Crypto assets – the currency of Fintech

The University of Sussex is the first university in England offering an undergraduate degree in Fintech, with students starting this September. The interdisciplinary course, jointly provided by the University of Sussex Business School and the School of Engineering and Informatics, draws on a range of research expertise. Carol Alexander, Professor of Finance, explains this developing area.

Why a course on Fintech?

The finance industry is of strategic importance to the UK. However, this potential can only be realised if the talent pool exists. By 2020 the Fintech industry is expected to create hundreds of thousands of jobs in the UK alone. It is already worth £7bn to the UK economy.

A combination of artificial intelligence (AI), the powerful machines that can analyse big data, and the move towards robotic economies are all a result of advances in technology. Just as supermarket checkouts are being replaced by computers and truck drivers are being replaced by driverless vehicles, so are a lot of the functions in financial institutions being performed on a machine, and blockchain underpins all this technology.

Students need to graduate with the skills for careers in this rapidly evolving sector.

How is Fintech already affecting the finance industry?

I would classify Fintech into five related areas. There’s robo advising, for instance nowadays your pension or any sort of fund investment can be high risk, low risk, medium risk … and then maybe there are a few other questions about your risk preferences… and instead of a someone sitting down with you, you’ve basically got a robot in charge of how your money is allocated.

Then there’s all types of crypto assets, including initial coin offerings (ICOs) which new companies can now use to raise capital instead of bonds or equities. (Analysing all the coins and their derivatives like futures and options in this new asset class is a speciality of Professor Alexander’s research).

Third, blockchain: one small example of millions of types of blockchain applications is in swaps where there are many different types of swaps paying one cash flow and receiving another cash flow. These payments are coded on a block chain to be automatically executed. So, there is no need for archaic and slow systems which are prone to error.

And then there’s peer-to-peer (P2P) lending, often linked to crypto asset markets, and with funds transferred on blockchains. This is a sort of shadow banking system; I can save my money with Lending Club and then somebody else will borrow that money and I’ll get a much higher rate of return than I do when just sticking it in the bank.

Finally, there is machine learning, which is just a fancy word for mathematical models or quantitative finance.

What aspects of Fintech does your research look at?

My research in quantitative finance relates to hedge funds and financial institutions, and aims to help these markets become more established. In particular, I’m looking at crypto asset markets, including analysing derivatives and developing new indices such as: reference rates for indicative values of funds; a sentiment index which we call the ‘greed index’ for crypto markets, using machine learning techniques applied to Reuters news and to other sources like Google and Facebook; and the Bitcoin ‘fear gauge’.

Any index can provide the basis for traded financial products – in fact, financial markets can develop to trade anything one can measure if there is the demand. As the crypto asset market matures, the diversity of traded instruments will increase. At the moment there are futures and options on Bitcoin and Ether, but these derivatives aren’t linked to prices of other derivatives products. One class of index I’ve developed with my students is named the ‘fear gauge’ after the same term was used 20 years ago to introduce the VIX. That’s the class of Volatility Indices which measure investors’ views about turbulence in US equity markets. There are some keen potential industry partners for listing these indices, and I think there will be very significant interest in them in the not-too distant future

As the crypto asset class grows, fiat currencies become less dominant. And I believe it’s the dominance of the US dollar following Nixon’s abolition of the gold standard (which means that the US can just print dollars ad infinitum) which is at the root of major global economic problems today.

After working with several exchanges in the US and UK on developing models for pricing and hedging indexed products (for which I have a couple of patents) and on designing margin rules, I have also been working on designing the reference rates used for crypto derivatives.

As the subject of Fintech grows within an academic setting, the number of papers published on crypto assets is rising. As such, the amount of freely available data on the subject is large, but not all of this data is accurate or reliable. In my recent research on this subject, I have found that more than half the papers in finance and economic journals published since 2017 on crypto assets have used wrong data. Where researchers in this area source their data from is crucial (if you put in rubbish data you get results that are equally rubbish), and my research has shown which sources of freely downloadable data are more reliable than others, and how researchers can prevent any errors in their data gathering in future.

What is the future for Fintech?

We are moving to a world where instead of stocks, companies (and even towns) will have their own coin (or token, another type of crypto asset). Facebook is already planning its own coin, Libra (the US Government will do everything it can to stop this) and the value of that coin will reflect the value of Facebook, just like shares do now. And, of course, the prices of these coins will still be manipulated, just like share prices are. We need regulation of crypto assets and the exchanges on which they trade before the market can evolve enough to surpass the US dollar.

Regulation hasn’t caught up with the development of Fintech we need to address new areas such as credit risk in P2P lending, market risk of trading crypto assets, or operational risks of ICOs. Fintech risk management is a niche area where there is huge demand for employment – that is why we offer the BSc in Fintech and the MSc Fintech Risk and Investment Analysis.