parties.  Database-database management systems (DBMS) are used to control and maintain most databases. This software serves as the interface between end users and the database itself, allowing the data to be easily organized, accessed, modified, updated, controlled, and managed. Like networks, databases can be centralized or decentralized and can be publicly or privately accessed. Cryptography is the practice of securing communications via the processes of encryption and decryption to transmit messages between trusted parties. cryptography provides a method to ensure data confidentiality, data integrity, and authenticity. Hashing Digital identity is simply information that can be used to unambiguously identify someone or something online. National passport or bank statement, to prove it.  Digital wallets (sometimes referred to as “e‐Wallets”) are electronic devices or online services that allow users to make electronic payments, store digital securities, or maintain personal information. A wallet of this type can be linked to the user's bank account or other financial institutions. Digital wallets are gaining popularity worldwide because, Less to Carry- include ID documents, health cards, membership cards, loyalty cards, and more Less Wasted Time- Checkout queues will become shorter Fewer Forms- Less paperwork Enhanced Security Key encryption is one of the core elements of the blockchain's security structure. When a digital wallet is first created, two keys, one public and one private, are created. When a digital wallet is first created, two keys, one public and one private, are created. The public key is similar to the user name and can be shared with others. The private key is like your password and should never be given out. The public key serves as the wallet's address and gives the user a point of access to send and receive tokens to the wallet. The private key gives the owner access privileges to the wallet and its contents. 3. Governance These parameters shape the way participants use and behave under a system. They establish how decisions are made and identify the distribution of privileges and responsibilities of various participants. The benefits of establishing clear rules. i. Conflicts of interest between parties can be identified, mitigated, and/or avoided. ii. System maintenance costs are reduced. iii. Additional participants are attracted to the system. Protocols are rules for electronic communication. Network protocols are programmed sets of rules that dictate the way in which information is treated and handled. They allow communications to be transmitted from one user to another. To operate effectively, protocols have to be pre‐defined and agreed upon in a communication network as standards. If protocols are not properly handled or rules are violated, communications will break down. Consensus is the process by which participants come to a mutual understanding about what is published in the ledger. There can be disputes as to who is a legitimate participant, what transactions are valid, what transactions occurred, and what transactions did not. When the stakes are high (and they usually are when money is involved), disputes are far more likely to happen. As a result, there have to be proper procedures and checks and balances in place to ensure all participants end up fairly treated.  DISTRIBUTED LEDGER TECHNOLOGY “Is there a difference between blockchain and distributed ledger technology?” BUILDING A BLOCKCHAIN Each block will contain three critical pieces of information: (a) the hash of the previous block, (b) data for the current block, and (c) a hash of the current block. Linking a Blockchain Together When a new blockchain is started, the first block must be unique. This is because there is no previous block to link it to called the “genesis block,” CREATING A BLOCKCHAIN TRANSACTION Part 1 – Alan wants to send 10 tokens to Beth. Alan will access his digital wallet and make a request to transfer the 10 tokens to Beth's wallet. Alan will need to enter Beth’s public key address so that the tokens can be transferred to the right place. Alan's digital wallet will need to confirm that the person requesting this transfer is indeed Alan. Alan could enter his password or use biometric identification to provide verification. The wallet will check its balance to make sure Alan has a sufficient amount. The wallet will then take Alan's private key and feed it though a special cryptographic function that will create a digital signature.  Once these authentication procedures are finished, the wallet incorporates all of the request's relative information – Alan and Beth's public key addresses, a timestamp, the token amount, and Alan's digital signature – into the appropriate cryptographic hashes and formats. The resulting data will then be used to create a new block. Part 2 – Alan's proposed block will now be sent to all participants on the blockchain. Every participant maintains his or her own copy of the blockchain ledger. Part 3 – The newly confirmed block will be connected to the end of the last version of the blockchain. The added block is now cryptographically linked to existing blocks. Part 4 – The new updated blockchain is complete and everyone will get a copy of the latest version. TAMPERING WITH A BLOCKCHAIN How and why someone could try and tamper with a ledger? 1. A participant could want to forge copies of tokens to make new ones to spend. AKA. Double-Spending or Token Forgery: Eg: Original Chain: The attacker sends 100 tokens to Vendor A for a product or service. Forked Chain: The attacker creates a new version of the blockchain where the 100 tokens are instead sent back to their own wallet, making it seem as if the transaction to Vendor A never happened. 2. A participant may try to spend more tokens than are in his or her account. 3. A participant may try to send multiple transactions simultaneously and may not have have enough to cover the sum amount of all the requests. Eg: suppose Kim has 100 tokens in his account. At the same time, he sends 75 tokens to Lee and 50 tokens to Pat. But Kim only has 100 tokens and is thus short 25 tokens. Blockchain transactions are always ordered before they are processed. 4. A participant may try to intercept the tokens. Contd… 5. A participant sends a bogus transaction to only select members of the network community for verification while other participants are left out. Smart Contracts- They are units of computer code that execute a set of commands when certain predefined conditions are true. ORACLES An oracle is an agreed‐upon and trusted third‐party data source. Through the use of oracles, smart contracts determine if, how, and when its contractual terms have been adequately fulfilled. Case Study: AXA's Flight Delay Insurance – “fizzy” Fizzy Insurance Platform Flow Diagram Key Components: Customer: The individual purchasing the insurance policy. AXA Website: The platform where customers can purchase policies and get quotes. Smart Contract: An automated contract on the Ethereum blockchain that handles policy terms and payouts. Air Traffic Databases: Sources of real-time flight data that feed information to the smart contract. Process Steps: 1.Customer visits AXA website and enters flight details. 2.AXA website calculates quote and presents it to the customer. 3.Customer purchases policy, creating a smart contract on the Ethereum blockchain. 4.Smart contract connects to air traffic databases. 5.Flight delay occurs. 6.Air traffic databases update the smart contract with delay information. 7.Smart contract verifies the delay duration. 8.If delay meets policy criteria, the smart contract automatically triggers compensation. 9.Smart contract compares landing time to scheduled arrival time. 10.If landing time is greater than two hours after scheduled arrival, smart contract triggers compensation 11.Compensation is sent to the customer's wallet. Fig: Benefits of Smart Contracts THE CHARACTERISTICS AND BENEFITS OF BLOCKCHAIN Benefits of blockchain: Transparent As the platform is not centrally controlled, the system should remain neutral and unbiased. Network of participants openly conduct transactions on a shared ledger. When any participant wants to transmit a message, the block is sent to all the peers. Thus, censorship should not be problematic. Trustworthy A network of users provides self‐policing over the activities on the blockchain. Coded procedures enable a uniform method to track and verify all data stored on a chain. Users have a proven outlet to control their own data, assets, and identity.  Secure Key encryption protects the rights of the individual users; at the same time, cryptographic functions ensure that everyone can view the contents of the ledger and its history. Mathematical rules ensure that the records kept on the chain are tamperproof and permanent. The decentralized nature of the network prevents any single points of failure from comprising the data. This makes blockchain less susceptible to fraud and cybercrime issues. Efficient The benefits of blockchain, eliminates manual interventions, and automate tasks like auditing, reporting, and notarizing. Cost reductions and quicker processing times can be realized as middlemen are cut out. Predefined rules can eliminate or mitigate disputes between participants. Technology can reduce risk and increase accuracy rates.  PUZZLE TIME Across 4 A self-executing contract with terms directly written into code. 5 A blockchain platform used by Fizzy AXA. 7 A blockchain-based platform for insurance. 9 A distributed digital ledger that records transactions in a way that makes them difficult or impossible to alter, hack, or cheat. 10 A cryptographic method that verifies the identity of the sender of a message. Down 1 A cryptographic method used to secure data. 2 A type of cryptography that uses a mathematical function to encrypt data. 3 A type of consensus mechanism used in blockchain. 6 A cryptographic algorithm used to create digital signatures. 8 A blockchain that is permissioned. ANSWERS 4. smartcontract 1. Encryption 5. Ethereum 2. Hash 7. Fizzy AXA 3. ProofOfStake 9. Blockchain 6. RSA 10. DigitalSignature 8. Private