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Name: FinTech 101
Author: Игорь Костючёнок

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History of Money

Intro

Money is at the center of a capitalist society we all live in. The money shows dominance and power. With the advance of the technology, money transforms into a fully digital asset that is less tangible yet still very powerful. This short book will show you the history of money, banking and payments. It will help you understand what hides behind the term FinTech and what is the current state of the financial technology.

Natural Exchange

Since the beginning of humanity people used natural exchange to get the goods, they need in exchange for the goods they have.

According to Aristotle: “Natural exchange as an exchange for the purpose of satisfying needs. Unnatural exchange, on the other hand, is the acquisition for the purpose of satisfying wants or for making profit”

Barter System

Bartering is a direct trade of goods and services.

This system has been used for centuries and long before money was invented. The value of bartering items can be decided upon with the other party. Bartering doesn't involve money which is one of the advantages.

Generally, trading in this manner today is done through online auctions and swap markets.

Bartering History

The history of bartering dates all the way back to 6000 BC.

Introduced by Mesopotamia tribes, bartering was adopted by Phoenicians. Goods were exchanged for food, tea, weapons, and spices.

At times, human skulls were used as well. Salt was another popular item exchanged.

When money was invented, bartering did not end, it became more organized and adapted to the times.

Pros

Cons

No need of money

No consumer protection or

warranty

Flexibility (exchanging goods for

goods, services for goods etc.)

Requires skills and experience

No fix exchange rate

Money vs Currency

The terms money and currency are often used interchangeably. According to some theories, money is inherently an intangible concept.

Currency, on the other hand, is the physical or tangible manifestation of the intangible concept of money.

According to this theory, money cannot be touched or smelled. Currency is the coin, note, object, or physical representation that is presented

in the form of money.

The basic form of money is numbers while the basic form of currency is paper banknotes, coins, or plastic cards like credit or debit cards.

Money

Money is a medium of exchange that can only exist in a governed society.

A type of currency slowly developed over the centuries that involved easily traded items like animal skins, salt, and weapons. These traded

goods served as the medium of exchange even though the value of each of these items was still negotiable in many cases. This system of trading spread across the world and still survives today in some parts of the globe.

One of the greatest achievements of the introduction of money was the increased speed at which business, whether it involved mammoth

slaying or monument-building, could be done.

Coins and Paper

First coins were minted in Guanzhuang in Henan Province, China around 640 BCE. Money is a medium of exchange that can only exist

in a governed society.

Meanwhile, further west during this era, in 600 BCE, the invention of metal coinage occurred when Lydia's King Alyattes – Lydian Stater was born. Lydian Stater helped the country increase both its internal and external trading systems, making it one of the richest empires in Asia Minor.

Once the Chinese had started making comparatively inexpensive paper from natural fibres, and invented block-printing, paper money came into use in the country.

Paper Money in Europe

Parts of Europe still used metal coins as their sole form of currency until the 16th century. Colonial acquisitions provided new sources of precious

metals and enabled European nations to keep minting a greater quantity of coins.

But banks eventually started using paper banknotes for depositors and borrowers to carry around in place of metal coins. These notes could

be taken to the bank at any time and exchanged for their face value in metal, usually silver or gold, coins.

In the beginning paper money was issued by banks or other private institutions rather than the government, which is now responsible for issuing currency in most countries.

Currency Market

The shift to paper money in Europe increased the amount of international trade. Banks and the ruling classes started buying currencies from other nations and created the first currency market. The

stability of a particular monarchy or government affected the value of the country's currency, and thus, that country's ability to trade on an

increasingly international currency market.

The competition between countries often led to currency wars, where competing countries would try to change the value of the competitor's

currency by driving it up and making the enemy's goods too expensive, by driving it down and reducing the enemy's buying power, or by

eliminating the currency completely.

Cheques

Cheques are a type of bill of exchange that were developed as a way to make payments without the need to carry large amounts of money. Paper money evolved from promissory notes; another form of negotiable instrument similar to cheques in that they were originally a written order to pay the given amount to whoever had it in their possession.

Cheques are basically the direct descendant of the original paper money issued by the banks.

Pre-plastic Cards

The first recorded credit card of sorts was identified in ancient Mesopotamia, when that civilization’s people used clay tablets to trade with its neighbors.

The first clear precursor of the credit card, as we know it, was the ‘Charga-Plate’, a two and half inch by one and a quarter inch rectangular sheet of metal, not unlike a military ‘dog tag’ that came into circulation in the early 1930s.

Diners Club Card was invented in 1957 one year

after Frank McNamara forgot his wallet at home

and had to use his wife’s money to pay for dinner.

Plastic Cards

1959 American Express introduces the first plastic card followed by the Bank of America and Diners Club in 1960.

Ron Klein an IBM Engineer invented magnetic stripe that’s used to store the customer’s information on the card. His wife gave him the idea to iron it on the card.

1968 two German engineers Jürgen Dethloff and

Helmut Gröttrup patented the incorporation of a

silicon integrated circuit chip into a plastic. It took

a while though until the first cards with the chip

were introduced in 1986.

Mobile Payments

The introduction of a smartphone and the rise of the smartphone adoption gave boost to a novel form of payment activated with the touch of your finger.

This form of payment first came to prominence in Asia and Europe before moving over to North America. From payments via text message, the technology evolved to allow checks to be deposited using the camera app on smart devices.

Mobile payment services like Apple Pay and Google Pay are vying for retailers to accept their platforms for point-of-sale payments. There are

also, apps dedicated to this method of payment, including Venmo and PayPal.

Virtual Currency

Virtual currency is a digital representation of money and only available in electronic form.

The appeal of virtual currency is that it offers the promise of lower transaction fees than traditional online payment mechanisms do and is operated by decentralized authorities, unlike government-issued currencies.

Bitcoin quickly became the standard for virtual currencies. It was released in 2009 by the pseudonymous Satoshi Nakamoto. All the

world's Bitcoin was worth just over $803.74 billion as of Dec. 12, 2023.

Virtual currencies like Bitcoin have no physical coinage because they are traded on exchanges.

Banks and Banking

Ancient times

The concept of banking dates back thousands of years, with early forms of banking emerging in ancient civilizations such as Mesopotamia, Egypt, Greece, and Rome.

The concept of banking for the first time started from the Mesopotamian civilization in 8th century B.C.E. This time economic activity was highly centralized about the royal houses and the priesthood.

Temples as Vaults

The temples and royal palaces were the important centers to which commodities were deposited and from which they were redistributed among the peoples. These were the places that offered best security to guard the deposited wealth of the people, probably in the forms of crops and daily uses commodities as well as precious stones.

So, it was in the temples and royal palaces of Mesopotamia, that the earliest banking industry of the world developed and the notions of safeguarding of the deposits took place.

Temples as Lenders

Historical records from Greece, Rome, Egypt, and Babylon suggest that temples loaned money in addition to keeping it safe. The fact that temples often functioned as the financial centers of their cities is one

reason why they were inevitably ransacked during wars.

Coins could be exchanged and hoarded more easily than other commodities, such as 300-pound pigs, so a class of wealthy merchants took to lending coins, with interest, to people in need of them. Temples

typically handled large loans, including those to various sovereigns, while wealthy merchant money lenders handled the rest.

Templars and Medici

The Knights Templar, a religious military order, provided secure storage for valuables and facilitated the transfer of funds for pilgrims traveling to the Holy Land. Their financial network laid the groundwork for modern banking practices.

The Italian city-states of Florence, Venice, and Genoa emerged as major banking centers in the 14th and 15th centuries.

The birth of modern banking is often attributed to the founding of the Bank of Amsterdam in 1609. It functioned as a central bank, stabilizing the value of the local currency and serving as a model for other central banks.

Adam Smith

–

Role of Banks in Economic Growth:

Banks, according to Smith, played a vital role in channelling savings into productive investments

–

Importance of Competition:

He believed that competition among banks would lead to efficiency and innovation

–

Risk Management:

He emphasized the need for banks to carefully assess the creditworthiness of borrowers and manage their exposure to risk

–

Role of Government Regulation:

Smith recognized the need for some degree of regulation in banking

–

Critique of Central Banking:

Smith was wary of the concentration of power, and he might have been sceptical of the centralized control over money and banking that central banks exercise

Banking parts

–

Chart of Accounts

– is a structured list of all the accounts used by an organization to record its financial transactions

–

Ledger

– detailed record or bookkeeping system that tracks all financial transactions conducted by a bank

–

Double Entry Bookkeeping

– is an accounting method used to record financial transactions where each transaction is entered in at least two accounts, resulting in a balanced set of accounting records

–

Correspondent Banking

– correspondent banking relationships facilitate cross-border transactions, foreign exchange, and international trade

Chart of Accounts (COA)

It provides a systematic framework for classifying, organizing, and reporting financial information.

Key features:

–

Account Numbers:

Each account has a unique identifier or account number

–

Account Types:

Accounts are classified into different types based on their purpose

–

Hierarchy:

The Chart of Accounts is organized hierarchically

–

Standardization:

However, standardization is often preferred within industries or regions to ensure consistency and comparability of financial reporting

–

Integration with Financial Reporting:

The Chart of Accounts forms the basis for preparing financial statements such as the balance sheet, income statement, and statement of cash flows

Ledger

Key features:

–

Transaction Recording: The banking ledger records all transactions in chronological order

–

Account Balances: The ledger maintains updated balances for each account

–

Classification and Categorization: Transactions recorded in the banking ledger are classified and categorized based on their nature and purpose

–

Double-Entry Bookkeeping: A system that records each transaction with corresponding debit and credit entries to ensure accuracy

–

Audit Trail: The banking ledger provides a detailed audit trail that traces the history of each transaction

–

Financial Reporting: The information recorded in the banking ledger serves as the basis for preparing various financial reports

Double-Entry Bookkeeping

This system follows the fundamental accounting equation:

Assets = Liabilities + Equity

Every transaction affects at least two accounts, with one account debited and another account credited. The total debits must equal the total credits.

–

Debits and Credits

are used to record changes in account balances

–

Dual Aspect

– every transaction has two aspects: a debit and a credit

–

Recording Transactions

: Each transaction is recorded in the appropriate accounts using journal entries

–

Trial Balance

: is prepared to ensure that the total debits equal the total credits in the ledger

–

Financial Statements

summarize the financial position, performance, and cash flows of the business based on the ledger information

Correspondent Banking

Correspondent banking relationships facilitate cross-border transactions, foreign exchange, and international trade.

Services Provided:

–

Clearing and settlement

of payments and funds transfers

–

Currency exchange

and foreign exchange services

–

Trade finance

, including letters of credit, guarantees, and documentary collections

–

Cash management and liquidity management

services

–

Custody

and safekeeping of assets

–

Access to local payment systems

and financial markets

–

Compliance and regulatory

support, including know-your-customer (KYC) and anti-money laundering (AML) checks

Banking Products

Modern banking consists of a range of financial services and activities provided by banks and other financial institutions.

Key components:

–

Deposit Accounts

–

Lending

–

Investment Services

–

Payment Services

–

Risk Management

–

Financial Intermediation

–

Foreign Exchange Services

–

Wealth Management

–

Regulatory Compliance

–

Digital Banking

Payments

Intro

Since money and payments are interconnected you will see many information that you are already familiar with from the “History of Money” lecture, that is why we will just briefly look at the history of payments and will move on to the payment standards and the future of payments.

History: Pre-Banking

–

Barter System

(Prehistoric Times to Ancient Civilizations)

–

Commodity Money

(Ancient Times)

–

Metal Coins

(7th Century BC – Middle Ages)

–

Paper Money

(7th Century AD -Modern Era)

History: Banking

Banking Systems (Medieval Europe onwards): Banks emerged as institutions for storing money, providing loans, and facilitating payments.

Checks (17th Century): Checks became a popular method of payment, allowing individuals to transfer funds without the need for physical currency.

Credit Cards (20th Century): Credit cards revolutionized payment systems by allowing consumers to make purchases on credit. Initially introduced by individual stores and later by banks, credit cards became

ubiquitous in modern economies.

Electronic and Digital Payments

Electronic Payments (Late 20th Century – Present): The rise of computers and the internet led to the development of electronic payment systems.

Digital and Mobile Payments (21st Century): With the proliferation of smartphones and internet connectivity, digital and mobile payment platforms have become increasingly popular.

Cryptocurrencies (2009 – Present): Bitcoin, introduced by an unknown person or group using the pseudonym Satoshi Nakamoto, marked the beginning of cryptocurrencies.

Payment Rails

Whenever we make a payment, an information exchange about your payment is happening between different financial institutions.

Payment rails refer to the underlying systems and networks that facilitate the transfer of funds between parties during a financial transaction. These systems serve as the infrastructure that enables the movement of money from one account to another.

The specific payment rails available vary by country and can include various electronic funds transfer mechanisms, card networks, and digital

payment systems.

Payment Rails: US

Automated Clearing House (ACH): ACH is a network for electronic payments and transfers in the United States, used for direct deposits,

bill payments, and other transactions. It’s run by NACHA and is usually cheaper than a wire transfer.

Fedwire: Fedwire is a real-time gross settlement system operated by the Federal Reserve Banks, enabling immediate transfer of funds between

financial institutions.

The Clearing House (TCH): TCH operates systems for processing large-value and time-sensitive payments, including the CHIPS (Clearing House Interbank Payments System) for high-value transactions.

Payment Rails: UK

Faster Payments Service (FPS): is a near-real-time payment system in the UK, facilitating electronic transfers between bank accounts within seconds. Created in 2008, the Faster Payment System is available 24/7/365 to most customers in the UK with a bank account.

Bacs: Bacs Payment Schemes Limited operates the Bacs system for processing bulk electronic payments, including direct debits and credits.

BACS ensures that financial transactions flow from one bank account to another throughout the UK.

CHAPS (Clearing House Automated Payment System): CHAPS is a same-day sterling payment system for high-value transactions in the UK. It involves the settlement of foreign exchange and money market transactions by financial institutions, businesses and individuals.

Payment Rails: EU

SEPA (Single Euro Payments Area): SEPA allows for the integration of electronic payments across EU member states, enabling cross-border transfers in euros under the same conditions as domestic payments. This local EU payment rail provides the same procedure for making both national and international payments.

TARGET2: is the Trans-European Automated Real-time Gross Settlement Express Transfer System owned and operated by the

Eurosystem. Central banks and commercialbanks can submit payment orders in euro to TARGET2, where they are processed and settled

in central bank money, i.e. money held in an account with a central bank.

Payment Rails: China

China National Advanced Payment System (CNAPS): CNAPS is China's interbank payment and settlement system, facilitating electronic funds transfers and settlements among banks.

CNAPS is operated by the China National Clearing Center (CNCC) and local clearing systems are mainly operated by PBC branches.

UnionPay: UnionPay (also known as China UnionPay, CUP or UPI) is the world’s biggest card network with more than 7 billion cards issued. It is widely used by Chinese shoppers internationally as well as domestically.

Payment Rails: India

Unified Payments Interface (UPI): UPI is a real-time payment system in India that enables instant fund transfers between bank accounts using mobile phones. With UPI, users can access multiple bank accounts in a single mobile application, allowing them to move money in real time.

National Electronic Funds Transfer (NEFT) and Real-Time Gross Settlement (RTGS): NEFT and RTGS are electronic payment systems in India, used for transferring funds between accounts held in different banks.

Payment Rails: SWIFT

SWIFT – Society for Worldwide Interbank Financial Telecommunication.

SWIFT was formed in 1973 to help standardize international funds transfers and prevent security risks that traditional telegraphic transfers posed. Its inaugural year, it was initially supported by 239 banks in 15 countries. By the time the first message was sent in 1977, that had expanded to 518 banks in 22 countries.

SWIFT is the network of 11,000 member financial institutions that enables fast, secure international wire transfers. The network doesn’t transfer any physical funds but rather provides a standard way to send payment orders. In 2020, around 35 million orders per day were sent via the SWIFT network.

Credit Card Networks

Credit card networks provide the communication system that issuing banks and businesses use to process credit card transactions.

There are two types of credit card networks – open and closed – and they treat card issuing differently.

Open credit card networks allow other financial institutions to issue their credit cards to customers:

–

Visa

–

Mastercard

In closed credit card networks, the credit card company exclusively issues the cards:

–

American Express

–

Discover

Credit card networks work by connecting the two parties involved in credit card purchases: the card issuer and the business.

Digital and Mobile Payments

With the proliferation of smartphones and internet connectivity, digital and mobile payment platforms have become increasingly popular. Services like PayPal, Venmo, Apple Pay, Google Pay, and cryptocurrencies offer convenient and secure ways to send and receive money electronically.

These types of mobile payments are still built on top of the existing banking or credit card payments infrastructure but add a layer of convenience on top.

Cryptocurrencies

Bitcoin, introduced by an unknown person or group using the pseudonym Satoshi Nakamoto, marked the beginning of cryptocurrencies.

Built on blockchain technology, cryptocurrencies aim to provide decentralized, secure, and anonymous transactions, challenging traditional financial systems.

Bitcoin and other cryptocurrencies that used for payments are built on top of the entirely new blockchain based infrastructure.

FinTech Categories

Intro

In parallel to the rise of FinTech adjacent areas of financially related startups have been created. Some of them are directly connected to FinTech and some others are bordering on FinTech.

Since financial industry is heavily regulated

the whole new sectors of companies have been created – RegTech and SupTech.

RegTech describes technology, used in the context of regulatory compliance, including tasks such as risk management. SupTech is technology used by supervisory authorities. Another area that is loosely connected to the financial industry is InsurTech.

FinTech Categories

–

FinTech

BaaS

Neobanks

Payments Processors

Loans and Lending

Cross-border payments

BNPL

–

RegTech

–

SupTech

–

InsurTech

BaaS

Banking-as-a-Service can either be offered by a bank or by a third-party service that offers its own core banking system (CBS) but utilizing someone else’s banking license.

A BaaS startup can offer following services:

–

APIs and Integration

–

White-label Solutions

–

Product Innovation

–

Regulatory Compliance

AML (Anti Money Laundering)

KYC (Know Your Customer)

–

Scalability and Flexibility

–

Customer Experience

BaaS – Startups

Company

Unit

ThoughtMachine

Railsr (RailsBank)

nCino

Synapse

Solaris

Germany

Finastra

Mbanq

Treezor

France

Neobanks

A neobank is a type of financial institution that operates exclusively online or through mobile apps, without traditional physical branches.

Neobanks often run on top of a BaaS backend.

Some of the key aspects of the neobanks are:

–

Digital-First Approach

–

No Physical Branches

–

Focus on User Experience

–

Tech-Driven Solution

–

Partnerships and Ecosystem

Neobanks – Companies

Neobank

Number of Customers

Chime

> 38M

Revolut

> 50M

N26

Germany

> 38M

Monzo

> 38M

Ally Bank

> 38M

Varo Bank

> 38M

Nubank

Brazil

> 38M

Payments Processing

Payments processing startups are innovative companies that provide technology-driven solutions to facilitate the processing of financial

transactions, including payments, transfers, and settlements. These startups leverage advancements in fintech, blockchain, artificial

intelligence, and data analytics to offer faster, more secure, and cost-effective payment solutions to businesses and consumers.

Payments processing startups enable businesses to accept online payments and manage transactions. Many of them also include POS

(point-of-sales) systems and business management tools.

Payments Processing – Startups

Company

Stripe

Square

Adyen

Netherlands

Braintree

Checkout.com

Mollie

Netherlands

Razorpay

India

Loans and Lending

FinTech startups in the lending space, often referred to as online lenders or alternative lenders, use technology to streamline the loan application

process, assess creditworthiness, and disburse funds quickly. These companies offer a range of loan products, including personal loans, small business loans, student loans, and consumer financing.

These loans FinTech startups are leveraging technology and data analytics to revolutionize the lending industry, providing borrowers with greater access to credit, faster approval times, and more transparent and flexible loan options compared to traditional banks.

Loans and Lending – Startups

Company

LendingClub

Prosper

Upstart

SoFi

Kabbage

Funding Circle

Cross-border payments

Cross-border payments startups are fintech companies that specialize in facilitating international money transfers and remittances. These startups leverage technology to offer faster, cheaper, and more transparent alternatives to traditional methods of transferring money across borders, such as bank wires and money transfer operators.

These cross-border payments startups are leveraging technology, digital infrastructure, and innovative business models to disrupt the traditional remittance industry and make international money transfers more accessible, affordable, and efficient for individuals and

businesses worldwide.

Cross-border Payments – Startups

Company

Wise

Remitly

CurrencyCloud

WorldRemit

Payoneer

BNPL

Buy Now, Pay Later (BNPL) startups are fintech companies that offer alternative payment solutions allowing consumers to make purchases

and pay for them in instalments over time, typically with little to no interest. These startups have gained significant popularity in recent years, particularly among younger consumers who prefer flexible payment options and want to avoid traditional credit cards or loans.

These BNPL startups are reshaping the retail and e-commerce landscape by providing consumers with flexible and convenient payment options while also helping merchants increase conversion rates and

reduce cart abandonment.

BNPL – Companies

Company

Klarna

Sweden

Afterpay

Australia

Affirm

Splitit

Sezzle

Pay in 4 (PayPal)

Zip (Quadpay)

RegTech

RegTech startups are companies that specialize in providing technology solutions to help businesses comply with regulatory requirements more

efficiently and effectively. These startups leverage advancements in artificial intelligence, machine learning, blockchain, and data analytics to address challenges related to regulatory compliance, risk management, and reporting.

The RegTech startups are helping businesses navigate the complex regulatory landscape, improve compliance processes, and reduce regulatory risks with technology-driven solutions. By automating manual tasks, enhancing data analytics capabilities, and providing real-time insights, these startups enable organizations to achieve greater efficiency, transparency, and accountability in regulatory compliance efforts.

RegTech – Key Aspects

–

Compliance Monitoring and Reporting

–

Know Your Customer (KYC) and Customer Due Diligence (CDD)

–

Transaction Monitoring and Surveillance

–

Regulatory Reporting and Compliance Management

–

Risk Management and Assessment

–

Cybersecurity and Data Protection

–

Regulatory Sandbox and Innovation Management

–

Training and Education

RegTech – Companies

Company

Services

ComplyAdvantage

–

AML

–

KYC

IdentityMind Global

–

AML

–

KYC

–

Fraud Prevention

ClauseMatch

–

Policy Management

–

Compliance

Behavox

Data and Communication Analytics

AQMetrix

Ireland

Risk and Performance Analytics

SupTech

SupTech, short for Supervisory Technology, refers to the use of technology by regulatory authorities (supervisors) to improve their oversight and supervision of financial institutions and markets.

SupTech aims to enhance regulatory effectiveness, efficiency, and transparency with use use of innovative tools, data analytics, and automation.

Overall, SupTech plays a crucial role in modernizing regulatory practices, strengthening financial supervision, and promoting financial

stability and integrity in global markets. As regulatory requirements continue to evolve and become more complex, the adoption of SupTech is expected to increase, driving greater efficiency, transparency, and resilience in the financial system.

SupTech – Key Aspects

–

Data Collection and Analysis

–

Risk Monitoring and Surveillance

–

Compliance and Reporting Automation

–

Supervisory Dashboards and Analytics

–

Regulatory Sandboxes and Innovation Hubs

–

Cybersecurity and Fraud Detection

–

Regulatory Compliance and Policy Analysis

–

Capacity Building and Training

SupTech – Companies

Company

Services

Suade Labs

Collect and Analyze Regulatory Data

Regnosys

Regulatory Reporting and Compliance

Alyne

Germany

Risk Management, Compliance and Cybersecurity

Apiax

Switzerland

Regulatory Compliance

Governance.com

Luxembourg

Regulatory Compliance, Risk Mangement and Reporting

InsurTech

InsurTech, short for Insurance Technology, refers to the innovative use of technology to enhance and transform various aspects of the insurance industry. InsurTech startups and companies leverage advancements in artificial intelligence, big data analytics, machine learning, blockchain, and Internet of Things (IoT) to improve efficiency,

customer experience, and risk management in insurance.

Overall, InsurTech is transforming the insurance industry by driving digitalization, innovation, and customer-centricity. As technology continues to evolve and consumer expectations change, InsurTech will play an increasingly critical role in shaping the future of insurance, making it more accessible, affordable, and adaptable to evolving

risks and needs.

InsurTech – Key Aspects

–

Digital Distribution Channels

–

Data Analytics and Underwriting

–

Claims Processing and Management

–

Usage-Based Insurance (UBI)

–

Peer-to-Peer Insurance

–

On-Demand Insurance

–

Risk Management and Prevention

–

Regulatory Compliance and Insurtech Sandbox

InsurTech – Companies

Company

Services

Lemonade

Pet, Car, Homeowners, Renters Insurance

Root Insurance

Car Insurance

Hippo Insurance

Homeowners Insurance

Oscar Health

Health Insurance

Ethos Life

Life Insurance

Correspondent Bank

Intro

It’s impossible for all banks and financial institutions in the world to have a direct relationship with each other.

Therefore, a solution is required for the global financial system that enables banks in different jurisdictions to do business, even in the absence of a relationship.

This solution is what’s known as a correspondent bank.

Definition

A correspondent bank is a financial institution that provides services to

another one—usually in another country. It acts as an intermediary or

agent, facilitating wire transfers, conducting business transactions,

accepting deposits and gathering documents on behalf of another bank.

Key Aspects

–

A correspondent bank is an authorized financial institution that provides services on behalf of another financial institution

–

Correspondent bank's services may include funds transfer, settlement, check clearing, and wire transfers

–

The accounts held between correspondent banks and the banks to which they are providing services are referred to as nostro and vostro accounts

–

Domestic banks can serve their international clients and gain access to foreign financial markets by using correspondent banks, rather than setting up branches overseas

3rd Party

Correspondent banks are third-party banks.

They act as middlemen between different

financial institutions. As such, they provide

treasury services between sending and

receiving banks, especially those in different

countries.

Services provided by correspondent banks:

–

funds transfer

–

settlement

–

check clearing

–

wire transfers

–

currency exchange

SWIFT

Correspondent banks are most commonly used when funds need to be transferred to a foreign country. This is done through SWIFT or the Society for Worldwide Interbank Financial Telecommunication. SWIFT is the largest network of correspondent banks worldwide. Its members

include 11,000 financial institutions in over 200 countries and territories.

If the domestic bank doesn’t have a relationship with the overseas bank that it needs to do a transaction with, it will search the SWIFT network

for a correspondent bank that has a formal relationship with both banks. When one has been found, the transaction will be initiated by transferring the funds to the special accounts held at the correspondent bank.

Nostro/Vostro Accounts

The accounts held between correspondent banks and the banks for which they provide services are referred to as nostro and vostro accounts.

Nostro is Latin for “our” and in the terms of correspondent banking, it means “our account, on your books”. Vostro means “yours” and in this case it stands for “your account, on our books”. It’s these accounts that make it possible to track cross- border debit and credit transactions.

So, when a domestic bank needs to transfer funds overseas, it will send the money into their nostro account at the correspondent bank. The transaction fee is deducted, and the funds are transferred by the correspondent into the receiving bank’s vostro account.

Correspondent Bank’s Value

For example, a bank in San Francisco that receives instructions to wire funds to a bank in Japan can't wire funds directly without a working relationship with the receiving bank.

Upon finding a correspondent bank having arrangements with both sides of the transfer, the originating bank sends the transferred funds to its

nostro account held at the correspondent bank.

In transactions such as this, the correspondent bank adds value in two ways:

–

It alleviates the need for the domestic bank to establish a physical presence abroad

–

It saves the work of setting up direct arrangements with other financial institutions around the world

Risks

Correspondent banking poses some risk-management challenges because the correspondent bank relies on its customer, the respondent bank, to perform Know Your Client (KYC) due diligence on its customers.

Reliance on a third party’s compliance program—rather than conducting KYC on all customers for whom the respondent bank is processing payments through the correspondent bank—is why this activity is generally considered to be high-risk, from a money-laundering perspective

Correspondent vs. Intermediary Bank

Both correspondent and intermediary banks act as third parties for other banks but there is a major difference between the two.

While correspondent banks normally handle transactions involving multiple currencies, an intermediary bank completes transactions

involving only a single currency. They are especially key for domestic banks that may be too small in size to handle these types of transactions.

The main difference between correspondent banks and intermediary banks is often the number of currencies in use in a transaction, with

correspondent banks handling more than one currency and intermediary banks generally working in one currency.

Pros and Cons

The biggest advantage that correspondent banks provide is that they empower domestic banks to access the global financial system without having to set up branches in foreign jurisdictions.

One disadvantage to customers is that transactions processed through correspondent banks tend to take time, often more so than they’d

expect.

The added cost is another disadvantage. Since correspondent banks charge a fee for the services that they provide, customers usually have to bear these charges.

Crypto

Intro

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or

bank, to uphold or maintain it.

Cryptocurrency does not exist in physical form (like paper money) and is typically not issued by a central authority (like FIAT money).

Formal Definition

According to Jan Lansky, a cryptocurrency is a system that meets six conditions:

No central authority. Its state is maintained through distributed consensus

The system keeps an overview of cryptocurrency units and their ownership

The system defines whether new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the circumstances of their origin and how to determine the ownership of these new units

Ownership of cryptocurrency units can be proved exclusively cryptographically

The system allows transactions to be performed in which ownership of the cryptographic units is changed. A transaction statement can only be issued by an entity proving the current ownership of these units

If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.

History – I

In 1983, American cryptographer David Chaum conceived of a type of cryptographic electronic money called ecash. Later, in 1995, he implemented it through Digicash, an early form of cryptographic electronic payments.

In 1996, the National Security Agency published a paper entitled “How to Make a Mint: The Cryptography of Anonymous Electronic Cash”, describing a cryptocurrency system.

In 1998, Wei Dai described b-money an anonymous, distributed electronic cash

system.

History – II

Shortly thereafter, Nick Szabo described bit gold. Like Bitcoin and other cryptocurrencies that would follow it, bit gold was described as an electronic currency system that required users to complete a proof-of-work function with solutions being cryptographically put together and published.

In January 2009, Bitcoin was created by pseudonymous developer Satoshi Nakamoto. It used SHA-256, a cryptographic hash function, in its proof-of-work scheme.

Blockchain History

Blockchain technology was first outlined in 1991 by Stuart Haber and W. Scott Stornetta, two researchers who wanted to implement a system where document timestamps could not be tampered with.

But it wasn’t until almost two decades later, with the launch of Bitcoin in January 2009, that blockchain had its first real-world application.

The key thing to understand is that Bitcoin uses blockchain as a means to transparently record a ledger of payments or other

transactions between parties.

Blockchain

Blockchain is the technology that enables the existence of cryptocurrency (among other things).

A blockchain is a decentralized database/ledger of all transactions across a peer-to-peer network.

A blockchain allows the data in a database to be spread out among several network nodes at various locations.

Because of the decentralized nature of the Bitcoin blockchain, all transactions can be transparently viewed by either having a personal node or using blockchain explorers.

Altcoins

Altcoin refers to any alternative cryptocurrency to Bitcoin. They often share code and functionality, and include coins such as Ether, Litecoin, and Dogecoin. The number of altcoins listed in cryptocurrency markets is rapidly multiplying, and they can be very volatile.

Of the $2.5 trillion that represents the total market capitalization of the more than 26,000 crypto assets available today, more than $389 billion is held in Ether, the biggest altcoin on the market.

Unlike bitcoin, characterized as a “decentralized currency” think of Ethereum as a distributed computing network

Stablecoins

Stablecoins are a type of cryptocurrency whose value is pegged to another asset, such as a fiat currency or gold, to maintain a stable

price.

Stablecoins play a crucial role in the cryptocurrency ecosystem due to their stability.

There are primarily three types of stablecoins:

–

fiat-collateralized – pegged to a specific asset

–

crypto-collateralized – backed by other cryptocurrencies

–

non-collateralized – use software algorithms to automatically adjust the supply of the stablecoin based on demand

Consensus Protocol

Cryptocurrencies, which have no physical note or coin exchange, are decentralized systems.

For the blockchain to work, every node needs access to the same, continually updating database.

When new data is added to the network, the majority of nodes must verify and confirm the legitimacy of the new data based on permissions or economic incentives; these are also called consensus mechanisms. When a consensus is reached, a new block is created and attached to the chain. All nodes are then updated to reflect the blockchain ledger.

Proof-of-Work vs. Proof-of-Stake

Proof-of-work and proof-of-stake are the two main consensus protocols.

In proof-of-work, miners compete to add the next block (a set of transactions) in the chain by racing to solve an extremely difficult cryptographic puzzle. The first to solve the puzzle, wins the lottery.

In proof-of-stake, instead of investing in expensive computer equipment in a race to mine blocks, a 'validator' invests in the coins of the system.

In proof of stake, your chance of being picked to create the next block depends on the fraction of coins in the system you own (or set aside for staking).

CBDC

A central bank digital currency (CBDC) is a form of digital currency issued by a country's central bank. It is similar to cryptocurrencies,

except that its value is fixed by the central bank and is equivalent to the country's fiat currency.

There are two types of CBDCs, wholesale and retail:

–

Wholesale CBDCs function similarly to holding reserves in a central bank

–

Retail CBDCs are government-backed digital currencies used by consumers and businesses

Token-based retail CBDC – requires public-private-key-pair

Account-based retail CBDC – requires digital identification

Is CBDC a Cryptocurrency?

Though the idea for central bank digital currencies (CBDCs) stems from cryptocurrencies and blockchain technology, CBDCs aren't cryptocurrencies. A central bank controls a CBDC, whereas cryptocurrencies are almost always decentralized, meaning they can't be

regulated by a single authority, such as a bank.

A CBDC can be based on a blockchain, but it doesn't need to be. The Federal Reserve Bank of Boston and the Massachusetts Institute of

Technology's Digital Currency Initiative found that distributed ledgers could hinder the efficiency and scalability of a CBDC.