Finance Beyond Fact and Fiction

FINANCIAL TRANSFORMATIONS IN POST-2008 EUROPE: A GLOSSARY

The scope of the effects of the 2008 financial crisis is still under discussion. Here’s a list of post-2008 financial reforms, innovations and evolutions investigated by the project Finance beyond Fact and Fiction. It is divided into three sections: financial reform, financial innovation and finance and politics.

FINANCIAL REGULATION AND SUPERVISION

BANKING STRESS TESTS: The key instrument employed by financial supervisors to manage banking systemic risks. Stress tests are designed to assess the resilience of bank balance sheets in the face of unlikely but serious adverse events, like a major economic collapse or a natural catastrophe. There were, thus far, five stress tests exercises in the EU: the 2009 and 2010 exercises were organised by the Committee of European Banking Supervision; the 2011 exercise was conducted by its successor, the European Banking Authority (vide EUROPEAN SYSTEM OF FINANCIAL SUPERVISION); the 2014 exercise was conducted by the European Banking Authority in conjunction with the European Central Bank Single Supervisory Mechanism (vide BANKING UNION); the 2016 exercise was conducted, again, only by the European Banking Authority. The efficacy of these exercises has been disputed.
BANKING UNION: A supervisory project designed to make EU banks more resilient, in which the European Central Bank assumes responsibilities of direct micro-prudential supervision of over a hundred banking groups in the Euro area, a task which is carried out in coordination with teams belonging to the national banking authorities and in accordance with EU objective of creating a single rulebook for financial markets. This arrangement is known as the Single Supervisory Mechanism and was established in November 2014. Participation in the Single Supervisory Mechanism is mandatory for all Eurozone countries and optional for other EU member states. The Banking Union also comprises the Single Resolution Mechanism (responsible for the resolution of banks) and the European Deposit Insurance Scheme (designed to protect retail deposits in the EU).
EUROPEAN SYSTEM OF FINANCIAL SUPERVISION: A set of international supervisory authorities established in 2011, comprising three microprudential organs — the European Banking Authority (based in London, to be relocated to Paris in the context of UK’s withdrawal from the EU), the European Securities and Markets Authority (based in Paris) and the European Insurance and Occupational Pensions Authority (based in Frankfurt), a.k.a. European Supervisory Authorities (ESAs) — alongside one macroprudential entity — the European Systemic Risk Board (also based in Frankfurt and working in close cooperation with the European Central Bank). This system acts in cooperation with both national financial supervisors and the European Commission, the Council and the European Parliament, with the aim of harmonising regulatory and supervisory practices at the EU level.
FINANCIAL STABILITY BOARD: An international oversight body set up in 2009 with the support of the G20. Established as a non-profit association under the Swiss law, the Financial Stability Board is hosted by the Bank for International Settlements and is expected to contribute to the harmonization and reform of the financial sector at a global level, namely through soft-law (standards). Presently, it comprises members from 25 different jurisdictions (including institutions such as ministries of finance, national central banks or the European Commission), 4 international financial institutions (e.g. the IMF and the World Bank) and 6 other international bodies. The decisions of the Financial Stability Board are taken by plenary consensus.
REGTECH: Digital technologies that enable enhanced supervisory and regulatory efficiency.
REGULATORY SANDBOX: An environment for financial experimentation closely supervised by financial authorities (financial supervisors and regulators) and structured around regulatory conversations concerned with innovative technologies and the experience of startups and financial incumbents with such technologies.

FINANCIAL INNOVATION

BITCOIN: The first cryptocurrency, created by a person or group under the pseudonym Satoshi Nakamoto. The Bitcoin whitepaper was released in 2008, and the first Bitcoin block was created in January 2009, engraved with a newspaper headline: The Times 03/Jan/2009 Chancellor on brink of second bailout for banks. Bitcoin’s innovation lies in the fact that it is deflationary non-credit money produced through a distributed network of nodes (logged devices on a blockchain network), where all transactions are registered in an immutable, synchronized shared ledger, now called blockchain. One of the ideas behind Bitcoin is to stimulate circulation rather than accumulation of currency. However, the creator Satoshi Nakamoto is estimated to own around 1 million Bitcoin.
BLOCKCHAIN: Distributed ledger technology that works online at the protocol level. It is an encrypted, distributed, immutable and synchronised database of (trans)actions where the latter are recorded in immutable blocks of transactions connected to each other - through hashes - in a chain of blocks. This technology may be open source, such as the Bitcoin blockchain for instance, but it can also be more exclusive, such as the R3 conglomerate proposal for blockchain infrastructure Corda. Blockchains may be public, as a completely transparent ledger of transactions that all the members in a open network can look into and which is governed by all the participants through a decentralised consensus algorithm. But they can also be private, being limited to a controlled number of participants who can choose the way the system will be governed among them - centrally, partly-centrally or decentrally.
CARBON CREDIT: Upon its inception, the carbon credit was regarded as an innovative financial instrument to help regulate greenhouse gas emissions and raise funds for green technological innovation worldwide. One credit refers to the permission to emit greenhouse gas that equals 1 tonne of carbon dioxide into the atmosphere. Carbon credit is thus a generic term for certificates that inscribe a multitude of different forms of emission savings that are estimated to have equal impacts on the atmosphere. Carbon credits are auctioned or traded in both regulated compliance markets and on a voluntary basis by people, who want to lower their carbon footprint. The price and value of carbon credits have fluctuated dramatically due to various influences ranging from policy and market regulation to general climate change awareness and societal commitment. There is also a difference in price depending upon the transparency, verifiability and trustworthiness of the means and methods through which the emission saving claimed by the credit is calculated.
CONSENSUS ALGORITHMS: Consensus algorithms are the mechanism through which consensus is established between users of a blockchain in order to verify and register transaction blocks. It is the trait that fundamentally legitimates the incorruptibility and immutability of the network. These algorithms can be designed in different ways, the main ones so far being Proof-of-Work (PoW), Proof-of-Stake (PoS) and Proof-of-Cooperation (PoC). With PoW, miners compete to solve cryptographic problems and are rewarded in cryptocurrency. With PoS, miners are selected according to the amount of tokens they own, and are rewarded in cryptocurrency. With PoC, previously validated miners cooperate to generate new blocks, with no significant reward.
CRYPTOCURRENCIES: Cryptocurrencies are a result of multiple technological developments, including cryptography and the creation and development internet protocols for anonymous electronic payments systems, such as the already gone David Chaum’s DigiCash (Chaum 1983), bit-gold (Szabo 1994) and B-money (Dai 1998). The first cryptocurrency ever to exist was Bitcoin, created by Satoshi Nakamoto in 2008. Since then, numerous other cryptocurrencies have been created, up to more than 1000 by the end of 2017.
DECENTRALISED APPLICATIONS: Applications built on top of blockchains which may include cryptocurrencies but also decentralised autonomous organizations governed through smart contracts.
DECENTRALISED AUTONOMOUS ORGANIZATIONS: ADecentralised networked organizations that are run through rules and actions shared by its members which are encoded in computer encoded contracts commonly called smart-contracts.
DIGITAL REPUTATION SYSTEMS: These are point- or token-based systems for rating individual or collective behaviour online or in the real world. It is commonly used to foster trust in online transactions or communication, but it can also be used as a mechanism for decentralised social control when applied at jurisdiction or broader community level.
FINTECH: Digital software and hardware designed to support either centralized or decentralized financial services.
INITIAL COIN OFFERING: An Initial Coin Offering (ICO) (or Initial Token Launch, c.f. TOKEN) stands for the process where a blockchain based project sells its initial coins or tokens (which can either represent a stake on the project, or other forms of value the token programmers wish to embed in them). Similar to an Initial Public Offering (IPO), this is a public sale. It is decentralised, working in a similar way as crowdfunding, but it normally involves a stake from the investor on a named project - it is then equity/project performance based. ICO’s are a common form of funding for blockchain projects. ICO markets are, so far, unregulated, raising concerns about investors protection from national authorities. In the United States, for example, the Securities and Exchange Commission (SEC) has stated that whether ICO’s fall under the securities law depends on each case and can be determined through the Howey Test.
METAVERSE: A digital network of 3D universes focused on sociality and rich user interaction through augmented and virtual reality, including economic relations and transactions mediated by blockchain technology.
MICROFINANCE: Financial services targeted at people without access to formal finance (for instance, MPesa or Kiva).
MINERS/MINING: Nodes on a blockchain which are responsible for the security and healthy functioning of the network. They work alone, or in mining pools, and lend computational power to the resolution of cryptography problems that enable transactions to be executed. Miners compete with each other to solve these problems and close blocks of transactions. Miners may be directly or indirectly awarded, depending on the consensus algorithm of the blockchain in question (cf. PoW and PoS). These are incentive-based decentralised security systems that make networks pretty secure since they disincentive ‘bad’ behaviour from the miners. However, the 51% miners’ hack attack, where a mining pool could manipulate the decentralised blockchain network, is a possibility. This event is yet to happen until today.
NFTS (NON-FUNGIBLE TOKENS): A non-interchangeable and non-fungible unit of data stored in a blockchain.
SMART-CONTRACTS: Automated contracts made between peers, first introduced on blockchain by Ethereum, a blockchain-based platform which enables the creation of cryptocurrencies, decentralised autonomous organizations and decentralised applications. Smart-contracts are contracts programmed to be executed according to future events triggered by the predicted actions of its stakeholders. A simple example may be ordering a package: if you make an online purchase your payment is stored in a smart contract made between you and the vendor. It will only be release to the vendor once, for instance, a valid shipment order is released according to the contract. Although these contracts may be used for commercial transactions they may be used in many other aspects which demand for the coordination of large scale groups involving people, entities or artifacts in online interactions.
TOKENS: Because a currency technically represents a unit of account, a store of value or a medium of exchange, and not all cryptocurrencies behave like a currency, the term token has introduced a wider concept. Tokens represent assets or utilities, that may or may not be fungible and tradeable, like commodities, reputation points or access rights to a given system.
WEB 3.0: A project for a completely decentralized internet without significant influence from tech giants and drawing on blockchain infrastructure.

FINANCE AND POLITICS

DIGITAL IDENTIFICATION/IDENTITIES: Digital identification is a digital proof that someone, or something, are who they claim they are. Digital identities are further composed of online (or even offline) footprints and activity, and thus more focused on agency and representation. Digital identification has been a recurrent subject in the scope of the European Union digital single market reform, particularly regarding the implementation of e-ID interoperability across member states and data privacy regulations. In this context, there are ongoing projects for e-ID service provision - often based on PKI, and sometimes on blockchain technology as well - coming from private and public entities alike. In a period where digital identifications and digital identities seem to be likely to become increasingly entangled, there are many questions being raised regarding digital track-records and metadata that include coming regulation, dilemmas concerning transparency, privacy, and security as well as broader issues of disintermediation, online reputation and digital governance.
EUROPEAN UNION EMISSIONS TRADING SCHEME: After the EU decided to adopt the Kyoto Protocol and institutionalize its own regulated ‘cap and trade’ carbon market in 2005, millions of carbon credits have been traded by European industries. The EU ETS is a compliance market, where specifically targeted industries are assigned emission quota and gradually are required to lower their emissions. If they fail to do so, they can offset their emissions by purchasing more allowances (credits) from industries that are below the cap, or they can fund emission reducing projects either within or outside the EU and thus earn new allowances. The EU ETS has been severely criticized for having too many free credits in circulation and the price remains low giving few industries an incentive to invest in emission reductions. Today the EU ETS is the world’s largest market in international emissions trading (https://ec.europa.eu/clima/policies/ets_en).
PARLIAMENTARY COMMITTEES OF INQUIRY: A non-judicial scrutiny mechanism which enables elected members of national parliaments to question actors of the financial system in order to understand how this system works, why certain financial problems occur and which legislative amendments may be necessary. These sessions are usually public. The number of banking troubles that followed the 2008 collapse translated into the formation of several such commissions in many European countries (in Portugal, there were seven such commissions formed since 2008, representing almost ten percent of the total of occasional parliamentary committees of inquiry since 1980).
“SCRUTINY SLOTS”: Periodical meetings (almost every month) between representatives of the three micro-prudential European Supervisory Authorities (cf. EUROPEAN SYSTEM OF FINANCIAL SUPERVISION) and elected members of the European Parliament belonging to the Economic and Monetary Affairs (ECON) Committee. These meetings take the form of a hearing, during which members of the European Parliament directly pose questions to representatives of the authorities with a view to possible legislative amendments.

WORKING CONCEPTS

BITCOIN EVANGELISTS: Charismatic speakers promoting the adoption of cryptocurrencies and the perks of blockchain technology.
MONETIZATION: Making money from previously unmonetized areas, for instance, through reward systems.
REPUTATION SYSTEMS: Digital interaction systems where interaction is mediated by ratings.
SOLUTIONISM: A term coined by Evgeny Morozov to address contemporary market attitudes towards technologies and panaceas for global problems.