Decentralized Finance (DeFi) is transforming the financial landscape by enabling peer-to-peer transactions without the need for traditional intermediaries like banks. DeFi offers a wide range of financial services, including lending, borrowing, trading, and more. Among the various DeFi platforms, Decentralized Exchanges (DEXs) have gained significant attention due to their ability to facilitate digital asset trading directly between users, including crypto currencies, stable coins, and governance tokens. DEXs provide greater privacy, security, and control over assets by eliminating intermediaries, allowing users to trade directly from their wallets. While DEXs offer numerous advantages, they also introduce significant risks that need to be considered and managed. These risks, ranging from operational vulnerabilities and security challenges to legal and compliance uncertainties, are thoroughly examined in this article. The Architecture and Key Components of Decentralized Finance (DeFi) DeFi represents one of the most recent and transformative innovations in the financial sector, experiencing rapid user growth, driven by the emergence of new use cases, the increasing adoption of crypto-assets, and the continuous development of new DeFi protocols. DeFi’s multi-layered architecture is based on four main components namely, permissionless blockchains, smart contracts, DeFi protocols, and decentralized applications (DApps). Starting with, permissionless blockchains are decentralized networks that allow anyone in any geographical location to participate without needing approval from intermediaries like banks or centralized institutions. These networks also pseudonymize participants, substituting identifying information with artificial identifiers to enhance privacy. Smart contracts serve as the foundational building blocks of DeFi systems. These self-executing code scripts automate the fulfillment of transaction terms and conditions, enabling streamlined and efficient process automation. The combination of multiple smart contracts forms DeFi’s protocol, allowing it to deliver complex financial products and functionalities such as lending, borrowing, and trading. Finally, DApps are web/mobile device applications that provide user-friendly interfaces for accessing DeFi services and products. DApps often use decentralized autonomous organizations (DAOs) for governance and decision-making, enabling transparent and community-driven control over DApps’ operations, including funding allocation, protocol upgrades, etc. DEXs: Growth, Mechanisms, and Associated Risks in the DeFi Ecosystem Among DeFi’s products and services, DEXs, a type of crypto exchange platform, have experienced significant growth and popularity in recent years. DEXs are applications that allow users to exchange digital assets without intermediaries. Most DEXs utilize Automated Market Makers (AMMs), which replace traditional order books with liquidity pools. AMMs are implemented as smart contracts that manage these pools and determine digital assets’ prices algorithmically. Liquidity providers deposit pairs of crypto-assets into the pools, enabling traders to swap assets directly. The smart contract dynamically adjusts swap rates based on the asset ratios in the pool. Security Risks in DEXs: Code Vulnerabilities, Scams, and User Management Challenges DEXs’ users could be broadly categorized into two categories: retail users who are the traders and swappers of DEXs platforms, and ecosystem contributors including developers and liquidity providers/investors. The open, permissionless, and pseudo-anonymous nature of DEXs along with the absence of intermediaries create regulatory gaps, which in turn introduce significant risks for both traders and liquidity providers. To start with, the public nature of DEXs makes it a fertile ground for hackers to exploit code vulnerabilities. This could result in financial losses through the direct theft of funds, as attackers exploit vulnerabilities in smart contracts to drain funds and digital assets from DEXs’ liquidity pools or traders' wallets. Moreover, the exploitation of code vulnerabilities could enable malicious actors to access critical control points in DeFi and DEX systems, such as their governance frameworks or their protocols’ consensus mechanisms. Such access can fundamentally alter the functioning of its underlying protocol, leading to significant financial and operational risks, such as manipulating transactions, draining funds, or executing malicious proposals to achieve majority control and authorizing unauthorized transactions. Likewise, the advantages offered by DEXs, such as self-custody, no Know Your Customer (KYC) requirements and access to emerging tokens, place greater responsibility on users, requiring them to exercise caution and diligence to identify potential scams. To illustrate, the permissionless and decentralized nature of DEXs allows for an open and free token listing, making it easy for scammers to mimic legitimate tokens before their official listing. This tricks buyers into purchasing fake tokens, leaving victims with worthless assets and no recourse. Furthermore, “rug pull” scams are quite recurrent on DEXs, where scammers create a new token and advertise it aggressively to attract investment. Once it gains traction, the scammers withdraw the liquidity from the pool, making it impossible for investors to sell their tokens, which again leaves them with worthless assets and no recourse to recover their funds. Similarly, while the decentralized nature of DEXs grants users self-custody over their assets, it introduces the risk of mismanaging user identity. Without a centralized entity for potential recourse, misplacing one’s private keys is irreversible, causing users to lose the only means of accessing the digital assets tied to that identity. Market Manipulation Risks in DEXs: Wash Trading, Front Running, and Pump-and-Dump Schemes DEXs are also prone to market manipulations, further exacerbated by users’ pseudonymity which creates challenges in evaluating aspects such as the extent of retail investor participation, market concentration, and risks associated with specific market participants or activities. One form of this is “Wash Trading”, where users with multiple accounts trade among themselves to inflate trading volumes and mislead others. To swappers/traders, this could create artificial price fluctuations, making them trade at unfavorable rates. On the other hand, wash trading could cause liquidity providers to misallocate their funds to pools with seemingly high activity but little genuine demand, leading to lower returns. “Front Running” is another form of market manipulation that arises on blockchains due to three primary factors: blockchains update at discrete intervals rather than continuously, pending transactions are publicly visible before finalization, and transactions are not processed in strict chronological order. This enables attackers to exploit such visibility to gain an unfair trading advantage. Through front running, attackers jump ahead of legitimate transactions and alter the order of trades, which can cause price changes that mislead other participants about the true supply and demand for an asset. A specific form of front running in DEXs that exploits the transparency and timing dynamics is known as “Just-In-Time (JIT) Liquidity”. In JLT, liquidity providers deposit liquidity to a pool just before a pending trading order is processed and withdraw such liquidity immediately after the trade is processed. This is done to earn trading fees without incurring price risks; thereby, harming normal liquidity providers who typically leave their assets in the pool for longer periods and bear price risks, which reduces their fee revenue. Another form of market manipulation is through “Pump and Dump” schemes, where groups of individuals, sometimes numbering in the millions within private social media groups, coordinate to artificially inflate the price of an asset, usually smaller or less liquid crypto assets, and sell at a profit before the price collapses. Financial Risks in DEXs: Impermanent Loss, Slippage, and Loss-Versus-Rebalancing (LVR) DEXs also impose multiple financial risks, with one of the most significant being "Impermanent loss." This occurs when traders exploit price differences in the liquidity pool through arbitrage, causing the value of assets in the pool to fluctuate compared to holding them outside. Liquidity providers may experience a loss in value, potentially greater than if they had kept their assets in their wallets. However, the loss is called "impermanent" because it can be reversed if the asset prices return to their original ratio. Nonetheless, if the provider withdraws their assets before that happens, the loss becomes permanent. Another financial risk is slippage risk which refers to the deviation between the expected swap rate and the actual rate achieved during the transaction; thereby, affecting traders. This concept mimics the "market impact" concept in traditional financial markets, where the price of an asset changes as a result of the trade itself. The extent of slippage depends on factors such as the size of the trade relative to the liquidity pool and the specific design of the DEXs’ AMM and its pricing mechanism. However, it is worth noting that some protocols implement pre-set slippage tolerance levels. A similar concept is known as the Loss-Versus-Rebalancing (LVR) which affects liquidity providers when arbitrageurs profit by trading against the pool at outdated prices, causing liquidity providers to incur value losses compared to holding assets directly. This happens because AMMs update their prices mechanically based on the pool's asset ratios rather than incorporating real-time market information. Governance, Compliance, and Regulatory Risks in DEXs: Illicit Activities, Oversight Challenges, and Token Concentration Moving on, similar to all decentralized applications, DEXs are associated with multiple regulatory and compliance risks, the most important being the conduct of illegal activity, particularly money laundering and terrorism financing. To illustrate, DEXs could be used to convert stolen crypto-assets to more volatile and liquid assets, that could easily further be converted into fiat assets in centralized trading platforms. Furthermore, the lack of standardization across DeFi’s and DEXs’ protocols creates difficulties in monitoring and oversight of trading activities on DEXs by regulators; thus, making it complex to identify systemic risks, track illicit activities (e.g., money laundering, fraud), or enforce compliance requirements. At its current state, DEXs’ protocols need to be assessed manually and individually, which is resource-intensive and limits regulators' ability to perform timely risk assessments. The complexity is further exacerbated by the composability of DeFi’s protocols where DEXs’ protocols could integrate with other platforms, further complicating the monitoring and tracing process of regulators. Moreover, DAOs’ governance is based on tokens that grant voting powers to their holders, enabling a community-driven decision-making process. Nonetheless, such tokens could be traded like other crypto-assets, which could cause such tokens to be concentrated in the hands of a few players. Such concentration of powers could also emerge from the developers and founders of the DEXs’ protocols. Furthermore, the pseudonymous nature of DAOs can create information asymmetries between creators and contributors, as insiders may hold critical knowledge that is not accessible to the broader community. This creates risks of biased governance where decisions might lack transparency or accountability, leading to mistrust among the broader community of token holders and users. Navigating Risks and Building Robust Regulations for the Future of DEXs To conclude, while DEXs offer privacy, control, and reduced reliance on intermediaries, they come with significant risks, including security vulnerabilities, scams, market manipulation, financial uncertainties, and governance and regulatory challenges. With the many risks associated with DEXs, it’s curious why users are drawn to benefits like anonymity, direct control over assets, and freedom from intermediaries. This poses questions on whether the advantages are truly enough to outweigh the inherent risks? It also underscore the need for a more robust and tailored regulatory framework. Infact, despite the recent progress in digital asset regulations, the regulatory approaches differ widely across jurisdictions, leading to regulatory fragmentation and multiple risks arising from regulatory arbitrage. As DeFi and DEXs continue to grow, regulatory approaches in many countries remain outdated, as they still focus on regulating intermediaries. This creates a significant pitfall, as this approach fails to address the particularities and characteristics of DeFi and DEX platforms. Rather, regulatory avenues should focus on developing regulations that focus on the different layers of the DeFi system such as blockchain infrastructure, services application layer, and systems allowing users to access these services. Addressing these risks through tailored regulations will be essential to fostering the continued growth and security of DEXs within the rapidly evolving DeFi ecosystem. References https://www.esma.europa.eu/sites/default/files/2023-10/ESMA50-2085271018-3349_TRV_Article_Decentralised_Finance_in_the_EU_Developments_and_Risks.pdf https://www.bis.org/bcbs/publ/wp44.pdf https://stanford-jblp.pubpub.org/pub/regulating-defi/release/1 https://www.esma.europa.eu/sites/default/files/2023-10/ESMA50-2085271018-3349_TRV_Article_Decentralised_Finance_in_the_EU_Developments_and_Risks.pdf https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4861942 https://link.springer.com/article/10.1007/s12525-024-00723-1#citeas https://coinmarketcap.com/academy/article/how-to-identify-and-avoid-uniswap-scams https://acpr.banque-france.fr/sites/default/files/medias/documents/20230403_decentralised_disintermediated_finance_en.pdf https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf https://www3.weforum.org/docs/WEF_Pathways_to_the_Regulation_of_Crypto_Assets_2023.pdf
The AI boom is transforming all industries. The financial industry is no exception. AI is increasingly prevalent in financial services and is reshaping traditional institutions by creating more efficient operating models. This article explores the opportunities AI could offer financial markets and the challenges it presents to different stakeholders. Opportunities In trading, AI tools can help companies execute processes quickly and efficiently. Traders must consider various factors, such as the economy, market, and strategies, to make informed decisions and accurate predictions. The implementation of AI can assist in this process by compensating for the limitations of traditional investment models. Big Data and Machine Learning These AI algorithms use machine learning technology to analyze vast amounts of data, such as stock prices, news articles, macroeconomic indicators, and sentiment analysis. Unlike human analysis, which can be limited by incomplete data, latency, or inaccurate results, AI algorithms can process millions of data points in just a few seconds. They can mobilize various data sources, analyze different types of data simultaneously (such as market prices, news, social media posts, satellite images, etc.), and identify patterns and complex correlations between multiple variables. These correlations can be difficult for human traders to assess. By utilizing statistical methods, algorithms can analyze large volumes of historical and real-time data to identify upward and downward trends. This allows for more accurate predictions of future market movements. Additionally, these AI algorithms can automatically derive rules and continuously learn to fine-tune their capabilities for an enhanced, data-driven decision-making process. High-frequency trading and Quants The impact of Al algorithms is eminent in high-frequency trading (HFT). In fact, there has been a race between HFT companies for increased automation that would allow them to minimize their execution and response time to nanoseconds. This is why it heavily relies on the use of AI. When deployed at all stages of trade, AI can allow HFT participants to benefit from an autonomous value chain, thus extremely reducing execution timeframes. For instance, these sophisticated technologies can swiftly detect signals, design strategies, and execute trades to capture undiscovered opportunities and capitalize on minor inconsistencies across markets. This can be achieved by trading at a rapid pace that can only be maintained by machines. Operational Efficiency The use of automation and computerized business operations has enabled many companies across various industries to reduce operational costs and increase productivity, leading to improved operational efficiency and profitability. This trend is also evident in financial institutions. Goldman Sachs's U.S. cash equities trading desk in New York has seen a significant reduction in employed traders over the past two decades. In 2000, the desk had 600 traders, but by 2017, that number had decreased to just two. This reduction is due to the increasing adoption of automated trading programs. Goldman Sachs has been intensifying its use of AI-driven programs, expanding from equities to forex and, more recently, derivatives markets. The investment bank is using neural networks, an AI method that imitates the human brain, to develop its software. Processes are becoming increasingly automated, from front-office to back-office operations. Nasdaq's new exchange AI-powered order type has improved fill rates by 20.3% and reduced markouts by 11.4%. AI can also help minimize losses related to operational risks, such as human error and fraud. Blackrock transformed its risk management function, a cost center by default, into a revenue stream by launching Aladdin, an AI-based software for risk assessment and portfolio management. Challenges Generative AI has become ubiquitous, from simple text generation to automated code testing. The market is projected to reach US$44.89 billion in 2023, with a CAGR of 24.4%. However, major banks and financial services firms such as JP Morgan Chase, Citibank, and Bank of America are currently banning the use of ChatGPT. Traditional and generative AI can pose a risk to financial institutions. This is because many innovative solutions are provided by external vendors. If these companies do not conduct the necessary due diligence in advance, implementing these solutions in their day-to-day operations can have profound implications for data privacy. The technology uses inputs from all users to fine-tune its capabilities, detect patterns, and draw inferences. Therefore, these risks are inherent to the technology. Data leakage, such as proprietary information, can have a severe impact on both organizations and investors. Therefore, it is important to minimize the probability of such incidents occurring. Last May, a falsified image of an explosion near the Pentagon moved markets. The AI-generated image had set off fears, which brought US stocks down. This event has shown how this technology can be a threat, as some actors may try to take advantage of the vulnerability of financial markets. The fraud scheme could extend to other kinds of spoofing, such as voice cloning, to further manipulate the markets. As new tools emerge, scrutiny should be heightened since cybersecurity is at stake and misinformation can easily feed investors panic, thus disrupting the market. Furthermore, the financial landscape is highly interconnected, and AI systems are interdependent. Therefore, as the financial industry adopts this technology, it could significantly expose itself to systemic risks by exacerbating biases, like herding behaviors, or by producing inaccurate results, also known as AI hallucinations. Financial institutions should be cautious about implementing third-party AI-based models due to transparency concerns. The architecture of algorithms can be very complex and can include an extensive number of parameters. It is a requirement for financial institutions to be able to explain the rationale behind their decisions to all stakeholders. Therefore, it is a new challenge for these organizations to grasp how these models work and generate their outputs. Conclusion AI is transforming financial institutions and the products and services they offer to clients. This includes chatbots, automated trading algorithms, and other innovations that enhance the customer experience. However, AI can also be disruptive to markets, posing financial and operational risks to all stakeholders. Regulators should focus on creating a framework that ensures the security, transparency, robustness, and stability of the financial landscape. Control functions must deepen their understanding of AI and its regulatory implications to design effective risk management practices. Sources https://mpra.ub.uni-muenchen.de/118175/1/Use%20of%20AI%20in%20Stock%20Trading.pdf https://www.ft.com/content/fdc1c064-1142-11e9-a581-4ff78404524e https://www.oecd.org/finance/financial-markets/Artificial-intelligence-machine-learning-big-data-in-finance.pdf https://www.technologyreview.com/2017/02/07/154141/as-goldman-embraces-automation-even-the-masters-of-the-universe-are-threatened/ https://www.statista.com/outlook/tmo/artificial-intelligence/generative-ai/worldwide https://finance.yahoo.com/news/companies-now-banning-workers-using-164126139.html https://www.nytimes.com/2023/05/23/business/ai-picture-stock-market.html https://www.nasdaq.com/press-release/nasdaq-announces-first-exchange-ai-powered-order-type-approved-by-the-sec-2023-09-08 https://www.imf.org/-/media/Files/Publications/FTN063/2023/English/FTNEA2023006.ashx#:~:text=Cybersecurity%20of%20GenAI%2C%20including%20potential,for%20example%2C%20in%20bank%20runs.
Fintech is disrupting the financial services industry by creating a digital alternative to traditional institutions. Fintech companies use innovative technologies and data analytics to facilitate access to banking and financial services, including payments, loans, and insurance. There is still a significant percentage of the world’s population that is excluded from the financial ecosystem and does not have access to platforms that allow them to track their spending, save money, or use other banking services. The percentage of adults making digital payments increased globally from 26% to 51% between 2014 and 2021, but in Latin America and the Caribbean, this number increased from 5% to 20% over the same period. The increase in account ownership in LAC is largely due to greater access to mobile money accounts, which has made financial products more accessible to women, low-income groups, and other excluded sectors. Financial Inclusion in Mexico In Mexico, in 2021, over 40% of the population was considered financially excluded, according to the ENIF survey. This means that they do not have access to formal financial services such as banking, saving, credit, and insurance. However, fintech has been playing a critical role in improving financial inclusion in the country by bringing financial services to the previously unbanked. This has forced large financial institutions to reevaluate their business practices, resulting in 16.8 million adults in Mexico having access to banking services through fintech platforms in 2020. According to the Mexican Banking and Securities Commission (CNBV), financial inclusion in Mexico has four fundamental components: Access: Infrastructure available to offer financial services and products. Use: Acquisition or contracting by the population of one or more financial products or services. Consumer protection: New or existing financial products and services are under a framework that guarantees transparency of information, fair treatment, and good practices. Financial education: Aptitudes, skills, and knowledge that the population acquires in order to be able to correctly manage and plan their personal finances. The World Bank reports that financial inclusion in Mexico has advanced due to the National Financial Inclusion Strategy, whose main policy goal is to allow 77% of the Mexican population to hold at least one financial product by 2024, compared to 68% in 2018. More than $200 million in loans have been given out in the last five years, primarily to residents in rural and marginalized communities. However, there is still a significant percentage of the population that doesn’t have access to essential financial products and services like savings accounts, credit, insurance, and pensions. This leaves a large portion of the population vulnerable to financial shocks, such as job loss or illness, and unable to save for important life events like education or retirement. Fintech is playing an important role in transforming financial inclusion in Mexico and bridging this gap. Fintech Solutions Fintech companies use specialized software and algorithms to bridge the gap between those with access to financial services and those without. As more people access the Internet through their mobile devices, fintech companies are able to reach a wider audience and offer their services through user-friendly mobile apps, making digital banking more accessible and affordable for people living in rural areas, low-income households, the elderly, or those working in the informal sector. In March 2018, Mexico published the Fintech Law after the number of financial technology companies grew by 50% in the previous two years. The Secretariat of Finance and Public Credit (Secretaría de Hacienda y Crédito Público or SHCP), the Mexican Banking and Securities Commission (CNBV), and the Central Bank (BANXICO) are the main regulators of this sector. The law aims to foster financial inclusion, provide greater legal certainty for users of fintech services, and generate more competition in the market. Fintech regulation has placed Mexico at the forefront of regulatory issues and consolidated its position as a pioneer in the field. By 2021, there were around 512 fintech startups in Mexico, making it the second largest fintech ecosystem in Latin America after Brazil. Their competitive advantage is the specialization in some products to meet different sectors, segments, and market needs, such as payments and remittances, loans, corporate financial management, among others. As we can see in Figure 1, Business and Consumer Lending is the subsector with the highest market share, coinciding with credit cards, which are the products for which fintechs are best known today. Figure 1. Fintech Subsectors and Market Share 2021 Source: Fintech Radar Mexico 2021 The sectors with the highest market share are Loans (21%) and Payments and Remittances (18%). A good example of those with a presence in Mexico are Nubank and Clip. Clip, as one of the leading companies, was the first terminal in the country (mobile and non-mobile) to accept all payment methods, pioneering innovation in business payment methods in Mexico. This helps SMEs increase their sales and have better control of their finances without paying high rates and commissions. Nubank, the largest neobank (which operates exclusively online) in Latin America, has a presence in Mexico, offering their first product: a credit card without annuities, acceptable in all businesses, and without long waiting times for approval. Nu Mexico is a company that has made a special effort to bridge the financial inclusion gap, as reported in 2022; 46% of its clients report a monthly income of less than 10,000 pesos; 1 in 3 customers over the age of 65 did not have a credit card before Nu card; its clients are located in 80% of the priority rural municipalities for the federal government. Future Prospects for Financial Inclusion with Fintech Financial inclusion has been a hot topic in Mexico, and fintech has played a key role in driving change. As more of the population gain access to internet connections and financial services, it is important to take a look at the future prospects of financial inclusion with fintech in Mexico. Offering individuals financial products like bank accounts and credit cards through their current smartphone service is one method of increasing financial inclusion. In Mexico, 67% of people over the age of 15 had smartphones in 2020, and that number is expected to rise to 74% by 2025. However, only 32% have made or received digital payments. This presents a significant opportunity to improve accessibility through digitized services. It is also important that both traditional financial institutions and fintechs continue to work together to re-educate people on the benefits of using electronic money; this not only expands access to financial services but also helps boost economic growth and reduce inequality. In conclusion, the outlook for fintech and financial inclusion in Mexico is positive. The industry has grown rapidly in recent years, driven by favorable regulatory policies, increasing smartphone penetration, growing demand for digital financial services, and a focus on reaching underserved populations. With continued innovation and expansion, the fintech industry is expected to play a key role in promoting financial inclusion and economic growth in Mexico in the years to come. Author: Meliza Rivas Sources: https://www.inegi.org.mx/programas/enif/2021/ https://www.inegi.org.mx/contenidos/saladeprensa/boletines/2021/EstSociodemo/ResultCenso2020_Nal.pdf https://microvestfund.com/fintech-a-bright-spot-in-mexicos-road-to-financial-inclusion/#:~:text=Despite%20medium%2Dterm%20liquidity%20issues,they%20have%20a%20bank%20account. https://www.afi-global.org/wp-content/uploads/2020/07/EN_Summary_National_Financial_Inclusion_Strategy.pdf https://mexicobusiness.news/entrepreneurs/news/role-fintech-financial-inclusion-mexico https://www.oecd-ilibrary.org/deliver/73e9341b-en.pdf?itemId=%2Fcontent%2Fpaper%2F73e9341b-en&mimeType=pdf https://www.gob.mx/cnbv/acciones-y-programas/inclusion-financiera-25319 https://www.gsma.com/mobileeconomy/wp-content/uploads/2021/11/GSMA_ME_LATAM_2021.pdf https://www.worldbank.org/en/results/2021/04/09/expanding-financial-access-for-mexico-s-poor-and-supporting-economic-sustainability#:~:text=Mexico%20lags%20in%20terms%20of,with%20similar%20levels%20of%20development. https://diafintech.com.mx/noticia/fintech-radar-mexico-2021-principales-hallazgos/ https://labsnews.com/en/news/business/the-13-latin-american-rockets-among-cb-insights-250-top-fintech-companies-of-2021/ https://interesante.com/top-10-fintech-startups-in-mexico/ https://blog.clip.mx/clip-fortalece-la-economia-emergente https://www.endeavor.org.mx/clip_una_revolucion_a_la_inclusion_financiera.html https://blog.nu.com.mx/nu-pieza-clave-de-la-inclusion-financiera/ https://www.bbva.com/es/las-fintech-invaden-mexico/ https://es.statista.com/grafico/27329/paises-latinoamericanos-con-mas-empresas-fintech/#:~:text=Brasil%20es%20claramente%20el%20pa%C3%ADs,del%2030%25%20del%20total%20regional. https://financer.com/mx/wiki/ley-fintech/#:~:text=El%20principal%20prop%C3%B3sito%20de%20esta,Los%20pagos%20electr%C3%B3nicos. https://fintechradar.finnovista.com/mexico/2021/en/ https://www.caf.com/en/knowledge/views/2022/12/financial-inclusion-in-latin-america-how-far-we-have-come/
Spending on virtual credit cards (VCCs) has surpassed corporate card expenditure for the first time in 2019, according to the Research and Markets business credit card report. Additionally, a new study by Juniper Research estimated that the global value of virtual card transactions will reach $6.8 trillion in 2026, representing a 370% increase from 2021. Businesses will account for 71% of total VCC transaction value, as preference for the convenience and security of virtual cards over costly and time-consuming methods grows over time. Is it necessary for your company to use virtual credit cards (VCCs)? What should you know to help your company avoid fraud and take advantage of VCC benefits? In this article, we’ll address those concerns by presenting the features of a VCC and explaining how it varies from a typical corporate credit card. What is a virtual credit card? Unlike a typical credit card, a virtual credit card is not a physical object. It’s a temporary and random set of 16 digits. It’s typically used to buy a single item using your smartphone or PC, and it’s generated online within seconds. Each time you use it, the disposable number changes, and it expires when it is no longer in use. A virtual credit card connects to but does not replace, your actual credit card account, so the charge you make on a VCC still pops up on your regular credit card statement. What does it a Digital Card look like & how is it generated? The electronic image of a VCC resembles that of a regular credit card, but it contains a number string that looks like this: xxx xxx xxx xxx 1234. The “x’s” stand for a random collection of numbers that hide your actual credit card number from fraudsters. The cards also feature a three-digit card verification number and an expiration date. Users may be able to get a virtual card number through their online account management site, depending on their bank or card issuer. They can set spending limits on each virtual card number they get and set unique expiration dates (typically no more than 60 days) using their current account to protect themselves from abuse, fraud, and overspending. Virtual credit cards are offered by a variety of major financial institutions, including Visa, American Express, Citibank, Capital One, and MasterCard (which operates its own virtual credit card service). If you have a credit card, you may already have access to a virtual card number. To find out, simply log into your online bank or card account and search for “Virtual Card Number” or “Virtual Account Number.” Can you get a virtual credit card with no deposit? As previously explained, a virtual credit card number is connected to an existing account with cash or a credit account with a line of credit. Users are given the option to create the virtual credit card as a single-use or multi-use card, with an expiration date of their choosing. They are also given the option to place a spending limit on the card, which allows them to access cash from their current account in a more structured and controlled manner. What’s the difference between digital wallets and virtual credit cards? A digital wallet works similarly to a virtual card, with a few noteworthy distinctions. Apple Pay and Google Pay, for example, store a digital version of your physical credit or debit card, including full card details. Digital wallets are considered a safe payment method since most digital wallets generate a temporary card number, similar to a virtual card, guaranteeing that your actual card number is never shown to a retailer. However, digital wallets are not accepted everywhere. Unlike virtual cards, which may be used for any online purchase that accepts credit cards, digital wallets can only be used at participating stores, whether online or in-store. Virtual Credit Card advantages Security: Global credit card fraud losses totaled $28.58 billion in 2020, with projections to reach $49.32 billion by 2030. Given the magnitude of these numbers, security should be a priority for all companies. Virtual credit cards help prevent fraudsters from stealing your company’s credit card information or hacking into your online transactions. Why? because VCC numbers are meaningless to fraudsters. The growth in corporate credit card fraud, as previously mentioned, is a driving reason for growth in the VCC industry. A JPMorgan survey of over 8,000 professionals found that VCCs were only targeted by scammers in 3% of the cases, while corporate credit cards were attacked in 34% of the cases. Low fees and costs: Most virtual card issuers don't charge customers anything more for the service, and it allows them to use a new asset without having to open a new account. Seamless Payment Method: There are various levels to the exceedingly complicated structure of domestic business payments. The sheer number of payments made and received by each company is the first layer of complication. According to Juniper Research, the average North American company makes 2,275 domestic payments in a single year. With so many small firms in North America, the average number of payments made by major corporations will exceed 100,000 every year, which works out to more than 270 payments every day. Given a large number of payments, the effort of handling these payments is massive, and the number of channels involved adds to the complexity. There’s also the issue of payment terms and deadlines, which differ from one vendor to the next. Other factors, such as invoice factoring or supply chain financing, may also further complicate the process. Fundamentally, this means that controlling payment flows is a difficult problem that demands a significant amount of resources. Virtual cards often allow additional transaction data, such as payee reference numbers, transaction category data, etc., to be linked to records, which is a crucial advantage for business operations. This speeds up payment reconciliation for both A/P and A/R procedures. Expense Management: Businesses can use VCCs to get more control over their employees’ expenditures. When an employee travels on business, they can estimate the cost of the trip and establish a VCC spending limit accordingly. For example, if the estimated amount is $1,000, the employee can request a $1,000 VCC from the corporation. By establishing spending limits on employees, a VCC reduces the financial risk to the company. Virtual Credit Card adoption challenges Like other innovative technological applications, virtual credit cards present their own set of challenges: Vendor adaptation: The fact that not all vendors are ready to take payments via virtual methods is a significant barrier. This problem occurs most frequently when purchasing goods or services from businesses that demand a physical card as proof of identity to prevent fraud, such as hotels that require visitors to provide a physical card at check-in or fax a credit card authorization form to confirm their reservation. However, as the payment industry evolves, many suppliers are making greater efforts to handle virtual payments, and major credit card networks have begun to offer mobile wallets for corporate use, implying that virtual credit cards will combine with mobile wallets in the not-too-distant future. This shift aligns with the broader transformations in financial services, including the increasing prevalence of mobile payment solutions. Returns & Refunds: This point is not particularly limited to companies, as individual consumers also face the same issue. With virtual credit cards, returning products ordered online to a real store might be difficult. This is because some retailers ask customers to swipe or enter the card used to make the transaction in order to process any refund. This certainly isn’t possible with a virtual credit card. In some situations, customers may have to accept store credit rather than a refund on their credit card. Recurring payments: recurring payments such as subscriptions may be affected by virtual credit cards with short expiration dates. To keep the subscription active, users have to update the virtual credit card information each time it expires. If they forget, the subscription may be suspended, requiring customers to repeat the process with a new virtual credit card number. However, some virtual credit cards could be easily set up with a specific spending limit and the preferred recurrence (for example, monthly or quarterly). Company migration: For some businesses, implementing virtual credit cards might be a difficult task. Companies that sign up directly with a payment partner will work with them to develop this payment mechanism on the technical side. Employee training following the rollout is another challenge for some organizations, especially those in industries that have long depended on more traditional payment methods. To sum up, virtual cards are gaining in popularity and are an excellent way to make safe payments. They are especially useful in business settings where a large number of employees require company cards, which are more expensive to operate with physical equipment and may be more vulnerable to manipulation and fraud. Virtual card numbers are one option for companies to manage finances and transactions with increased spending controls and reporting features while eliminating security concerns on both sides of a transaction as privacy becomes more essential. However, like any new technology, virtual credit cards have their own set of obstacles that might hinder some companies from using them based on their payment needs. Sources https://www.juniperresearch.com/press/virtual-card-transaction-values-to-increase?ch=370% https://www.juniperresearch.com/researchstore/fintech-payments/virtual-cards-market-research-report https://www.paymentsdive.com/news/card-industry-faces-400b-in-fraud-losses-over-next-decade-nilson-says/611521/#:~:text=Fighting%20fraud&text=Global%20card%20fraud%20losses%20of,2019%2C%20per%20the%20Nilson%20report. https://cdn2.hubspot.net/hubfs/418036/WP_Sage_AP_Automation_virtualcreditcard-jul2017.pdf https://www.forbes.com/advisor/credit-cards/virtual-credit-card-numbers-guide/ https://www.axerve.com/en/learn/insights/virtual-credit-cards https://www.creditkarma.com/credit-cards/i/virtual-credit-card https://www.avidxchange.com/blog/virtual-credit-cards-what-they-are-why-theyre-so-popular/ https://www.cnet.com/personal-finance/credit-cards/what-is-a-virtual-card-and-how-do-you-use-it/
After attracting mainstream attention when Beeple sold his NFT collection for a whopping $69 million at Christie’s (1), the non-fungible token marketplace registered an unprecedented boom by the end of 2021, with sales recording a 21,000% jump compared to 2020’s numbers, according to a report from NFT data company “Nonfungible.com”, partnered with BNP Paribas’s L’Atelier (2). While the future of this market remains open to speculation, we will explore three possible scenarios the NFT market might experience based on examples of real NFT projects. Blockchain & Ethereum: Key enablers of NFTs To better speculate on the future scenarios of NFTs, we need to gain a better understanding of their foundation, specifically Blockchain, which serves as the backbone of NFTs. Blockchain was developed in the aftermath of the 2008 financial crisis, becoming a massive enabler for change in a broken system. Blockchain records all transactions in a way that makes it nearly impossible to hack, cheat, or change the system. The goal behind this technology was to create a new decentralized monetary system by transferring control and decision-making from centralized entities to a distributed network. The major blockchain innovations were cryptocurrencies (e.g., Bitcoin, Ethereum…) and NFTs. Ethereum is a cryptocurrency that can be obtained in the same manner that a national currency can be exchanged for a foreign currency. The only difference is that instead of going to banks, people can exchange their money on secure platforms such as Coinbase or Metamask (3). Although banks might be considered a more secure option given the fact that they are insured, crypto exchanges are far more secure since they are built on Blockchain technology, which ensures that every touchpoint is tracked, making it near impossible for any transaction to be hacked. Ethereum provides an additional versatile platform to other cryptos, which allows developers to implement Smart Contracts, improving traceability and verification (4). 1st Scenario: -The Good- NFTs Advantages and use cases as an enabler for a better future Historically, the economy works in such a way that the final consumer earns money, which he then spends on buying physical goods. However, with the advent of digital tools (social media, gaming, streaming…), consumption habits are changing. Transactions are shifting away from physical goods and more toward digital goods, which poses a problem: digital goods are harder to monetize. Consider the following example: an artist creates a physical painting that he attempts to sell, and someone attempts to produce replicas of his artwork. The buyer, in this case, would be able to tell the difference between the authentic and “fake” painting (brush strokes, signature, etc.). However, in the case of a digital artist, painting the same piece of art on his digital tool, he runs the risk of losing control over the asset the moment he puts it up for sale (as a JPEG image), given how easy it is to make copies, which would then look identical to the original art form, causing it to lose scarcity and thus value. This is what NFTs are trying to change. Based on Blockchain technology, NFTs can indisputably verify the original version of a digital product, which is attributed to a one-of-a-kind token of ownership that has a unique value. So, when people are trading NFTs, what they are really doing is buying and selling their virtual ownership of something. Based on this formula, we will present 3 future usages of NFTs that can potentially change how we perceive the digital world. Community -Bored Ape Yacht Club- While the bar regarding customer relationship is currently set so low in many NFT projects (essentially no customer relationship after the transaction), there is one collection of NFTs called the “Bored Ape Yacht Club”, with 10,000 unique ape images (the cheapest one going for $200,000). The point is, we regularly find that superstars (Neymar, Post Malone, etc.) and people who own these NFTs are using these photos everywhere, as a symbol of pride that they’re part of this exclusive club. On top of that, the creators of this Bored Ape collection organize physical get-togethers for people who own a bored ape NFT (5). Although this remains the exception, for now, we can expect a brighter future for NFT projects following a similar, or inspired approach, giving more than ownership of an NFT. Gaming -Blankos Block Party- Many companies are betting that NFTs will enter the video game world in a big way, which, if successful, could introduce NFTs to a massive new audience and forever change the way we value digital objects. Think of this: gamers already spend money on buying and selling game keys, digital weapons, and rare skins (cosmetic gear). Although these operate on legally dicey ground, it’s the game developer that ultimately owns the traded goods, not the players. A good example that comes to mind is Counter Strike: Global Offensive, which has always had one of the most significant grey markets, with players allegedly spending $100,000 on a specific weapon skin (6). This is where Blankos comes into play. The game operates on the premises of accessibility, ownership, and scarcity. It is a free title where players can collect, customize, or sell NFTs of characters and objects created by developers and major brands. The results so far speak for themselves. Blankos entered early access in June 2021. One week later, it recorded 100,000 NFT purchases, with major brands and artists including Burberry, Quiccs, and Deadmau5 launching in-game items (7). Documentation -Blockcerts- It is possible to use NFTs to verify documentation, such as certifications, diplomas, medical histories, passports, etc. For example, when it comes to academic credentials, hiring managers can quickly verify the certifications and degrees of job candidates. This would be a huge breakthrough to prevent fraud and smooth the verification processes. Blockcerts is a blockchain-based service that already makes it possible to verify academic credentials (8). However, it doesn’t use NFT technology quite yet, which would make it even more useful in the future. 2nd Scenario: -The bad- NFTs, the next financial bubble The NFT market has lately been criticized for being a bubble. A report from “Nonfungible.com” presents the market as a buyers’ market. In fact, while the number of NFT sellers increased by a mind-blowing 3,669% compared to last year, the number of buyers increased by “only” 2,962%. The report also finds that NFTs are kept for only 48 days on average in 2021 before being sold, compared to 156 days the year before (9). This sparks concerns that the market might be saturated. Additionally, looking at NFT’s “Silent Crash”, which occurred in April 2021, the floor value of NFTs dropped significantly. Although prices had been slowly dropping since February 2021, as buyers weren’t investing or buying and sellers had to drop their prices because the market wasn’t moving, the NFT market took a hit. By June 2021, news headlined that the NFT market had officially crashed, falling nearly 90% from its peak (in May) (10). Eventually, the NFT market survived, mainly with NFT buyers showing an upward trend, helped by athletes and celebrities showing off their NFT collectibles. Fast forward to March 2022, where the average sale price of an NFT is now below $2,000, down from over $6,800 in January, according to Nonfungible (11). Even the Bored Ape Yacht Club, one of the best names in the NFT sphere, has seen its value slip. Not so long ago, the NFT market capitalization had reached $23 million. By April 21st, 2022, it was barely over $10 million, according to CoinMarketCap(12) . Although this drop may seem to be caused by a variety of factors, such as inflation, the Ukrainian/Russian war, as well as the increased scrutiny of NFTs by the Securities and Exchange Commission, skeptics are still warning of an NFT collapse, described as a “cataclysmic market crash” (13). 3rd Scenario: -The ugly- NFTs, scam, cash grab, and environmental disaster The more people discover about how NFTs are currently being used, the more concerned they get about what is yet to come. In fact, while NFTs were created with the intention of respecting the artist, the majority of them now are being used as cash grabs by opportunistic business owners. As an example, we can take a look at the Lazy Lions, which have been described as mass-produced, computer-generated cash grabs that have been manipulating the market (14). Additionally, almost all NFT transactions use Ethereum, which is not environmentally friendly, to say the least. Ethereum uses a security mechanism called proof of work, which is what makes the NFTs fraud-proof. This security measure requires a significant number of computers around the world to be working simultaneously, resulting in high electricity consumption. While many do not see how NFTs could be the next big thing in the digital world, some see it as a digital breakthrough. NFTs are believed to be putting power and economic control back into the hands of digital creators and pushing forward the next internet revolution. This being said, NFTs have a long way to go to reach this potential. Sources: 1: The Wall Street Journal: Your NFT Sold for $69 Million. 2: The 2021 NFT Market Report: Presented by Non-fungible and L’Atelier 3: Forbes: How to Buy a Cryptocurrency? 4: Ethereum: What’s an NFT ? 5: CNET: Bored Ape Yacht Club NFTs: Everything you need to know 6: Ginx: Someone bought a CS:GO Skin for $100,000. 7: Engadget: Blankos Block Party is an NFT Trojan Horse for the video game industry 8: Blockcerts.org 9: The 2021 NFT Market Report: Presented by Non-fungible and L’Atelier 10: Kotaku The NFT Market Has Collapsed, Oh No 11: Nonfungible.com/Market-tracker 12: CoinMarketCap/Nft 13: Fortune: NFT Collector predicts the market is about to crash 14: NFT evening: Lazy lions market manipulation
