Blockchain & Money: Session 10: Financial System Challenges & Opportunities by M.I.T. Sloan School of Management with Professor Gary Gensler

• Session 10 Study Questions:
  • What are the tradeoffs of centralized institutions and markets in the financial sector?
  • Which challenges of the financial sector–periodic crises, concentrated risks, economic rents, legacy systems, processing risks, financial inclusion–might present opportunities for blockchain applications?
  • How does blockchain technology fit within other trends–particularly with regard to technology–facing the financial sector in 2018?

• Session 10 Readings:
  • ‘Top financial services issues of 2018’ PwC Financial Services Institute
  • ‘Sheila Bair on What Hasn’t Changed since the Great Recession’, New York Magazine.
  • ‘The Rise of Market Concentration and Rent Seeking in Financial Sector’, Zhang.
  • Optional: ‘Ten Years after the Crash, We are Living in a World it Brutally Remade’, New York Magazine.

Overview: Finance & Financial Institutions; Finance & Regulation; Finance & Technology; Credit & Capital Markets; Financial Sector Risk Management and Crises; Financial Sector Opportunities; Conclusions.

Regulation & Law & Consolidation happening in many industries (i.e.–from local drugstores to chains like CVS.) Banking also went through this. The U.S. did NOT have interstate banking until the 1970’s. In 1994 national banking became a thing. And then in 1999 we had the combination of commercial & investment banking allowed together.

What is the Role of Finance?

Moving, Allocating, & Pricing: Money & Risk

• Financial Institutions: Intermediaries of Financial Assets & Liabilities.
  • Functions
    • Investments (aka store of value)
    • Credit (aka borrowing value)
    • RIsk Transformation
    • Advice regarding Financial Assets & Liabilities
  • Sectors
    • Commercial Banks & Credit Unions
    • Investment Banks & Brokerage Firms
    • Insurance Companies & Underwriters
    • Collective Investment Vehicles, Mutual Funds, Pension Funds, & Annuities
    • Asset Managers & Financial Advisors
    • Exchanges, Clearinghouses, & Settlement Organizations

Financial Markets

• Primary Markets
• Secondary Markets
  • Exchange Trading
  • Over the Counter
• Asset Management
• Market Infrastructure

Finance has 1). Ledgers (a record of transactions!), and 2). Payment & Settlement Systems.

***Ledgers matter to Blockchain, and Blockchain matters to ledgers!

*** When you’re keeping a record of things of value, then the immutable nature of Blockchain becomes more relevant! –Prof Gary Gensler

Ledgers–records economic activity & financial relationships; records transactions & accounts.

Payment & Settlement System–method to amend & record ledgers for money & financial assets; Authorizing, Clearing & Recording Final Transfers of Value;

Finance & Regulation–Finance has long been subject to Public Policy debates & regulation.

We don’t have regulation because of blockchain, and we don’t necessarily need a new set of regulations. Its because finance is so central to economies, we’ve been grappling with regulation for a longtime.

Finance & Technology–finance has long been in a symbiotic relationship with the technology of its time. Blockchain is just in this log history, a part of it, a continuation of that relationship. Finance, Regulation, & Technology have had this intertwined relationship throughout history.

Central Banks came along initially in the late 17th century (late 1600’s) as a check on the sovereign (the ruler) in terms of currency. If the currency could be de-valued from inflation, that could lead to instability.

Ledger System–relies on a system of ledgers. Relies on one big ledger at the Central Bank, and then every commercial bank has a reserve account, and that reserve account is the master ledger at the Central Bank, in essence.

• Technologies of our Time Affecting Finance:
  • A.I. and M.L.
  • Blockchain
  • Cloud
  • Open API
  • Biometrics
  • Chatbots
  • Mobile
  • RPA

Credit–borrowing money or value with an agreement to repay in the future.

• Financial Sector Risk Management:
  • Market–Price, Rate, Spread, Basis, Volatility.
  • Credit
  • Underwriting
  • Liquidity–how quickly to turn into cold hard cash?
  • Funding
  • Settlement
  • Model-Correlation
  • Operational & Cyber
  • Legal & Compliance
  • Reputational
  • Systemic

• Financial Sector Crises:
  • Latin American Debt Crisis–late 1970s
  • Continental Illinois–1984
  • Black Monday–1987
  • Savings & Loan Crisis–1986-1995
  • Asian & Russian Debt Crisis–1997-1998
  • Subprime Mortgage Crisis–2008
  • European Debt Crisis–2009-

• 2008 Financial Crisis:
  • Weak Underwriting & Predatory Lending
    • Subprime Mortgage Crisis & Housing Bubble
  • Easy Credit & Financial Derivatives
    • Increased Leverage & Interconnectedness
  • Poor Risk Management & Incentive Structures
    • Many Vulnerable Financial Institutions
  • Multiple Failures
    • Systemic Loss of Funding & Liquidity
    • Contagion & Near Collapse in Highly Interconnected System.

• Financial Sector –> Opportunities
  • Legacy Customer Interface, Data & Processing Systems;
  • Economic Rents
  • Concentrated Risks
  • Infrastructure Systems’ Costs & Counterparty Risks
  • Periodic Crises & Instability
  • Financial Inclusion
  • Wide Acceptance & Adoption of New Tech
  • Rapidly expanding customer data
  • Financial sector costs: 7.5% of U.S. GDP
  • Payment system costs: 1/2-1% of Global GDP

• Financial Sector Potential Use Cases:
  • Payment Systems–Cross border, Large interbank, & Retail
  • Central Bank Digital Currency & Private Sector Stable Value Tokens
  • Secondary Market Trading–Crypto-exchanges & custody
  • Venture Capital–Crowdfunding through Initial Coin Offerings
  • Clearing, Settlement and Processing–Securities & Derivatives

Biblio:

• Gary Gensler. 15.S12 Blockchain and Money. Fall 2018. Massachusetts Institute of Technology: MIT OpenCourseWare, https://ocw.mit.edu. License: Creative Commons BY-NC-SA.

Video Link: Session 10: Financial System Challenges & Opportunities