Fintech and smart contracts

JUST AS ‘SMARTPHONE’ has become the buzzword of the telecommunications and computer sector, “fintech” has become the buzzword of the financial sector. This column discusses the impact of fintech on the provision of financial services. It commences by defining fintech and outlining the various areas in which it is relevant. It then examines a particular application of fintech, namely, smart contracts and the legal challenges that arise in this regard.

WHAT IS FINTECH?

Reflecting the combination of “finance” and “technology”, fintech focuses on the various ways in which technology can be utilized to increase the efficiency of financial services and change the way in which financial services are delivered.

It appears that the potential of fintech is unlimited, in both the business-to-consumer (B2C) and business-to-business (B2B) markets, and that its impact will be profound. On the one hand, fintech may facilitate the existing financial infrastructure by increasing efficiencies and reducing risks. For example, online payment systems and online banking services enable money to be transferred instantaneously without the risks associated with cash or cheques.

On the other hand, fintech may disrupt the existing financial infrastructure by replacing it with new systems and platforms. For example, fintech provides new platforms for raising finance through peer-to-peer lending and crowdfunding.

These platforms enable finance to be raised directly from investors without the need to engage the services of traditional financial intermediaries such as banks. In addition to payment systems and financing platforms, the impact of fintech is evident in three other areas. First, innovative software applications enable financial services to be delivered in new ways. For example, digital or “smart” disclosure presents investors with new ways of accessing and analyzing information concerning financial products, and thereby increases the likelihood that they will engage with disclosure and make an informed decision about whether to purchase a financial product.

In addition, through the use of algorithms, digital advice (also referred to as “robo-advice”) enables financial product advice to be tailored to investors without the direct involvement of a human adviser. Put simply, an algorithm is a set of steps that are followed in order to solve a problem or to complete a computer process.

Second, new technology for data analysis (known as financial data analytics) enables financial information to be analysed more quickly and accurately. This is often based on “big data”, namely, large data sets that can be analyzed by computers in order to determine trends in human behaviour and activity.

Third, distributed ledger technology enables data concerning transactions to be recorded and shared across a network of parties. Because all the parties have access to a single database, or ledger, and because the data is held by, or distributed to, each party, the accuracy and the security of the transaction data can be guaranteed.

An integral component of distributed ledger technology is the “blockchain”. This refers to the chain of transactions that are recorded on the ledger. All transactions on the ledger are grouped into blocks and a new block is added to the chain each time a new transaction is verified. An important application of blockchain technology is the creation of “crypto-currencies” such as Bitcoin. Crypto-currencies are digital currencies that use encryption technology to generate units of currency and verify the transfer of funds.

The use of technology for the above purposes gives rise to a range of legal and regulatory issues. These issues include the application of laws and regulations governing data privacy, cybersecurity, anti-money laundering and financial crime.

A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia.