Fintech—financial technology—will, in the eyes of some, revolutionize the world. To
others, it is just the most recent evolutionary stage of the financial industry. It has,
however, the power to overcome barriers of access and inclusion to people in many
countries, altering the trajectory of economic betterment for many. Fintech could
conceptually include any technology associated with the movement of or transactions
involving money. The abacus, cash register, and automated teller machine (ATM) are all
examples of financial technological developments. The term today is more commonly
associated with online payments processing, such as AliPay, PayPal, or M-Pesa and
cryptocurrencies like Bitcoin and Litecoin.
But fintech is much more than just payments processing or cryptocurrencies. 3
Developments in financial technology associated with Internet access and mobile
communications can potentially disrupt nearly every dimension of financial services. At
present, across the globe, from Kenya to Kathmandu, new platforms and processes and
products are advancing as rapidly as most nations will allow them to. The potential for
fintech across countries will in many ways cross three different axes of national
development: (1) level of economic development, (2) financial sector infrastructure, and
(3) bank/financial services regulatory landscapes. But like all technologies, they are not
inherently good or evil; the societal outcome depends on how they are applied.
Access to critical financial services, such as payments, savings and insurance, helps people
improve their lives. But access is unequal and poor people and small firms typically have
many fewer options. Fintech has shown its potential to close gaps in the delivery of
financial services to households and firms in emerging markets and developing
economies. Initially, such benefits were channeled via mobile money and digital payments
Research conducted at country and regional level, and more recently at global level, has
shown the effectiveness of such solutions for financial inclusion. Other types of fintech
firms, such as lending and capital raising platforms, are showing their potential to improve
access to finance for underserved groups, including SMEs, although these platform
solutions are still at an early stage in the majority of emerging markets and developing
economies. Finally, firms that provide supporting services such as credit scoring or digital
ID solutions are helping to expand the benefits of fintech across the entire financial sector.
—“The Global Covid-19 FinTech Market Rapid Assessment Study,” World Bank Group,
2020, p. 8.
What is fintech’s real potential? Which societal financial functions are likely to be impacted?
A basic overview of which financial functions and services society utilizes has been
somewhat missing from the discussion. The World Economic Forum offered up a basic
description of the financial landscape, what it called the Wheel, a number of years ago
that is helpful in understanding the multitude of financial service sectors that could
potentially be impacted by fintech. The Wheel identifies six sectors of potential impact.4
1. Payments. The execution of payment processing for both B2C and B2B transactions
was the first and generally easiest financial service to be impacted by fintech. The
movement toward digital payments is already quite advanced in a number of nations
where the people are often ahead of the institutions, both banks and regulators.
2. Market provisioning. The development of technological data collection and analysis,
some using artificial intelligence for rapid financial assessments, some using artificial
intelligence, is expected to be a key area of impact. This sector is still considered in
its infancy, as the artificial intelligence and big data necessary to support its use are
still considered developing.
3. Investment management. The increased reach of fintech to previously ignored and
underserved demographic and income sectors (e.g., Robinhood) has already proven
both powerful and disruptive. The promise of the developing world is enormous in
changing spending/saving-investment behaviors.
4. Insurance. Access to insurance services, particularly affordable services, is one
of the key development barriers in emerging economies. Insurance is often one of
the requirements for acquiring and utilizing assets for business and economic
development. But new digital insurance providers are rapidly changing who and
what is insured at what costs.
5. Deposits and lending. This is one of the core traditional banking functions that is
already undergoing disruptive change. Financial institutions have been rapidly
adopting fintech apps for deposit taking but have been slow to advance the
lending functions. Fintech lending has some of the greatest potential but also some
of the greatest risks—for example, the experience China has had with peer-to-peer
(P2P) lending—for the global financial system.
6. Capital raising. Internet-based capital-raising channels such as crowdfunding
have rapidly developed their own financial ecosystems. More innovation than
disruption, fintech capital raising represents some of the greatest potential
improvements in society through economic development.
This is just one taxonomy of societal financial functions. But regardless of how the
financial service cake is sliced, it is clear that fintech’s potential to alter the lives of
people in all countries and markets is real and, in many cases, already here. The recent
global pandemic provided a multitude of examples of how fintech could provide more
information and more financial services to people everywhere, partially in support of
the world’s struggle to ease human suffering from COVID.
Digital financial services are faster, more efficient, and typically cheaper than
traditional financial services and, therefore, increasingly reaching lower-income
households and small- and -medium-sized enterprises (SMEs). During the COVID-19
health crisis, digital financial services can and are enabling contactless and cashless
transactions. Where digital financial inclusion is advanced, they are helping facilitate
the efficient and quick deployment of government support measures, including to
people and firms affected by the pandemic.—“The Promise of Fintech, Financial
Inclusion in the Post COVID-19 Era,” Ratna Sahay, Ulric Eriksson von Allmen,
Amina Lahreche, Purva Khera, Sumiko Ogawa, Majid Bazarbash, and Kim Beaton,
International Monetary Fund, No. 20/09, 2020.
One of the curious facets of fintech is that it may have the greatest impact on
countries which are largely under-banked and, simultaneously, those that are overbanked.
Like mobile phones in countries without existing landline infrastructures, fintech can
leapfrog the legacy physical infrastructure of traditional banking. It can potentially
provide all of the basic financial services that the large marble-columned edifices
have provided in older industrial markets for centuries at a fraction of the cost, both
capital and operating. In these countries—for example, those in Sub-Saharan Africa—
banking sectors are in some cases rudimentary, with a large part of the population not
having access to traditional banking services. Here fintech can be fundamental,
accessible at low cost, and powerful in reach. There is little to “disrupt”; here fintech
can be seen in the role of a new financial infrastructure. And that can in turn act as a
device for inclusion.
t the same time, fintech’s potential may also be quite impactful and disruptive in the
older highly banked industrialized markets. These are markets—for example, the
United States or Mexico—where banks have operated profitably for more than two
centuries. They are established within a societal structure of laws, regulations, and
institutions that shelter and protect their activities and markets. And that long-term
protection has in many cases resulted in low rates of innovation, most importantly in
the under-investment in digital and cellular financial services that many customers
now desire—now that people have discovered what those services may offer and cost.
The traditional highly banked developed markets may be ripe for fintech disruption,
as new digital financial services may be much cheaper and more efficient than the
bureaucratic, stodgy banking empires of the past. But that will only happen if they can
break down the political power and breach the turf of the established institutions.
The one sector of possibly the greatest potential benefit in global business is digital
lending. A naive or simplistic view of the world might be to visualize that the rich,
highly industrialized countries, that play host to most of the world’s capital, could see
massive opportunities in getting the capital to the business entrepreneurs, startups, and
under-capitalized enterprises in the emerging world. This access, once again, has been
somewhat denied as established banking industries in countries, not foreign investors
or lenders, define the rules of access. Again, fintech innovations, like FairMoney in
Nigeria or Goldman Sachs in Mexico, are finding their way through the forests of
national regulatory barriers and data deficiencies to offer small enterprises access to
One example of the potential power of fintech for good is that of international money
transfers. Migrant workers all over the world continue to suffer extremely high
transfer costs, often ranging between 5% to 25%, to simply transfer the income they
have generated in a host country back to their families and friends in their home
International money transfers in many ways represent one of the biggest challenges of
fintech: low-income populations, with no legal standing, political standing, or banking
access, attempting to move small amounts of money across borders. Fintech firms
have started building their own international correspondent relationships, some
banking, allowing these transfers to bypass the legacy banking systems that exploited
lower-income migrant populations. Unfortunately, that does not mean that the fintech
providers do not similarly exploit low-income customers. M-Pesa, a payment
processing platform founded in Kenya and then expanded to a multitude of countries
across Africa, is considered by many one of the true success stories of fintech. But a
multitude of studies have cited its monopoly status. With no real competitors, it has
been able to charge high fees for its use. Once again technology does not assure
healthy societal outcomes.
Promise and Peril
Probably no single case exemplifies the risks and rewards of fintech better than
Alipay and China. China, all agree, is the leader in fintech development, in some ways
because it is a nexus of both categories of markets described in the previous section—
under-banked and over-banked. And China also offers a powerful device of
expediting fintech—those most capable of embracing digital transactions are also
those with some of the greatest income/wealth-generating capabilities. Oh, to be
Home to an old, bureaucratic, and politically powerful banking industry, it has seen
the advancement of two of the world’s largest and most successful digital payments
systems, WeChatPay (a unit of Tencent) and AliPay (a unit of Ant Group). These
digital payments applications allow buying and selling of all things economic without
the use of traditional cash, bank checks, or credit cards while operating outside the
traditional banking system. AliPay, the largest, is a third-party mobile and online
payment platform utilizing a Quick Response (QR) code on a personal phone to
conduct electronically recorded transactions in an instant. As the world’s largest
online payment platform it grew in market share and reach with the most advanced of
consumers in Shanghai (over-banked) to the poorest of farmers in the inland
In November 2020, AliPay’s parent company, the Ant Group, was 48 hours away
from its initial public offering (IPO) when the Chinese government stepped in and
stopped it. Expected to be the largest IPO in financial history, the Ant Group and its
founder Jack Ma had purportedly grown so large and so powerful that Chinese
authorities worried about its impact on their financial system’s stability. One specific
activity was Ant’s role in originating loans, playing a middleman role in connecting
borrowers with lenders (banks) through its digital interface. The fear was that it was
starting to operate similar to bank lending seen in the U.S. leading up to the financial
crisis of 2008, where a lack of prudent due diligence in lending led to subprime
borrowing—and repayment delinquencies—at record rates.6 In the months that
followed, the Chinese government rolled out a series of additional regulations to
ensure that most lending remained in the hands of the banks themselves, for now.
Fintech offers new and impactful opportunities for money and capital to flow outside
the brick-and-mortar institutions of the past and present. Strangely, whether fintech
will threaten the banks, partner with the banks, or both is dominating much of the
discussion at present. Yet the banks or existing financial institutions are largely only
distributors, the plumbing and plumber, moving the capital from those who have it to
those who wish to use it. With greater capital freedom will come risks and failures
that cause governments to take one step back with each two steps forward. Such is
experience. The net result, that’s positive.
Why has China proven to be the leader in fintech?
The Ups and Downs of Volatility2
Global currency volatility reached its lowest level in more than 40 years in January 2020.
It would prove to be the true bottom before the bounce.
In January 2020 the United States and China signed a trade agreement ending a longstanding spat in which the U.S. accused China of manipulating the value of the Chinese
renminbi. The agreement was considered enormously important—calming the
relationship between the world’s two largest trading partners. In the days that followed,
JP Morgan’s Global FX Volatility Index, a measure of currency volatility, hit a record low
of 5.18, a value approached but never reached over the previous 20 years. This of course
made currency options extremely cheap. As illustrated in Exhibit A, each of the previous
record lows was followed by short and significant increases in volatility. Fundamentalists
would of course look to find economic drivers of these changes, while technical chartists
would see trend and barriers driving change. Regardless, in January 2020 currency
volatility globally was a sea of glass.
Global Pandemic (COVID)
Investors are scrambling to adjust their portfolios to a surge of volatility in foreign
exchange markets, as the coronavirus outbreak and massive swings in oil prices roil
currencies around the globe.
—“Explosion in Forex Volatility Cheers Some, Bruises Others as Virus Fears Drive Swings,”
Reuters, March 11, 2020.
Every global currency trader wishes that, in the early spring of 2020, they could have
possessed that most mystical of capabilities—the third eye. Having an organ with which
the individual investor or currency trader could see the future would have been quite an
advantage. With March 2020 came COVID—the global pandemic. And to add insult to
injury, a nearly instantaneous drop in global oil prices sent markets spiraling downward
even further. Currency volatilities soared. The volatilities associated with the world’s three
most widely traded currencies—the U.S. dollar, the euro, and the Japanese yen—all
spiked upward. Exhibit B illustrates how implied volatilities on at-the-money (ATM) strike
rate calls on both the yen and the euro skyrocketed to 16% and 13%, respectively.
Everyone knows what followed—2020, the year of lemons: Global pandemic, quarantine,
isolation, unemployment, and economic crisis. Eventually, in 2021, through social
distancing, a multitude of anti-pandemic practices, and the development of vaccines,
much of the world returned to some form of new normal.
The world’s currency markets, however, recovered much more rapidly. For global
currencies like the dollar, euro, and yen, recovery took only two to three months to return
to moderate volatilities. For country currencies that always seemed to suffer more
debilitating times like the Brazilian real and Mexican peso, the recovery in option
volatilities was slower and more muted, as illustrated in Exhibit C. Currencies like the peso
and real are, unfortunately, a bit more used to suffering such high volatilities, induced by
political uncertainties or periodic bouts of inflation or currency uncertainty. But the global
stalwarts—the dollar, euro, and yen—rarely have experienced such volatility, such as that
of the global financial crisis in 2008–2009.
The more violently prices fluctuate, the more chance there is that an out-of-the-money
option . . . becomes a winning lottery ticket at some point before it matures.
—“When You Have Options, Volatility Is Your Friend,” The Economist, May 11, 2019.
Fear, anxiety, uncertainty, volatility—one and the same. When selling currency options,
or holding currency options, volatility is said to be your friend.3 The logic is simple.
Increases in volatility drive increases in the value of options.
There are hundreds of different option trading strategies, and the unpredictability of
volatility is at the core of many. Currency option pricing is based on choices—the currency
pair, the strike rate, the time to maturity, observables—the appropriate term interest rates
associated with the two currencies, and one unknowable—what the volatility will be for
the coming term. As is fundamental to economics and finance, when we do not know the
future, we analyze the past. Most option volatility assumptions for pricing are based on
extrapolation of what similar volatilities have been for the most recent past.
This is not a surprising problem. No one knows the future. Even Fischer Black, the Nobel
Prize–winning co-developer of modern option pricing theory with Myron Scholes, noted,
“The Black-Scholes formula is still around, even though it depends on 10 unrealistic
assumptions.”4 A major flaw was that the pricing formulas for assets of any kind—stocks,
bonds, and currencies among others—assumed the assets’ volatilities were known and
fixed. They are not. He also noted that volatility differences would have profound impacts
on far-out-of-the-money strike rates. He then offered some advice. “You should ‘buy
volatility’ if you think volatility will rise, and ‘sell volatility’ if you think it will fall.” He also
noted that far out-of-the-money options were extremely sensitive to changes in volatility.
This proved a fruitful line of thought for some.
Tail Risk (Fat Tails)
Put another way, investors are more volatile than investments. Economic reality governs
the returns earned by our businesses, and Black Swans are unlikely. But emotions and
perceptions—the swings of hope, greed, and fear among the participants in our financial
system—govern the returns earned in our markets. Emotional factors magnify or
minimize this central core of economic reality, and Black Swans can appear at any time.
—John C. Bogle, Founder of The Vanguard Group.
One man has spent much of his career developing theories along similar lines: Nassim
Nicholas Taleb. Taleb published a book in 2001 titled Fooled by Randomness in which he
introduced the analogy of the black swan.6 The argument is quite simple: Prior to the
discovery of Australia and the existence of black swans, all swans were thought to be
white. Black swans did not exist because no one had ever seen one. But that did not mean
they did not exist. Taleb then applied this premise to financial markets, arguing that
simply because a specific event had never occurred did not mean it couldn’t. He
concluded that most statistically based analyses, whether it be portfolios or options,
regularly underestimated the probabilities associated with extreme events.
Taleb argued that a black swan event is characterized by three fundamentals, in order:
1. Rarity: The event is a shock or surprise to the observer.
2. Extremeness: The event has a major impact.
3. Retrospective predictability: After the event has occurred, the event is rationalized
by hindsight and found to have been predictable.
Although the third argument is a characteristic of human intellectual nature, it is the first
element which is fundamental to the debate. If an event has not been recorded, does
that mean it cannot occur? Option theory is a mathematical analysis of inputs and
assumptions. Its outcomes are no better than its inputs. The theory itself does not predict
price movements. It simply prices rights on the basis of current market conditions and
assumptions about the future based on the recent past—a past that has occurred.
Taleb does not argue that he has some secret ability to predict the future when historical
data cannot. Rather, he argues that investors should structure their investments to either
protect against or embrace the extremes. Leverage the improbable events rather than
the probable ones. He argues for what many call “investment humility,” to acknowledge
that the world we live in is not always the one we think we live in and to understand how
much we will never understand.
For example, traditional Black-Scholes option pricing assumes that volatility is normally
distributed. This means that the model assumes that there is a 99.7% probability of
volatility occurring within three standard deviations of the mean (or 0.3% of it falling
outside three standard deviations). But what if this is underestimating the probability of
volatility falling outside? This is what is referred to as tail-risk or alternatively relatively fat
tails of the normal distribution.
Taleb developed investing strategies based on this inappropriate distribution of
probabilities in his opinion. The barbel strategy combines safe investments with
opportunities. An investor should create a strategy that was shaped like a barbel. Most of
the capital, say 90%, should be invested in very low-risk investments, like Treasury bonds.
These investments are likely to yield the traditional results seen in normal distributions.
But, cognizant of the bias or inadequacies of traditional statistics, the investor should also
invest some small portion, say 10%, of their capital in the extremes—the ends of the barbel.
These extremes, the potential fat tails of the unknowable distribution, performed like
lottery tickets. They generally never occur and therefore expire worthless. But, but, in rare
cases, they prove true and extremely valuable.
Currency option pricing in the marketplace must follow rational thought and statistical
methods. They need predictions of what may come, even if it is generally based on the
past, a past which may not include the so-called “outliers.” Kenneth Arrow, a famed
economist and Nobel Prize winner himself, relayed the following story about statistics,
forecasting, and humans recognizing what they don’t know. During the World War II a
group of statisticians were tasked with forecasting weather patterns over the English
The statisticians subjected these forecasts to verification and found they differed in no
way from chance. The forecasters themselves were convinced and requested that the
forecasts be discontinued. The reply read approximately like this: “The Commanding
General is well aware that the forecasts are no good. However, he needs them for
Taleb, in a revised edition of Black Swan Theory, noted that “the event,” whatever it may
be, is a surprise to the specific observer and that “what is a surprise to the turkey is not a
surprise to the butcher.” The challenge of course is to avoid being the turkey.
Does the global pandemic of March 2020 fulfill the criteria for a black swan event?
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