Reading 1.3 Flashcards
3 stages of Financial Services
1) FS 1.0 - traditional financial institutions serve as intermediaries, bring together buyers and sellers to trade financial assets
2) FS 2.0 - Fintech automates traditional financial services, orders placed over a network with financial intermediaries
3) FS 3.0 - DeFi, uses smart contracts on blockchain and provides P2P fin services
WEB 3.0
3rd gen of WWW on distributed ledger tech (DLT) = decentralized interconnected protocols, privacy preserving and blockchain technology
Tokenization definition
Issuing a token that is a digital representation of an asset, secured on the blockchain
Fungible and non fungible
Fungible - indistinguishable from each other and mutually interchangeable (ex USD bill)
Non fungible - unique, not interchangeable (ex diamonds)
DeFi shifts the industry from who to whom?
From “oligarchies” underpinned by fiat currency to digital “cooperatives”
2 classifications of DeFi
1) Contemporary - current state of DeFi - tokenization of traditional financial services
2) Universal - potential DeFi - tokenization of any asset and trading on specialist P2P network
Initial Exchange offering
Public Offering of tokenized securities
Where is financial regulation now and where will it be with DeFi?
1) Now: focuses on intermediaries
2) Future: Focuses on registered platforms
Ownership economy
Economic system in which participants also hold ownership or financial stake in the system
Decentralized data (DeData)
Tokenized data - which addresses society’s concern about issues of ownership, privacy and personal data monetization
Decentralized applications (DApps)
Applications built on Web 3.0 using tokenization, smart contracts, other decentralized computing and storage protocols
Traditional vs Decentralized Finance on
Economy, financial services, assets, money, control, data ownership, infrastructure
1) Corporate economy vs Ownership economy
2) Intermediary-based vs Peer-to-peer
3) Securities vs Tokenization of any digital or physical asset
4) Fiat currencies vs Cryptocurrencies and tokens
5) Big corporates vs Consumers
6) Corporate vs Citizen
7) Web 2.0 + cloud vs Web 3.0 + blockchain
3 stages of DeFi
1) DeFi 1.0 - bitcoin era: basic cryptocurrency transactions, slow, expensive
2) DeFi 2.0 - fintech era: automates traditional financial services using blockchain and tokenization
3) DeFi 3.0 - web 3.0: a future decentralized economy with a system of blockchains and protocols
Crypto coin vs Blockchain token
1) crypto - digital currency (all coins)
2) blockchain token - digital asset created, traded and stored in digital format (meta data)
6 different roles of tokens
1) asset tokens - backed by physical or digital asset
2) payment tokens - crypto coins
3) security tokens - digital shares issued at ICOs
4) Utility tokens - access to a certain blockchain based product or service
5) governance token - decision making rights among token holders
6) reward tokens - rewards for participation
Data economy
Digital environment where data is organized so that is can be bought and sold
Differences between Web 1,2,3?
1) access: read only, purpose: connecting info, content: curated by experts, web type: simple
2) access: read-write, purpose: connecting people, content: blogging and social media, web type: social
3) access: read-write-execute, purpose: connecting vaue, content: peer to peer, web type: tokenized
DID definition
Decentralized Identifiers that enable verifiable, decentralized digital identity of any object
Developed by the W3C (www consortium)
DOI definition
Digital object identifiers - used to identify things on the internet and resolve their location
UOI Def
Universal Object Identifier - all digital and physical identifier - USED IN NFTs
Edge computing and storage
Data is processed on the periphery (users PC) as close as possible to the source of data (instead of a central data center)
IPFS def
Interplanetary File System - decentralized distributed across a web3 peer file sharing system
Not efficient for large size files
The file is divided into smaller segments and distributed across several IPFS peers
Federated Learning
Machine learning technique that trains models at the edge (instead of in the central location) using distributed datasets WHILE MAINTAINING DATA PRIVACY
Because the data does not leave the owner
Differential privacy
Providing privacy while using the dataset for analysis without revealing personal info
Difference between Distributed Ledger Tech and Blockchain
DLT - is the parent technology of blockchain, could be seen as a database
Blockchain builds on DLT
Properties of DLT
A distributed ledger is a database that is shared and synchronized across multiple sites, institutions, or geographies; often accessible by multiple users.
Properties:
i. Distributed - All network participants have a copy of the ledger for transparency.
ii. Unanimous - All network participants agree to the validity of each record.
iii. Immutable - All validated records are irreversible (i.e., cannot be changed).
iv. Time-stamped - Each transaction has a timestamp recorded on a block in the network.
v. Anonymous - Participants’ identities are either anonymous or pseudonymous.
vi. Secure - Each record is encrypted.
vii. Programmable - Blockchains are programmable (using smart contracts).
Types of blockchain
- Public blockchain - This is a (permissionless) blockchain network in which anyone can join (e.g., Ethereum).
- Private blockchain - This is a (permissioned) blockchain network controlled by a single authority. In private blockchains, some private transactions may only be seen by those with permission.
3) Hybrid: This is a mix of a public and private blockchain, thus uses a mix of decentralized and centralized mechanisms: it is a public blockchain where a private blockchain network is “pegged.” - transaction data verified publicly, stored privately with those who have access
4) Consortium Blockchain (Federated blockchain) - permission-less blockchain governed by group of entities
5) Sidechain - parallel to the primary blockchain & can operate independently
Blockchain Security elements:
1) Cryptography - (asymmetric cryptography and Zero knowledge proof) is used) maintain:
- integrity
- confidentiality
- privacy
- authentication
- non repudiation (inability to deny)
2) Consensus mechanism - fault tolerant - validates transactions written onto the blockchain
3) Incentivization - honesty is rewarded
Asymmetric cryptography
Using 2 keys:
1) private key to encrypt
2) public key to decrypt
Consensus mechanism elements
Byzantine fault tolerant consensus mechanism:
1) PoW (proof of work) - solve complex problem
2) PoS (Proof of stake) - miners take a stake in the digital currency to prove transaction
3) DPoS (Delegated proof of stake) - miners vote and elect delegates who validate transactions
2 substacks of the DeFi technology stack
1) infrastructural substack: tools & services on top of which DeFi services are built
2) Functional substack: interoperable financial services, each layer provides greater customization
FCA
Financial Conduct Authority
Financial regulatory body in the UK
CBIRC
China Banking and Insurance Regulatory Commission
Now called the National Administration of Financial Regulation
2 key trading technologies
1) Central Limit order books (CLOBs) - electronic list that matches clients orders for a security organized by price
2) Multi-dealer Platforms (MDPs) - non exchange financial trading platforms that enable trade matching - gain access to a range of prices
SDPs
Single Dealer Platforms - portals via which traders gain access to prices from one dealer
5 stages of electronic trading
1) Data access
2) Pre-trade (data) analysis. 3 models used:
3) trading signal generation - identification of portfolio to be constructed based on pre trade analysis
4) Trade Execution - using CLOB
5) Post Trade Analysis - analysis of trade results
3 models used in Pre-trade (data) analysis
1) Alpha model - forecasts best potential returns
2) Risk Model - evaluates risk associated with an investment
3) Traditional cost model - cost of all assets potentially bought or sold
Slippage
The difference between the expected price of a trade and the price at which the trade is executed.
3 main types of decentralized crypto exchanges and examples
1) AMMs - Automated Market Makers - direct trading between users using smart contracts. Data is provided by blockchain oracles
EX: Uniswap and Balancer
2) Order Books DEXs - on chain (Bitshares & StellarTerm) and off chain (Binance DEX & EtherDelta).
3) DEX aggregators - use several DEXs to offer traders the best price, minimal slippage, optimized fees. Try to solve 1) liquidity 2) protecting from pricing effects 3) reducing chance of failed transaction (dYxY & PancakeSwap)
DeFi exchange issues
1) low liquidity
2) Speed: DEX is slower than CEX due to blockchain tech
3) Fees - can be costly
4) Blockchain interoperability - additional aggregators needed to enable switching between blockchain platforms
5) Fairness - subjects to market manipulation
6) Smart contract errors
7) Regulation
VC Funding process
- Fundraising launched by early-stage company
- Funding/ deal sourcing and pitch to venture capitalists
- VC selection/ valuation of funding opportunities
- VC investment in return for equity
- Post-investment activities (e.g., product and financing strategies)
- VC exit via sale of stock, acquisition, or IPO
Traditional funding strategies
1) Bootstrapping - A company founder starts and expands a business using his own money or the company’s revenue.
2) Angel investment - Money is invested in a start-up in exchange for a minority stake.
3) Venture capital - Capital provided to start-ups in exchange for equity.
4) Business incubators and accelerators - These entities may provide funds, expertise, and mentoring in exchange for a small equity stake.
5) Grants - Funding is provided by public-sector grants or loans.
6) Acquisition (or trade sale)
- Initial public offering (IPO)
VC firms and angel investors face several challenges.
- Competition - Investors compete to identify the next high-growth start-up.
- Valuations - Startups typically do not know their valuation that will match venture capitalists’ expectations.
- Failure rate - Investors lose money since 90% of start-ups fail in their first three years.
• For this reason, venture capitalists seek to invest in start-ups with large, quick exit potential. - Technical expertise - Venture capitalists need access to technical expertise for valuation and selection.
- Investment lock-in - Venture capitalists may be subject to a period when their investments cannot be redeemed or sold.
- Raising next fund - Venture capitalists have the challenge of raising future funds.
Tokenized investing benefits
- Increased liquidity for startups
- lower risk for investors
- faster settlement
-improved risk management
Exchange offering
Public offering of digital assets sold via and underwritten by security token exchanges
Tokenized fund definition and types
Investors subscribe for tokens that represent interest in the fund
Types:
1) open ended - no limit on number of investors and number of tokens issued
2) closed ended - issue a fixed number of units
STO definition and benefits
1) Security Token Offering = ICO on a security token exchanges
2) Regulated and have potential to provide significant efficiencies
UTO
Utility Token Offering = raising capital through selling access to the service
PTO
Platform Token Offering - platforms to serve as underwriters for their participants and start ups
Policy actions with regards to Fintech innovations
1) Regulatory sandbox - allows DeFi to develop under regulatory oversight
2) Guidance - issuing guidance for the companies while working with them, public bodies and public
3) Legislation
4) Enforcement
CBDC and how would it help with fintech regulation?
Central Bank Digital Currency
It would be integrated into the DeFi products and services and allow for control from CBs
Enforcement 4 levels of mediation
i. Warning companies to comply or users concerning risks.
ii. Exemping regulations in return for certain protections.
ili. Prohibiting certain activities in the DeFi sector.
iv. Enforcing legal requirements when not complied with.
2 components of DeFi regulation
1) DeFi Fintech
2) DeFi RegTech - police decentralized finance
6 categories of DeFi risks according to WEF and examples
1) consumer - asset volatility, fraud
2) financial - market, counterparty and liquidity risk
3) technical (software failure) - transaction, smart contract, miner and oracle risk
4) operational (governance) - maintenance, forks, key management, redress of disputes
5) legal compliance - market manipulation, fraud, products to be banned
6) emergent (undermining of the financial system) - flash crashes, destabilizing financial markets
