Fintech Final Study Guide PDF

Brief history of fintech and what it is: - Finance: a term for matters regarding the management, creation, and study of money and investments - Fintech: Fintech refers to the integration of technology into offerings by financial services companies in order to improve their use an...

Brief history of fintech and what it is: - Finance: a term for matters regarding the management, creation, and study of money and investments - Fintech: Fintech refers to the integration of technology into offerings by financial services companies in order to improve their use and delivery to consumers Events Leading to the FinTech Boom 1. Historical Evolution: ○ Finance innovations date back to bartering systems (6000 BC), evolving through currency (3000 BC), credit systems (3500 BC), banking, and tools like checks (800s). ○ Major advancements like credit cards (1940s) and electronic transfers (1970s) set the stage for modern finance. 2. Pre-2008 Landscape: ○ Online banking and credit cards became widespread by the early 2000s. ○ Financial systems heavily relied on banks for wealth storage, credit, and transactions, requiring significant trust. 3. 2008 Financial Crisis: ○ Collapse of major banks led to skepticism about traditional financial systems. ○ Government interventions like the Dodd-Frank Act aimed to restore trust but provoked public backlash. 4. Technological Catalysts: ○ Innovations like the iPhone (2007), Amazon Web Services (2006), and social media platforms fueled the digital transformation. Technological Changes Post-FinTech Boom 1. Rise of FinTechs: ○ Post-2008 saw a surge in startups focused on solving consumer pain points using technologies like cloud computing, big data, blockchain, and AI. ○ Key focus areas: Payments, digital banking, wealth management, and crowdfunding. 2. Shifts in Financial Services: ○ Banks adapted with tools like mobile banking and chatbots, but FinTechs drove a narrative of either revolution (disruption of traditional systems) or evolution (integration with existing models). 3. Fourth Industrial Revolution: ○ Characterized by a fusion of technologies, blurring physical, digital, and biological boundaries, emphasizing comprehensive stakeholder collaboration. 4. FinTech 3.0 (2009–present):  ○ Marked by startups and tech companies directly offering financial products, disrupting traditional intermediaries. Payments: - Role of Money: - Functions: Unit of account, medium of exchange, and store of value. - Characteristics: Durability, portability, divisibility, uniformity, limited supply, and acceptability. - Bank-Centric Systems Pre-2008: - Payments revolved around banks as intermediaries. - Banks provided services like storing funds, maintaining ledgers, and enabling transactions, funded by deposits and transaction fees. - Transaction Limitations: - Complex processes involving multiple intermediaries (banks, networks, processors, and merchants). - High costs (fees contributing 2-5% of sale prices). - Vulnerabilities: Security risks (e.g., $10B in fraud in the U.S. in 2022), poor user experience, and biases in credit issuance. - Post-2008 Shift: - The financial crisis exposed inefficiencies and risks in traditional systems. - Inspired exploration of alternative, technology-driven payment solutions. Technological Changes in Payment Systems 1. Modern FinTech Payment Solutions: ○ Embedded Finance: Integrating financial services into platforms. ○ Buy Now, Pay Later (BNPL): Offering installment plans and instant loans. ○ Peer-to-Peer Services (P2P): Simplifying money transfers without intermediaries. 2. Apple Pay Example: ○ Addresses security (encryption, biometric guardrails) and user experience. ○ Earns via a 0.15% "interchange" fee charged to issuers. ○ Highlights the trade-offs of convenience vs. privacy and additional fees. 3. FinTech Disruption: ○ Focuses on reducing costs, improving efficiency, and enhancing convenience through technologies like NFC (Near Field Communication), encryption, and digital wallets. 4. Challenges and Trade-offs: ○ Despite FinTech solutions, issues like privacy concerns, data misuse, and growing fee structures persist. Digital Banking - Pre-2008 Payment Systems: - Financial transactions were bank-centric, relying heavily on intermediaries for services like storing funds, processing payments, and credit issuance. - Cash was the primary medium, but it had limitations (e.g., portability and divisibility). - 2008 Financial Crisis: - Exposed inefficiencies and risks in traditional banking systems. - Sparked demand for alternative payment methods to address shortcomings in trust, cost, and convenience. - Challenges in Legacy Systems: - Intermediary-driven processes increased costs and delays. - Security vulnerabilities led to significant fraud losses (~$10 billion in the U.S. in 2022). - Lack of peer-to-peer options and biases in credit access hindered inclusivity. Technological Changes and FinTech Innovations 1. Modern Payment Process: ○ Multiple parties involved in transactions: Issuer (e.g., banks like Chase): Guarantees payment. Merchant: Vendor selling goods. Network (e.g., Visa): Relays and approves payment requests. Processor (e.g., Square): Handles transaction data. ○ Transactions are settled via regulated payment rails (e.g., ACH). 2. FinTech Solutions: ○ Embedded Finance: Consolidates financial services into platforms. ○ Buy Now, Pay Later (BNPL): Flexible payment installments for consumers. ○ Peer-to-Peer Services (P2P): Simplifies direct money transfers. 3. Apple Pay Example: ○ Addresses user experience and fraud through encrypted card data and biometric authentication. ○ Generates revenue via a 0.15% interchange fee charged to issuers. 4. Fee Structure: ○ Parties like issuers, networks, and processors take fees amounting to ~2-5% of transaction values. ○ Example: A $1,000 purchase may result in fees split among these stakeholders, reducing merchant earnings. 5. Key FinTech Advancements:  ○ Digital wallets, NFC technology, and integrated platforms improve convenience and security. ○ Focused on making payments faster, cheaper, and more user-friendly while addressing longstanding challenges. Wealth Management - Savings Overview Saving is transferring money from your present self to your future self. Reasons for saving: 1. Precautionary (job loss, unexpected expenses). 2. Planned consumption (retirement, large purchases). Financial life stages: 1. Childhood: Earnings negligible; dependent on parents. 2. Secondary Education: Expenses moderate (tuition); net borrower. 3. Working Years: Earnings grow; net saver. 4. Retirement: Negligible earnings; predictable expenses; net borrower. Key insight: Savings management focuses on smoothing consumption between high-earning and low-earning periods. Challenges in Savings Management Unanticipated expenses. Determining retirement duration and required savings. Balancing borrowing and saving. Financial Planning Approaches 1. Traditional Finance (TradFi): ○ Use financial planners for guidance on saving, borrowing, and investment allocation. ○ Planners’ compensation: flat fee, AUM fee, or commissions. ○ Potential conflicts of interest in commission-based advice. 2. FinTech Solutions: ○ Robo-advisors (e.g., Betterment): Fully automate financial planning with algorithms. Services include tax management, cost reduction, and goal personalization. Lower fees, accessible, and user-friendly. ○ Challenges: Limited personalization; increased competition from traditional firms. Example Scenario Robo-advising Cost Comparison: ○ Fidelity charges 0.50% AUM; Betterment charges a $200 flat fee. ○ For $10,000 managed, Fidelity costs $50/year; Betterment is $200. ○ Breakeven point for preferring Fidelity: >$40,000 in assets. Equity Investing What is Equity? Equity: Ownership in a company, with voting rights on decisions. ○ Payoff: Dividends proportional to holdings. Residual claims after debt obligations. ○ Pros: Unlimited upside if the company performs well. ○ Cons: High risk; paid last in liquidation. Fixed Income: Lending money (e.g., bonds). ○ Payoff: Predetermined, static payments (interest and principal). ○ Pros: Low risk; paid before equity holders. ○ Cons: No upside beyond contractual payments. Investment Mechanics Companies raise equity via IPOs or SEOs. Secondary market: ○ Ownership changes between investors; companies don’t receive proceeds. Major players: ○ Exchanges: Facilitate trading (e.g., NYSE, NASDAQ). ○ Brokerages: Enable individual trading (e.g., Charles Schwab, Fidelity). ○ Investment Companies: Manage funds on behalf of clients. Pricing and Profits Brokers and exchanges earn via: ○ Commissions, fees, order flows, and data sales. ○ Exchanges also charge listing and membership fees. FinTech in Equity Investing Robinhood Example: ○ Zero commissions; easy IPO access; user-friendly interface.  ○ Revenue sources: Payment for order flow, subscriptions, lending, interchange fees. ○ Issues: Less guidance; broad access to risky investments. Borrowing: What is Borrowing? Borrowing transfers money from the future self to the present self. Requires facilitators (e.g., banks, investors) due to: ○ Risk (default). ○ Liquidity (access to funds). ○ Matching and monitoring costs. Borrowing Practices Individuals: Credit cards (~25%), loans (~15%), family, etc. Businesses: ○ Small: Credit cards (~20%), bank loans (~12%), equity. ○ Large: Bank loans (~7%), public debt (~5%), equity (~7%). Role of Banks Matching: ○ Assess creditworthiness via credit checks, debt-to-income ratios, and collateral. ○ Centralized savings and borrowing location. Monitoring: ○ Ensures repayment via financial reviews and repossessions. ○ Adds efficiency but incurs costs. Challenges Underserved demographics (e.g., reliance on FICO scores). Systemic risks from centralized decision-making. Balancing costs, fairness, and monopoly risks. FinTech Solutions Crowdfunding: Direct borrower-lender interaction (e.g., LendingClub, Prosper). ○ Faster funding, more flexibility, higher costs. ○ Models: Marketplace: Loans filtered and sold to investors. Balance Sheet: Investors pick loans directly.  Non-Investment Options: ○ Donations: Platforms like GoFundMe (no returns expected). ○ Rewards: Platforms like Kickstarter (product/service promised). LendingClub Example Allows savers to select loans. Borrowers provide financial information; lenders diversify portfolios. Issues: Often unsecured, higher risk. Blockchain: A digital ledger distributed across multiple computers that records all transactions securely and transparently. Double Spending Problem: The risk of spending the same digital currency twice. Blockchain prevents this by verifying every transaction. Each Bitcoin can be traced from its creation to its current owner Decentralization: Decision-making and data are spread across many nodes instead of being controlled by a central entity Ledger: A digital record-keeping system that keeps track of all transactions Pseudonymity: Using addresses or digital identities that are not directly tied to a real-world identity Private Keys: A secret code that allows you to access and control your digital assets. unlocks the ability to send money from that address. Think about it as a signature that verifies that you approved the transfer of funds Mempool: A temporary waiting area for unconfirmed transactions in the blockchain Blocks: Units of data containing multiple transactions, forming the blockchain. Mining: The process of validating and adding new transactions to the blockchain, often rewarded with coins. Validating: The act of checking if transactions are legitimate according to the blockchain’s rules. Consensus Mechanism: A method used by blockchain networks to agree on the state of the ledger. Examples include Proof of Work and Proof of Stake. “The set of ideas, protocols and incentives that enable a distributed set of nodes to agree on the state of a blockchain” Proof of Work: A consensus mechanism where miners solve complex puzzles to validate transactions and secure the network Proof of Stake: A consensus mechanism where validators are chosen based on the amount of coins they hold and are willing to "stake" as collateral. Staking: Locking up coins to help validate transactions in Proof of Stake networks, earning rewards. Bitcoin: The first and most popular cryptocurrency using blockchain technology. Based around facilitating payment in bitcoin Ethereum: A blockchain network known for enabling smart contracts and decentralized applications (DApps). NOT created for a P2P payment system, though it can be Ether: The native cryptocurrency of the Ethereum network. serves as the currency to complete any digital transaction on the Ethereum blockchain Coins: Digital assets that operate on their own blockchain (e.g., Bitcoin, Ether) Tokens: Digital assets created on existing blockchains (like Ethereum) but don't have their own network. NFTs (Non-Fungible Tokens):Unique digital assets representing ownership of specific items like art, music, etc Decentralized Applications (DApps): Applications built on blockchain networks that operate without central control Smart Contracts: Self-executing contracts with terms directly written into code on the blockchain. Gas Fees: price paid for each blockchain transaction to miners to incentivize maintaining the blockchain Tips: Additional fees users can pay to prioritize their transactions. Oracles: Services that provide real-world data to smart contracts on the blockchain. serves as the bridge between the blockchain and the real-world Oracles obtain data from reliable sources in the real world and bring that information onto the blockchain Forks: Updates or splits in a blockchain that result from changes in its protocol. They can be hard (major change) or soft (minor change). instances where one blockchain is divided into multiple blockchains due to a disagreement in consensus Burning: Permanently removing tokens from circulation to reduce supply. Minting: Creating new coins or tokens on the blockchain. Exchanges: Platforms where you can buy, sell, and trade cryptocurrencies. Coinbase: A popular centralized exchange where users can buy, sell, and trade cryptocurrencies. Uniswap: A decentralized exchange using an automated market maker model instead of traditional order books Liquidity Pool: A pool of funds that enables trading on decentralized exchanges by providing liquidity. Constant Product Rule: An algorithm used by Uniswap to set prices based on the size of liquidity pools. Slippage: The difference between the expected price of a trade and the actual price due to market changes or low liquidity. Stablecoins: Cryptocurrencies designed to maintain a stable value, usually pegged to a fiat currency like USD. Collateral: Assets that back or secure a loan or a stablecoin. Collateral Ratio and Collateral Factor: Ratios indicating how much collateral is needed to secure a loan. A higher ratio means more collateral Vaults: Secure storage for digital assets or a mechanism for issuing stablecoins backed by collateral. MakerDAO: A decentralized protocol behind DAI, a stablecoin pegged to the USD. USDC: A widely used stablecoin pegged to the USD DAI: A stablecoin created by MakerDAO, pegged to the USD, but backed by crypto collateral. Compound: A DeFi protocol that allows users to lend and borrow cryptocurrencies. Leverage: Using borrowed funds to increase potential returns on an investment. Perpetual Futures: A type of futures contract without an expiry date, allowing continuous trading based on an underlying asset dYdX: A decentralized exchange focusing on derivatives like perpetual futures and margin trading. Purpose of a Blockchain A blockchain is a decentralized, distributed ledger that securely records transactions across many computers. Its primary purpose is to ensure transparency, security, and immutability without the need for a central authority, reducing the risk of fraud and manipulation. Centralized vs. Decentralized Ledgers Centralized Ledger: A single entity (e.g., a bank) controls the ledger. All transactions are validated and stored by this central authority. Decentralized Ledger: Multiple participants (nodes) maintain a distributed ledger. No single party controls the network, ensuring greate security and resilience. Steps for a Transaction to Be Added to a Blockchain  1. Transaction Initiation: A user initiates a transaction (e.g., sending cryptocurrency). 2. Broadcasting: The transaction is broadcasted to the network of nodes. 3. Validation: Nodes validate the transaction based on predefined rules. 4. Block Formation: Validated transactions are grouped into a "block." 5. Mining/Proofing: Miners or validators confirm the block through a consensus mechanism (e.g., Proof of Work or Proof of Stake). 6. Addition to Blockchain: The block is added to the blockchain, and the transaction is complete. Proof of Work vs. Proof of Stake Proof of Work (PoW): Miners solve complex mathematical puzzles to validate transactions and add blocks to the blockchain. It requires significant computational power and energy. Proof of Stake (PoS): Validators are chosen to create new blocks based on the number of coins they hold and are willing to "stake" as collateral. It’s more energy-efficient than PoW. Bitcoin vs. Ethereum Blockchains Bitcoin: A decentralized digital currency focusing on secure, peer-to-peer transactions. It uses a PoW consensus mechanism. Ethereum: A blockchain that supports smart contracts and decentralized applications (dApps). Ethereum is transitioning from PoW to PoS to improve scalability and energy efficiency. Buying and Selling Cryptocurrency Buying: Cryptocurrencies can be bought through exchanges using traditional money or other cryptocurrencies. You set up an account on an exchange (e.g., Coinbase), deposit funds, and purchase the crypto. Selling: To sell, you place a sell order on the exchange. Once matched with a buyer, the exchange transfers the cryptocurrency to the buyer and funds to your account. Exchange Rates and Arbitrage Exchange Rates: The price of one cryptocurrency relative to another or fiat currency. It fluctuates based on supply and demand. Arbitrage: The practice of exploiting price differences for the same asset across different exchanges. Traders buy at a lower price on one exchange and sell at a higher price on another, making a profit. How Stablecoins Maintain Their Peg Stablecoins are cryptocurrencies designed to maintain a stable value, often pegged to fiat currencies (like USD). This is achieved through: Collateralization: Backed by reserves of fiat or other assets. Algorithmic Mechanisms: Adjust the supply of stablecoins in circulation based on demand to maintain the peg. Purpose of Vaults and Liquidity Pools Vaults: A platform where users lock up their cryptocurrency in exchange for rewards, usually through yield farming or staking. Liquidity Pools: A collection of funds provided by users to facilitate trading on decentralized exchanges (DEXs). Users earn fees or rewards in return for supplying liquidity. Borrowing on a Blockchain Blockchain-based borrowing allows users to lend and borrow cryptocurrencies without intermediaries. Using smart contracts, users can provide collateral (usually in crypto) and borrow assets. Borrowers must repay the loan with interest; if they default, collateral is forfeited. Basics of Perpetual Futures Perpetual futures are derivative contracts that allow traders to buy or sell an asset at a specified price without an expiration date. They are typically used for speculating on the future price of cryptocurrencies. Unlike traditional futures, they don’t have a set maturity date and are usually settled through periodic funding fees between buyers and sellers. Discussions: - Buy Now, Pay Later (BNPL) has emerged as a significant innovation in the FinTech landscape, driven by the rapid growth of online shopping and consumer demand for flexible payment solutions. Unlike traditional credit cards, BNPL offers short-term financing options for consumers to split purchases into installment payments, often interest-free if paid on time. - Artificial Intelligence (AI) is poised to revolutionize education by enhancing learning experiences, improving access to resources, and tailoring instruction to individual needs. The video explores various ways AI could reshape education and highlights potential opportunities and challenges as it integrates into learning environments. - The video explores the growing trend of cobranded credit cards and focuses on a case study of the BILT card, a unique partnership between the fintech startup BILT and Wells Fargo. This card allows renters to earn rewards on their rent payments, an innovative way to bridge the gap between essential monthly expenses and financial rewards. - The video delves into the growing crisis of crypto scams, particularly focusing on schemes like "pig butchering" in which scammers build trust with their victims over time before encouraging them to invest in fraudulent cryptocurrency opportunities. These scams have resulted in billions of dollars in losses, with victims often unable to recover their funds due to the global and sophisticated nature of the operations. - The video explores Chime, a digital-only banking company that offers a fee-free alternative to traditional banks. As a leader in the fintech space, Chime simplifies banking by providing essential services like checking accounts, savings accounts, and debit cards without the typical fees associated with conventional banks. The video highlights the company’s growth and appeal, particularly among younger and tech-savvy consumers. - In this TEDx talk, Soumya Choudhury explores the potential of blockchain technology to transform supply chain management by improving efficiency, transparency, and security. Blockchain, a decentralized digital ledger, offers significant benefits by ensuring secure, transparent, and tamper-proof tracking of goods and transactions across global supply chains. Choudhury highlights how blockchain can address key challenges like fraud, counterfeiting, and inefficiencies, which are prevalent in traditional supply chains. - the article discusses seven key legal issues fintech companies face, such as data privacy, compliance, fraud prevention, and intellectual property. It highlights the importance of adhering to regulatory frameworks, using AI ethically, and ensuring cybersecurity. Additionally, it notes the need for fintechs to manage risks related to hacking and market manipulation. For consumers, it emphasizes the role of compliance regulations in safeguarding personal financial data and securing digital transactions. - The video about Dogecoin covers its origins as a meme coin, inspired by the popular Doge meme. Initially created as a joke, Dogecoin gained traction due to its community-driven nature and support from influencers, like Elon Musk. It has no specific utility compared to other cryptocurrencies but has become a speculative investment. - Robo-advisors are transforming investment management by using machine learning and AI to create personalized portfolios based on financial goals, risk tolerance, and time horizons. The article compares robo-advisors with traditional financial advisors, emphasizing that while robo-advisors are efficient and cost-effective, they lack the personalized touch of human advisors. - The video "Predatory Gamification of Investing" explores how trading platforms, particularly Robinhood, use game-like features to encourage more frequent trading.  While this makes investing more accessible and exciting, it can also lead to risky behavior, particularly with complex instruments like options. The gamification strategy boosts user engagement but often at the cost of users' financial well-being. - The article discusses the collapse of Synapse, a fintech middleman, which left over 100,000 Americans with frozen accounts. The bankruptcy highlighted risks in the fintech space, particularly the lack of regulatory oversight. - The article highlights the rise of P2P payment apps like Venmo, CashApp, and PayPal, driven by consumer demand for convenience and instantaneous transactions. These apps offer features like storing money, credit products, and direct transfers. However, they also carry risks, such as fraud, security vulnerabilities, and lack of regulation. - In the video, Steve Armato from Amazon explains how generative AI is used to improve delivery times and logistics efficiency, such as optimizing the supply chain, inventory placement, and route planning. This advanced technology allows Amazon to stay ahead of competitors by offering personalized recommendations and enhancing customer service with AI-driven tools like Rufus. However, the use of AI raises concerns about privacy, as data is collected for personalized experiences, which could lead to increased scrutiny and regulation to protect consumer privacy. - The article discusses how insurance companies are using telematics and data from automakers and smartphone apps to track and rate drivers, creating more personalized insurance rates. However, this raises ethical concerns about privacy, whether consumers understand the terms, and fairness in the system. - The video discusses Abalobi, a fintech non-profit in South Africa that supports sustainable fishing practices, improving local fishermen's lives by connecting them directly with customers. - The video discusses tokenizing real-world assets (RWAs), focusing on real estate, gold, and other assets using blockchain. Companies like Homebase allow fractional ownership of properties, while others like Pax Gold and Centrifuge focus on different tokenized applications. - The article explains how a U.S. Central Bank Digital Currency (CBDC) could work, acting as a blockchain-based version of the U.S. dollar. It outlines potential advantages like improving cross-border payments and financial inclusivity, but also highlights disadvantages such as privacy concerns and risks to the financial system's stability. It’s a significant development in the context of global digital currency discussions. - The article discusses JPMorgan Chase's response to a Consumer Financial Protection Bureau (CFPB) probe regarding fraud prevention on the Zelle platform. JPMorgan claims the CFPB is overstepping, as their efforts focus on whether banks are doing enough to prevent fraud and educate consumers. The discussion centers around transaction integrity, fraud detection responsibility, and the role of financial institutions in protecting consumers. - The article examines how social media has reshaped stock market trends by influencing investor behavior. It highlights how social media posts and influencers, including figures like Elon Musk, can significantly impact stock prices. The piece also provides case studies of investments influenced by social media discussions. - The article from McKinsey explores how generative AI is being used in credit risk management to streamline processes such as underwriting, portfolio monitoring, and customer engagement. The technology offers efficiency gains but also introduces challenges like data quality issues and governance concerns. - The McKinsey article explains Proof of Stake (PoS), a blockchain consensus mechanism that is more energy-efficient than Proof of Work (PoW). It involves staking cryptocurrency to validate transactions, and the more a user stakes, the higher their chances of being selected to validate blocks. PoS is seen as a more scalable and eco-friendly alternative, with platforms like Ethereum transitioning to it. - The article explores how technologies like blockchain, AI, and augmented reality are reshaping online sports betting. It covers how these innovations improve transparency, security, and user engagement, but also raises ethical concerns related to gambling. The integration of cryptocurrencies offers privacy benefits but may lead to regulatory challenges. - The article explains how Python is revolutionizing the finance and fintech industries. Its simplicity and flexibility make it ideal for handling complex financial tasks, like data analysis, risk management, and algorithmic trading. Python's extensive libraries support these tasks, making it a favored language for developers in finance. Popular fintech apps like Robinhood and Stripe utilize Python for quick prototyping and robust data science applications.