May 1, 20214 min read

Quantum computing in Finance

Updated: May 2, 2021

Quantum computing processes information using the laws of quantum mechanics and takes advantage of superposition, the ability to operate simultaneously in multiple states. The idea is similar to the two-state system that electrons can exist in 2 (or more) states at once. This explains the behaviour of energy and material on the atomic and subatomic levels.

The possibility of creating such computers were thought of in the early 1970’s. At the first conference on the Physics of Computation in 1980 Paul Benioff and Richard Feynman suggested that a computer can operate under the laws of quantum mechanics and proposed a basic quantum computer model.

This caught the attention of many physicists who perfected and sculpted the quantum computer as we know today. In recent years quantum computers have gained wider awareness as it has crossed many milestones and proven to be useful (google “quantum supremacy”).

Classic computer VS Quantum computer

In our daily lives classic computer or smartphone will operate using millions of individual binary digits called bits, either 0 or 1. This is sufficient to store, process and manipulate information.

In quantum computing the information is manipulated using quantum bits (quBits) governed by the law of quantum mechanics. Those quBits have the ability to exist in both states 0 and 1 (or any number between), simultaneously (superposition and entanglement) this phenomena allows mind blowingly faster and more complex computation.

Those chandelier like computers must operate at a temperature close to -273°C (near absolute zero), have no atmospheric pressure and be isolated from the earth’s magnetic field or else it may lose its efficiency and reliability. Needless to say that quantum computers are not yet commercially available and will at first complement classic computers.

This technological disruption will improve industries such as energy, financial services, health care and manufacturing:

Such processing potential could shape the world of finance in the following ways:

Portfolio optimisation: Improve the efficiency of Markowitz optimisation model using quantum annealing. This mathematical technique finds the lowest energy state for a complex system, simply put, the highest return portfolio at lowest volatility. Quantum annealers are already commercialised by D-wave and will be used to complement modern portfolio theory and make tangent portfolios more accessible.

Risk analysis: Quantum computers will allow algorithms to analyse risk more efficiently than Monte Carlo simulations traditionally used on classical computers (Stefan Woerner & Daniel J. Egger,2019). This will be applicable to insurance and credit scores and will for eg: improve estimated level of risk associated with a loan.

Better pricing of financial assets: especially derivatives which is done by forecasting scenarios. Often done by using the Black-Scholes-Merton (BSM) model which prices a many financial derivatives using an analytical solvable model with a small number of input parameters. It will allow faster Monte Carlo simulations to produce close to real-time pricing of derivatives instead of in days. Also detect cross-currency arbitrage (currency cycle that provides returns) quicker.

Increased High frequency trading & algorithmic trading: Will lead to more volatile markets and possibly an increase in flash crashes similar to that of 06/06/2010 which was triggered by computers trading algorithms reacting to aberrations in the market by automatically selling large volumes. Currently about 70%-80% of US market shares traded are done by algorithms, we could see this figure increase especially in emerging markets (India currently about 40%)

Logistics and supply chain optimisation: Will help meet customer demand while avoiding waste with processing speeds hundreds of millions of times faster. The B2B & B2C efficiency will continue to increase with orders becoming more complex, personalized and quicker delivery.

Safety through quantum cryptography: In banking it will allow better monitoring of transactions, reduced operational costs, more accurate processing of clients preferences, client data safety and overall safer information transmission. Quantum cryptography will also allow other major institutions to keep communication safe. According to J.Powel (FED chairman) " I would say that the risk that we keep our eyes on the most now is cyber risk..... There's a lot of effort going in to deal with those threats. That's a big part of the threat picture in today's world".

The World Economic Forum (WEF) is now predicting that we will see the first generation of commercially-available, quantum-inspired devices by 2025. The idea however, that quantum computers will be widely available in the next few years is still far fetched. Any discovery or achievement will not be disclosed as it is in the advantage of companies to stay quiet about the competitive advantage they gain/have gained from quantum computing.

Companies developing quantum computing are mostly private or owned by tech giants. Quantum startups have flourishing in recent years with the help of venture capital investors:

D-Wave, PsiQuantum, QC Ware, Zapata Computing, 1QBit, Rigetti, ID Quantique, IQM. However most are private or owned by tech giants.

This technology is improving rapidly and could potentially be a “hype” or even a bubble sector for investors in the upcoming years as it is difficult to assess when and to what extend quantum computing will disrupt our daily lives.