Decrypting crypto finance

We take a look at what crypto finance is and how it might be used in the motor finance sector.

"Cryptocurrencies” and “the blockchain” are the sort of phrases that seem to be everywhere but which few people actually understand.

An advocate of this technology would paint you a picture of car finance in the next decade. There are trends already in motion which we can expect to continue and transform the car finance sector. Direct car ownership will continue to decline, while sharing solutions grow to control an ever-larger sector of the market. We can expect to see mobility operators that own and manage large fleets of vehicles, operating around the clack and accessed easily through users’ phones.

Cars will become seen less as a product to sell, and more as an asset that needs to be kept in constant use to provide significant returns for fleet managers.

This will mean ensuring customers enjoy a frictionless experience while keeping operating costs low. Ideally, it will mean the car itself is self-managing, conducting its own maintenance, handling financing and payments independently.

Crypto-technology advocates argue that this vehicle could be tracked throughout its lifetime on a blockchain where concerned parties can verify the car’s information at any time, enhancing transparency but guaranteeing privacy.

It will allow the fleet manager to verify all transactions relating to the car, as well as its financing status. The end-user can have confidence that previous renters properly released their usage rights without needing to see who the previous user was or what they did with the car.

In this vision of the future autonomous cars are equipped with mobile payment wallets connected to the wider transactional systems through blockchain technology, letting the cars bill customers directly for the journey, as well as other potential services and expenses such as in-car entertainment, or road tolls and on-demand insurance.

It is an appealing sounding vision of the future, but to understand how the blockchain is integral to it, we first need to understand the blockchain itself.

What is the blockchain?

While a lot of the terminology around the blockchain can sound daunting, the basic concept is actually fairly simple. It is a database of transactions, but rather than storing the database in one place, it is encrypted and distributed across all its users, and is continually checked and double-checked between copies. Cryptocurrencies and NFTs (non-fungible tokens) use the blockchain to keep track of transactions without resorting to a centralised authority.

The blockchain has allowed for the creation of “digital objects”, which can be transferred from one person to another without the sender being able to keep hold of it, forge it, or retransfer it. In short, it allows for the creation of one thing the digital has not had until now – scarcity.

Trade using the blockchain means that digital assets can be securely transferred from point to point without needing a trusted intermediary. These transactions are also irreversible and immutable, making external censorship impossible so long as the network is secure and strong enough.

Supporters of the technology argue that through decentralisation blockchain technology can solve many of the challenges around trust requirements in business processes and interactions by keeping track of the historical and current ownership rights of an asset at any time without the need for an intermediary or overseeing authority.

The blockchain in car finance

Blockchain technology has already seen applications in the car finance sector. Deloitte’s “Smart-ID” platform uses blockchain technology as an alternative to traditional ways of providing identity, creating a “universal” digital identity for users that creates new ways for individuals, organisations and electronic devices to verify identity credentials for transactions.

Through the Smart-ID system, users can create and store identity attributed like an ID reference, passport or driving licence, which with third-party endorsements will form verifiable credentials that can be used in any digital interaction.

Blockchain also has applications in the arena of international transactions. Cross-border transactions are often a painfully expensive and slow process, but blockchain technology can speed up and simplify that process while reducing costs.

This is another area Deloitte has been looking into, building a prototype that allows its customers to send money across borders with only the phone number and email address of the recipient. It shows how blockchain technologies, alongside other forms of distributed database and cloud technology, can take the friction out of international trade.

Unknown territory

Many people looking at the potential applications of blockchain technology and the crypto sector is a global one that is evolving rapidly, but cryptoassets remain largely unregulated.

In the UK the FCA requires cryptoasset custodians and exchanges to register with it, but this is purely to allow the agency to identify money launderers and does not give the regulatory body any additional remit, tools or powers to protect consumers, as is the case for regulated activities.

Firms under the Fifth Anti-Money Laundering Directive are expected to have robust anti-money laundering frameworks in place, and the FCA will only register entities that do.

There are concerns that crypto-based markets could pose increasing risks to consumers and market integrity, in particular when cryptoassets are used as a speculative investment or for lending and borrowing. The FCA is currently working with the Treasury and other regulators to inform thinking on whether further regulatory or legislative actions are required to mitigate those risks.

A Cryptoassets Taskforce has been established, including the FCA, Treasury and Bank of England, and last year the Treasury consulted to extend regulation to stablecoins used as payments and bring all cryptoassets into the financial promotions regime.

There are also environmental concerns around blockchain-based transactions. A report from finance site MoneySupermarket showed that a single transaction with Bitcoin, the most popularly used cryptocurrency, uses 1,173 Kilowatt Hours (kWh), enough to power the typical UK home for more than three months at a cost of roughly £125. Decommissioned fossil fuel plants have been brought back online to farm bitcoin.

It is not surprising that blockchain technology has many in the financial sector excited by its potential, but as well as practical and regulatory challenges, it also presents ethical ones.