Blockchain and FinTech

Lecture 1 Arash Aloosh

NEOMA Business School - 2021
A disruptive subject needs
a disruptive pedagogy
Mutual learning not conventional teacher-student leaning
I will only teach you the basic and big picture. Then, you will be divided into
groups to study different subjects and teach each other about your subjects
• Each group will perform research for a deeper understanding of a part of
the subject. To begging with, you need to come up with interesting
research questions
• Then you will need to collect information and categorize them
• Finally you need to effectively transfer your knowledge to me and your
classmates through presenting your research questions and findings
Audiences should ask clarification questions to help our mutual learning!
A finance course dedicated to soft skills
Networking
• Approaching professionals: getting their attention, involving them in your
project, interview them in a class intervention
Interviewing professionals
Invite and interview professionals in a our class
Presenting Conceptuals
Conceptual vs Conventional
Asking relevant questions
Bottomline: it is important both for your own project and for our mutual
learning (to help all of us better understand each subjects). This is an
important skill for your future career and your social impacts
Course Objectives
• Understand the impact of recent technological advances on the fast-
changing financial industry

• Understand the core of blockchain technology and its potential

applications

For the given regulations, better financial services and products:

Cheaper, Faster, and More Inclusive

• Develop technical, financial and strategic skills to analyze the FinTech

industry
Course Menu
• Introduction to financial markets and products
(Back up before learning about a complex ecosystem of FinTech start-ups,
Banks, and tech giants like Facebook, Amazon, Google, Orange and etc.)

• Digital finance and financial technology (FinTech)

• Introduction to Blockchain and Cryptocurrencies

• Blockchain applications: Bitcoin, ICOs, KYC, Trade Finance and etc.

Grading
Group work is not graded. It is only to help you in
studying and understanding the subject.
Otherwise every thing is graded individually in
this class.

Two Oral Presentations (Group project plus

individual project) and class participation: 60%
Final Exam (either a case study or a report): 40%

• Group project: Analyzing FinTechs

• Group of around 4-5 students and pick one FinTech sector
• Present the sector and analyse the major start-up/company in the sector
https://docs.google.com/spreadsheets/d/1HNQ-
las7HgLqTYdm1ENcVE7YRZLCvu1ZupoHqWTjrtg/edit?usp=sharing
Contact a start-up in the sector, interview them and invite them to an online class intervention
• Be active in the class!
Grading
Individual project

• Analyzing French and Foreign Tokens (individual work)

• Analyze a token; google it… on the “ICO bench” or other websites
• Present one token and analyse it using course materials and discussions
• Consider its competitors and criticize its potential weakness and cons
• Be active in the class!
Course Readings
• Lecture Notes and other materials on Courses
• For FinTechs, you can visit:
https://francefintech.org/wp-
content/uploads/2020/01/Panorama_fintech_francaises_2020-
1.pdf
Note: the above link includes some French FinTechs. You may go
beyond these FinTechs.
• For cryptocurrencies, you can visit:
https://icobench.com/
https://www.tokendata.io/ (for the failed tokens)
• Other references:
• Frederic Mishkin, Stanley Eakins (2011), Financial Markets and
Institutions, Pearson Education
• Also check the syllabus
Our Interaction
• What can you expect from me?
• To do my best in making the course interesting.
• To be gladly available for you.
• To listen to your wishes, suggestions, etc.
• What else do you expect? Say it now!

• What do I expect from you?

• To learn from you!
“You need to learn something about blockchain and FinTech and then
teach me and your classmates.”
• Final goal of this class: learn to ask good questions.
Questions are more important than the answers!!!

Deal?
Traditional Financial Markets
• Why do the financial markets exist?

• What are the major financial markets?

• What are the major impacts of financial markets?

Global Financial Market

Source: McKinsey Global Institute, Haver, BIS, Deutsche Bank estimates

Global Foreign Exchange Markets
Financial Institutions/Intermediaries

• Private financial intermediaries:

Banks (commercial, saving, investing, credit unions and
…), insurance companies, asset managements (mutual
funds, hedge funds, pension funds), and other finance
companies
• Central banks:
Monetary policy: managing interest rates, inflation,
business cycles, and money supply
• Governmental Regulators, supervisors, and NGOs:
SEC, Standard and Poor’s, IMF and etc.
Overviews

Channels of Funds: direct v.s. indirect

1- Structure of financial markets
• Direct Channel (Debt and Equity markets)
Two types of Funds:
a. Debt or mortgage: borrower pays the holder fixed
amounts at regular intervals (interest and principal)
Maturity: the period until the expiration date

b. Equity or Stock: claims to share in the net income and

assets of a business
Dividend: periodic payments of stocks
Overviews
• Primary v.s. Secondary markets
Primary market: a market to trade new issues of a stock or
bond
It is often traded behind closed doors by investment banks!
Secondary market: a market to trade securities that have
been previously issued
It is traded by brokers and dealers
Overviews
• Exchanges v.s. Over-The-Counter markets
Exchanges: markets where buyers and sellers of securities
meet in one central trade location
e.g., NYSE, Euronext Paris, and LSE
Over-The-Counter (OTC): at different location, each dealer
has an inventory of securities to trade
e.g., U.S. government bonds and foreign exchanges
Overviews
• Money v.s. Capital markets
Money market: is usually for short-term debts (less than one
year)
Capital market: is usually for long-term debts and equities ,
which are less traded and less liquid compared to short-term
debts
Overviews
• International financial markets
Foreign bond: is sold in a foreign country and denominated
in that country’s currency. E.g., Société Générale sells a bond
in the United States denominated in the U.S. dollar.
Eurobond: is sold in a currency other than that of the country
in which it is sold. E.g. Société Générale sells a bond
denominated in U.S. dollar sold in Paris
Eurocurrency: is a foreign currency deposited in banks
outside the home country. Chinese Yuan in the French banks
World stock markets: mutual funds are expert in trading
foreign stocks
Overviews

2- Function of financial intermediaries (FIs)

• Indirect channel for financing
FIs reduce costs of financing! Which costs & how?
Transaction Costs: the time and money in carrying out
financial transactions
Economy of Scale: the reduction in transaction costs per unit
of transaction as the transaction size increases

Is financing a cushy job or a challenging job?

Overviews
• Adverse Selection v.s. Moral Hazard
Information Asymmetry: the information set of two parties
is not the same or complete

Before transaction;
Adverse Selection: a borrower with adverse credit is more
actively search a loan and more likely to get it!
After transaction;
Moral Hazard: a risk (hazard) that the borrower engages in
activities undesirable (immoral) to the lender.
Overviews
• Major Financial Intermediaries
Depository institutions (Banks):
Commercial banks, saving and loan associations, credit
unions
Contractual savings institutions:
Insurance companies, pension and retirement funds
Investment institutions:
Finance companies, Mutual Funds, and Money-market funds
Commercial Banks
• Collect Deposits
• Grant loans
• To individuals (Retail banking)
• To companies (Corporate banking)
• Handle payments
• Heavily Regulated
Balance Sheet
of a Bank
• Total assets = total liabilities + capital

Assets Liabilities (and Capital)

Balance Sheet
of a Bank

Assets Liabilities and Capital

Function of a Bank

Assets Liabilities (and Capital)

Function of a Bank

Assets Liabilities (and Capital)

Function of a Bank

Assets Liabilities (and Capital)

Function of a Bank

Assets Liabilities (and Capital)

Function of a Bank
Thrift Industry

• The regulation and structure similar to the

commercial banking industry. It includes:
─savings and loan associations (S&Ls)
─mutual savings banks
─credit unions
• Idea developed in Germany where a group pooled assets to use a
collateral for a loan
• The loan proceeds were then loaned to members of the group.
• Default was rare since all the group members knew each other.
Mutual Fund

Diversifying:
Do NOT put all your eggs in one Basket!

Suppose you wanted to start savings for retirement, but

you can only afford to invest $100 / month, while many
stocks worth more than 100€ (per share). How do you
develop a diversified portfolio?
Mutual Fund Growth
• At the beginning of 2013, 57% of retirement assets were held by mutual funds.

• 28% of the U.S. stock market and almost 44% of all U.S. households hold stock via

mutual funds.

• Assets held by global mutual funds have grown by about 17% per year for the last
25 years, reaching over $40 trillion in 2017.
...

...
...

...
Money Market Mutual Funds
Global Mutual Funds
Hedge Fund

• A special type of mutual fund that received considerable

attention following the collapse of Long Term Capital
Management.
• Different from typical mutual funds, as follows:
─ High minimum investment, averaging around $1 million
─ Long-term commitment of funds is required
─ High fees: typically 1% of assets plus 20% of profits
─ Highly levered
─ Little current regulation
Insurance Company

• Who prefer NOT to buy Health Insurance?

• Insurance companies assume the risk of their clients in
return for a fee, called the premium.
• Most people purchase insurance because they are risk-
averse; They would rather pay a the premium than accept
a gamble
• Conflict between “medical malpractice insurers” and
“hospital and physician”
Financial Institutions and the
Going Public/Private Process

• Pre-market: venture capital or private equity

• Primary market: investment banks
• Secondary market: securities dealers and brokers
(trading), and investment banks (consulting,
performing Merger and Acquisition)
• Post-market: capital buyout or private equity
Private Equity

• Private equities (PEs) invest in new companies,

buyout existing divisions, etc.
• PE got a boost in 1978 when pension funds were
permitted to invest in PE firms.
Investment Bank
Investment banks play many roles in both the primary
and secondary markets.
• IPO sales: The investment banker purchases the
entire offering at a predetermined price and then
resell the offering (securities) in the market. The
services provided during this process include:
─Giving Advice
─Filing Documents
─Underwriting, Best Efforts, or Private Placement
 Relative Costs of Issuing Securities

Source: Adapted from I. Lee, S. Lochhead, J. Ritter, and Q. Zhao, “The Costs of Raising
Capital,” Journal of Financial Research 19(1) (1996): 59–74.
Largest U.S. IPOs
Top Global IPO Underwriters, Ranked by 2014 Proceeds
Investment Bank
• Equity Sales: when a firm sells an entire division (or
maybe the entire company), enlisting the aid of an
investment banker.
─Assists in determining the value of the division or firm and
find potential buyers
─Develop confidential financial statements for the division
for prospective buyer (confidential memorandum)
─Prepare a letter of intent to continue, assist with due
diligence, and help reach a definitive agreement
Investment Bank
• Merger and Acquisition (M&A):
• Investment bankers may assist both acquiring firms and
potential targets
• Investment bankers will assist in all areas, including deal
specifics, lining up financing, legal issues, etc.
Securities Dealers and Brokers

Securities Brokerage services:

• Securities Orders: when you call a brokerage house to buy
or sell a security.
• Other services: Insurance against loss of actual
security documents, and research and investment
advices.
Securities Dealers services:
• Hold inventories of securities on their own
account
• Provide liquidity to the market by standing by
ready to buy or sell securities (market making)
• Especially important for thinly traded securities
Should there be any supervision or
regulation? Why?
• Regulation of the Financial System
Why the financial system needs regulations?

Some videos:
http://www.investopedia.com/video/play/retail-banking/
http://www.investopedia.com/video/play/investment-banking/
http://www.investopedia.com/video/play/commercial-bank/
http://www.investopedia.com/video/play/what-are-hedge-funds/
http://www.investopedia.com/video/play/introduction-mutual-funds/
http://www.investopedia.com/video/play/financial-intermediary/
Central Bank (CB)
• Central banks are the government authorities in
charge of monetary policy (and fiscal policy).
• In the U.S., the Federal Reserve System (Fed).
• In Europe, the ECB and individual countries central banks.
• Although we typically hear about central banks in
connection with interest rates, their actions also
affect credit, the money supply, and inflation among
others.
Central Bank
• Two competing theories try to explain the observed
behavior of central banks:
─Public Interest View: the central bank serves the public
interest.
─Theory of Bureaucratic Behavior: the central bank will seek
to maximize its own welfare.
European Central Bank (ECB)

• Founded in 1999 and is housed in Frankfurt,

Germany.
• Executive board consists of the president, vice
president, and four members, all serving eight-year
terms.
• The policy group consists of the executive board and
governors from the 19 member countries central
banks.
ECB

• The ECB is the most independent central bank in the

world. It was given independence in the Maastricht
Treaty, and that policy can only be changed by
amending the treaty.
• The treaty set the ECB’s long-term goal as price
stability, so it’s not entirely free to pursue its own
goals.
ECB vs. Fed

Difference between the Fed and the ECB:

• Budgets of the Fed are controlled by the Board of
Governors (BOG), while the National banks that make
up the ECB control their own budgets (and the ECBs).
• Monetary operations are conducted at the national
level, not directly by the ECB.
• The ECB is not involved in bank regulation or
supervision.
• No voting! All decisions are made by consensus.
• Finally, the ECB may actually expand/shrink in the
future, while the Fed obviously won’t.
CB: Monetary Policy
• The management of the money supply.
• Its theories are complex and often controversial.
• We are affected by this policy, and a basic
understanding of how it works is, therefore,
important.
Management of Money Supply
by CBs

• Money supply: buying government bonds (expanding

the money supply) or selling them (contracting the
money supply)
• known as Open Market Operations.
• Alters the amount of money in the economy while
affecting the price of short-term government bonds and
interbank interest rates.
• Money Demand: The price of money is the interest
rate charged to borrowers.
• Known as Discount Rate
• Increasing (decreasing) interest rate lowers (increases) the
money demand
Management of Money Supply
by CBs

• Reserve Requirements: Banks must keep banking reserves on hand

to handle actual cash needs, but they can lend an amount equal to
several times their actual reserves.
• The money lent out by banks increases the money
supply.
• Every bank subject to the same rule for checkable
deposits.
• Rarely used as a tool
• Raising causes liquidity problems for banks
• Makes liquidity management unnecessarily difficult

• http://www.investopedia.com/video/play/monetary-policy/

• In addition to Monetary policy, CBs conduct fiscal policy: refers to

taxation, government spending, and etc.
Other Goals of Monetary Policy

• Goals:
─High employment
─ Want demand = supply, or natural rate of unemployment
─Economic growth (natural rate of output)
─Stability of financial markets
─Interest-rate stability
─Foreign exchange market stability
• Goals are often in conflict
Lessons from
the Global Financial Crisis

• Should Central Banks Respond to Asset Price Bubbles?

• Credit-driven bubbles: yes! But the right tool is not
obvious.
• Optimism-driven bubble: less dangerous and maybe not
necessary! Ex., the tech bubble of the late-1990s.
• Macro-prudential regulation: Increase disclosure and
capital requirements, and close risk-monitoring and
reactions.
• Subject to political pressure
• Institutions are good at finding ways around regulation
Best policy is not clear!!
Corporate Finance
Corporate

Need Money Projects Cash Flow

How Much?

Financial Statements
Source of Finance
Equity and Bond
Or borrowing from
financial intermediaries

58
Financial Risk
• Uncertainty: There is some probability that we do not achieve the
target or the conditions change

The higher probability of deviating from the target, the more risk

• Deviations: the amount of difference between the realized outcome

and the target

The more deviation from the out come, the more risk
Financial Risk Management Products
• Derivative: an instrument whose value depends on, or is derived
from, the value of another asset.
• Derivatives include futures, forwards, swaps, options, etc.
• Why Derivatives? a key to transfer financial risks
• The underlying assets include stocks, currencies, interest rates,
commodities, debt instruments, electricity, insurance payouts, the
weather (20% of the US economy – Nowadays we can trade
Temperature as a commodity), etc.
Example: Futures on Milk Price
• Profit of Company A:
• Production cost of 1 liter of milk= €0.80
• Optimal sale price of 1 liter of milk= €1.00
• Total production of milk= 10000 lit
• Total Profit=

• Profit of Company B:
• Production cost of 1 ice cream = €1.40
• 0.5 lit of milk= €0.50
• Other costs= €0.90
• Optimal sale price of 1 ice cream = €1.50
• Total production of ice cream = 20000 unit
• Total consumption of milk= (20000*0.5=) 10000 liter
• Total Profit=
Ex: Higher Milk Price
• Milk price goes up to 1.30 €/lit
• Profit of Company A:
• Total Profit=
• Profit of Company B:
• Production cost of 1 ice cream = €1.55
• 0.50 lit of milk= €0.65
• Other costs= €0.90
• Total Profit=
Ex: Lower Milk Price
• Milk price goes down to 0.70 €/lit
• Profit of Company A:
• Total Profit=
• Profit of Company B:
• Production cost of 1 ice cream = €1.25
• 0.50 lit of milk= €0.35
• Other costs= €0.90
• Total Profit=
Example: Futures on Milk Price

• Both Companies do not know the future price of milk. While,

They like to fix the future price of milk.
• How?
Financial Innovation
• In recent years the traditional banking business of
making loans that are funded by deposits has been in
decline.
• It has been partially replaced by the shadow banking
and recently the FinTech:
─Response to Changes in Demand Conditions
─Response to Changes in Supply Conditions
─Avoidance of Existing Regulation
Financial Innovation
• Response to Changes in Demand Conditions
• Huge increase in interest-rate risk starting in 1960s
• Adjustable-Rate Mortgages are an example of the reply to
interest-rate volatility
• Introduction of derivatives to hedge risk
• Response to Changes in Supply Conditions
• Major change is improvement in information technology
• From store credit cards (before WWII) to credit cards.
• ATMs, online banking, and mobile apps
• E-money and cashless society (Scandinavians and China)
Financial Innovation
• Response to Changes in Regulations
• Money Market Mutual Funds (MMMFs): allow investors
similar access to their funds as a bank savings accounts, but
offered higher rates, especially in the late 1970s.
• Banks expands lending into riskier areas (e.g., real estate)
• Banks expands into off-balance sheet activities
• Creates problems for regulatory systems
• Risks taken by MMMFs almost brought down the
industry in 2008.

• http://www.investopedia.com/terms/s/shadow-banking-system.asp
Financial Innovation and the
Decline in Traditional Banking
 FinTech (Financial Technology)
AI, Big Data, ML, and Blockchain
• Revolution in financial service industry
• Using information and mobile
technologies
• Reduce costs and time
• Improve services:
• Big Data, Risk Management and Analytics
(to understand consumer spending habits
and market predictions)
• Payments and Money Transfer
• Insurance
• Open Banking
• Crowdfunding and Peer-to-Peer lending
• Trade Finance
• Wealth management and Investment
(Robo-advisers)
Top FinTechs
• Top 50 in Europe:
https://thefintech50.com/the-fintech50-2020

• Top 50 innovative:
https://www.forbes.com/fintech/2021/#352ac5b331a6