Right now we need embedded health as much as embedded finance

Embedded finance is great and I love having apps on my phone that take care of the interface to the tedious world of banks and money so that I don’t have to deal with them. But embedded finance doesn’t get me out of the house. And it can’t get me in to watch Manchester City again. It can’t get me on a plane to Singapore. Perhaps to get the post-COVID economy moving again, embedded health APIs will be more important than embedded finance APIs!

What’s the point of having all sorts of clever instant credit, credit transfer and buy on credit mechanisms that I can use to buy a new shirt if I am not allowed to go to meetings? Why bother with fancy QR code contact-free dining experiences if I am not allowed into a restaurant? How do I benefit from sophisticated electronic tickets dropped directly into my phone when there is nowhere to go on the train? What is needed to ease the economy back on track in the recurring pandemic, new normal world is the ability to show a vaccination record as well as a plane ticket and a negative test result along with a restaurant booking.

In fact, so pressing is this need that I might go so far as to predict that the virus shock may well mean a quantum leap in strategy in the world of digital identity: what if it is not finance or government, as most of us had assumed, but travel and hospitality that drives digital identity into the mass market?

Barman

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

It is actually pretty easy to imagine the customer journey with embedded health. I go online to buy ticket to see Hawkwind in concert at the London Palladium in May but in order to check out I must first present a certificate to show that I have been vaccinated against COVID-19 (I’m afraid that the Hawkwind fan demographic renders this necessary) and a certificate to show that I have been vaccinated against Yellow Fever or whatever else the London Palladium demands from would-be patrons. I present the digital certificates and go about my day.

That is quite easy to draw as some boxes and arrows mapping out a customer experience journey on a whiteboard, but what has to happen to make it a reality? That’s where things become a little more complex.

Vaccine Passports

There are some well understood issues around identification and authentication but to my mind these are largely solved. There are plenty of companies that can do digital onboarding pretty efficiently (indeed, I am an advisor to the board of one of them, Au10tix) and there are plenty of companies that can do authentication: If I could have used “sign in with Apple at the London Palladium”, I undoubtedly would have. What’s missing, and where there has to be some progress to bring that smooth customer experience into being, is the standardisation of the creation, presentation and verification of the health-related data.

(Just to divert for a moment to be specific about language: I use claim to mean the process of presenting a credential to be verified and I use credential to mean some attribute that has been attested to by somebody that the verifier can trust. By trust, of course, I mean “can sue for large amounts of money if the data turns out to be incorrect”.)

If a theatre, or more likely a theatre’s merchant services processor (MSP), wants me to show that I have been vaccinated then both the claim process and the claim data have to be in some sort of standard format. Otherwise we will end up in bubbles and make no real progress. It is clear that something has to be done. Ursula von der Leyen, the president of European Commission, recently said that a “Digital Green Pass” would provide proof of inoculation, test results of those not inoculate and antibody status of those who had had the disease. This is inevitable, frankly, in one form or another. But how exactly would it work?

There are some great companies out there who are already working hard to make the transport and display of results as easy as possible.Yoti, for example, have been involved in a number of trials using FRANKD. This is a rapid Point of Care Covid-19 RT-LAMP. People scan a unique QR code on their FRANKD test bag to add their identity to the test. After a testing swab is taken, results are processed and delivered straight to the individuals’ Yoti app within 30 minutes. To scale up, though, we need standards that identity providers can use to interoperate with service providers of all kinds. This is why the foundation of the Vaccination Credential Initiative (VCI) is so important.

VCI is a coalition of public and private partners including Microsoft, Salesforce, Oracle, The Commons Project Foundation, Mayo Clinic and many others working to enable digital access to vaccination records using the open, interoperable SMART Health Cards specification, based on the W3C Verifiable Credential (VC) and HL7 FHIR standards. FHIR stands for Fast Healthcare Interoperability Resources, a standards framework created by Health Level Seven International (HL7) , a not-for-profit, ANSI-accredited organisation developing standards for the exchange, integration, sharing and retrieval of electronic health information. The idea, essentially, is to group a set of FHIR content resources (eg, immunisation or observation) for presentation in the form of a verifiable credential.

The New York Times showed a mock-up (from The Commons Project) of what a digital vaccine credential might look like in practice, using a pretty straightforward QR code interface that passengers are already familiar with for check in.

Travel

Waiting for a globally-interoperable set of standards won’t help to boost the economy today, so it seems to me that it makes sense to link sector-specific identities together with sector-specific credentials that can be later bridged at the back-end. The obvious place to start implementing something like the EU’s Digital Green Pass is in the travel sector and the obvious people to co-ordinate this are the International Air Transport Association (IATA) and, indeed, the COVID-driven need for a such credentials has led IATA and British Airways’ parent company, International Airlines Group (IAG), to starting work together in this direction.

I hope they chose to use open standards for their Travel Pass Initiative (TPI). TPI brings together four interoperable “modules” that combine to deliver a practical solution to get people moving again. These modules are:

  • A up-to-date list of requirements for travel (ie, what vaccines or tests are necessary for travel on specific routes) so that travellers know what they need to do to travel;
  • A registry of health centres that can carry out vaccinations and tests that travellers need;
  • A contactless travel app for travellers so that they can find out what the travel requirements are, where they can get the tests and vaccines and store the results;
  • An application for labs to report results.

Singapore Airlines has been the first carrier to adopt the new standard and begin verification based on the IATA TPI framework. Passengers who receive a negative test or vaccine will be given either a digital or paper QR code to take to the airport. Emirates will implement the first phase in Dubai in April and will use the app for the validation of COVID-19 PCR tests before departure. Using the app, which will automagically post details to the check in system, passengers travelling from Dubai will be able to share their test status directly with the airline before reaching the airport. 

So if this works for getting on planes… why not use the same registries and APIs to power applications for restaurants and pubs to get the economy moving again? I’d be more than happy to be required to show my test status to get into the Etihad to watch the mighty Manchester City via a Travel Pass app, or my British Airways app, or my Man City app or whatever other convenient application was accessing standardised VCI vaccination and test records through the IATA API. And if IATA and VCI together create a global standardised platform then the opportunity for fintechs to exploit the combination of embedded health and embedded finance together in apps will be enormous.

(An edited version of this piece appeared on Forbes, 25th January 2021.)

Tulips, steam and decentralised finance

When we are thinking about where the worlds of Bitcoin and cryptocurrencies, “smart” “contracts” and decentralised finance (defi) will go, it can be helpful to find historical analogies that can provide a shared narrative to facilitate communications between stakeholders and provide foundations for strategic planning. But it’s important to find the right analogies and, even more importantly, to derive the right lessons from them.

For example: people discussing Bitcoin will often refer to the famous “tulip bubble” in 17th century Holland. But if you study this episode, what you discover is not a mass market mania but speculation by a small group of rich people who could well afford to lose money. And you will also see the creation of a regulated futures market that played a role in the financial revolution that contributed to a Dutch golden age which meant that balances at the Bank of Amsterdam became a pan-European currency and, as noted in an interesting paper from the Atlanta Fed last year, the florin (the unit of account for those balances) played a role “not unlike that of the U.S. dollar today”.

FOMO

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

As I am very interested in learning from a) history and b) smart people, I set up a room to discuss the topic on Clubhouse. (I have to say this transformed my view of Clubhouse, because I was blown away by the quality of the discussion that ensued and how much I learned in such a short time. Truly, arguing with smart people is by far and away the fastest way to acquire actual knowledge!)

Cryptocurrencies are more like railway shares in Victorian Britain than tulips in the Dutch Golden Age. Click To Tweet

Aside from tulips, another well-known “bubble”, Britain’s 19th century railway mania, was the subject of some discussion in the room. This particular example is worth studying because I agree with Nouriel Roubini and Preston Byrne’s observation that that the cryptocurrency mania of today “is not unlike the railway mania at the dawn of the industrial revolution in the mid-19th century”. If you want to read more about this, I wrote a detailed article about it a couple of years ago and, in fact, noted the incredible scale of the mania in Financial World magazine a decade back: The first railway service in the world started running between Liverpool and Manchester in 1830 and less than twenty years later the London & North Western railway had become the Apple of its day, the biggest company in the world. This boom in turn led to a colossal crash in 1866, which then led to a revolution in accounting and auditing.

My good friend Maya Zahavi drew the parallel between railway mania driving the introduction of accounting standards that led to new global capital markets in Victorian times (which in turn led to new kinds of regulation and institutions) and that world of defi: The world of financial services, including lending, exchanges, investment and more that are built on shared ledgers and smart contracts. I think she is right. I have long held the view that while cryptocurrencies themselves may or may not have a future as money, the evolution of digital assets that are secured by the underlying networks (“tokens”) points towards new services, markets and institutions that may well lead to a better financial sector.

This view, that digital assets (“tokens”) are where the next generation of financial services will be forged, was reinforced in a new paper published in the Federal Reserve Bank of St. Louis Review. In it, Fabian Shar explores the evolution of markets based on tokens that sit on blockchains of one form or another. He looks at three models for “promise-based” tokens: off-chain collateral, on-chain collateral, and no collateral.

  • Off-chain collateral means that the underlying assets are stored with an escrow service, for example, a commercial bank. There are already several examples of off-chain collateralised stablecoins. The most popular ones are USDT and USDC which both USD-backed* ERC-20 tokens on the Ethereum blockchain.
  • On-chain collateral means that the assets are locked on the blockchain (in a smart contract).
  • Algorithmic tokens that are not backed by collateral at all, but whose value is maintained by algorithmic market interaction. This was, incidentally,  the original meaning of the word “stablecoins” that has now been hijacked by imprecision)

The trading of these tokens, if it were to take place in the existing market infrastructures, would be interesting enough. But to Maya’s point, this is not where we are going. We are heading into the defi era where there is an impending explosion of business models, institutional arrangements and transaction complexity which, when it settles, will leave us in a new financial world. I strongly agree with the view of Jay Clayton (when chairman of the U.S. Securities and Exchange Commission) that “everything will be tokenised” and the obvious corollary to this that everything will be decentralised. It is not the underlying cryptocurrencies that will be the money of the future but the that they support. As the St. Louis Fed’s paper concludes, and as I wrote in Forbes back in January, defi may potentially contribute to a more robust and transparent financial infrastructure.

In the long run (and the lessons from history are clear), I think this will be much more important and lead to much greater structural change (and therefore opportunities) than cryptocurrencies. We can already see the world of tokens entering the mainstream: Dapper Labs (the company behind the famous token game CryptoKitties) is as I write raising $250 million at a $2 billion valuation and Celo, a defi alternative to Facebook’s Diem, has just raised $20 million from (amongst others) noted Silicon Valley investors Andreessen Horowitz.

There are good reasons to welcome these pointers to the emerging paradigm. While defi is now mainly used for speculation between tokens of many varieties, in the longer term it offers the promise of much reduced costs in financial intermediation by both removing middlemen and automating them, it opens up the possibilities for new financial instruments better suited to the new economy (instruments built for bots to trade, not for people to understand). It also, and most importantly (for reasons discussed before), offers a more transparent market with accountability as part of the infrastructure. Don’t be put off by the Wild West of defi as it stands now, begin your scenario planning for defi as it will (inevitably) become.

*Does not constitute financial advice.

[An edited version of this article was first posted at Forbes, 15th February 2021.]

QR Q.E.D.

As I recall, some of the delegates at the 2016 cryptocurrency conference Consensus were sceptical when I shared my preferred strategy for securing my digital dosh, which was to convert the security key into a QR code and have it tattooed onto my scrotum. You could see them wondering about my grasp of the relevant risk models and questioning my confidence in the technology. I was not dismayed by their negative reaction. In fact, I had suggested this approach to managing privates keys (sic) before and had even toyed with the idea of patenting this breakthrough in cyber defence, on the grounds that you can patent anything no matter how trivial and obvious there days, but sadly I never got round to it. Now I am kicking myself about it, because I was delighted to read in the New York Times that numerous people of an innovative bent have indeed had QR code tattoos and… guess what, they work.

Www dgwbirch code

Everyone uses QR codes now. They are on advertisements, face masks, business cards and Zoom backgrounds. There are two reasons for this: COVID-19 and Apple. A couple of years ago, Apple changed the iPhone software so that you could scan QR codes with your iPhone camera and not have to run a separate app. At a stroke, gazillions of people gained the ability to automagically engage in contact-free transactions, while shortly afterwards along came the pandemic and the demand for contact-free transactions for everything, not only shopping, went into overdrive.

Everyone uses QR codes now. There are two reasons for this: COVID-19 and Apple. Click To Tweet

(It’s not all down to Apple, of course. The cameras in mobile phones have improved across the board so that QR codes can be scanned clearly from a safe distance so that consumers can stand a couple of metres away from the point of sale and buy without using cash. )

Supermarket codewith kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Just look around and see how quickly the technology has accelerated in coffee shops and cafes, pubs and clubs, fast food and just about everywhere else. At the cafe near me, the transformation was overnight. Now you sit down, scan a QR code and order on your phone, then a server brings you your food and drink. And when you’ve finished, you just get up and walk out. And that last point, the ability to pay and go instead of waiting for and then paying a bill, is a delight for customers and premises alike. One US technology provider has measured that this saves saves 21 minutes of table time on average and, as they note, that’s great for a restaurant “because they have the ability to increase their revenue per hour per seat” as well as removing the need to touch devices and keypads (which is why so much of the restaurant industry’s investments in in-store tech has gone toward contactless payment solutions through QR codes).

At the Women in Payments Symposium this month, Rebecca Speck from Discover gave a very good presentation on the dynamics in contactless payments. She showed figures for Quick Service Restaurants (QSR) in the USA, where half of all payments are already contact-free, that gave a pretty even split between cards, apps and xPays. My guess is that in time the restaurant chains will continue to incentivise customers into their apps and we will see the use of both chip and PIN and contactless cards fall, fulfilling the prediction that Anthony Jenkins made (when he was head of Barclaycard, before he was the CEO of Barclays) when he said, as memory serves, that mobile phones would get rid of cards long before they get rid of cash.

Check In

I’ve been very interested to see the emerging dynamics at retail point of sale (POS) across sectors. A few years ago, I was of the general opinion that QR code for payments would fade away because tapping with cards or phones was quicker and more secure. But one retailer after another began to start using QR instead of NFC, partly because they didn’t want consumers to have to understand how to turn on and use NFC in smartphones and partly because Apple wouldn’t let them access payment interfaces in iPhones anyway. When the biggest retailers decided to go QR instead of contactless, you could see which way the wind was blowing. Walmart, to take the obvious example, introduced QR into Walmart Pay. Instead of selecting Walmart Pay at checkout, customers can now scan a QR code and Walmart Pay is connected so that customers can pay contact-free.

In strategic terms, my strawman assumption going back five years was that retailers were going to get rid of payments at POS and shift to payments inside their own apps, apps that they use to deliver better customer services. Or, in the bumper-sticker version, “we’re going from check-out to check-in”. This is where the supermarket chains went in the UK, where Tesco became “the latest grocer to develop its own technology to bypass the costly Android and Apple systems” and Sainsbury’s was trialling its SmartShop app which allows users to create their own shopping lists, navigate stores and make payments at dedicated kiosks. In the UK, Tesco has just announced that their mobile payment app Pay+ has now taken its first billion in payments.

As with other retailers, one of the attractions for supermarket chains is that their app can combine payments, loyalty and spend tracking in one and a simple quick QR scan is all that is needed to get everything done. I’m sure this combination (and, if I remember correctly, prescriptions) is what attracts consumers to using the CVS app, where shoppers will be able to scan a QR code on their phones to pay using stored debit or credit cards, bank accounts, PayPal balance, PayPal Credit, Venmo balance or Venmo Rewards. This focus on apps at POS was an obvious strategic focus long before Tim Cook stood up on stage to explains “the benefits of Apple Pay in apps“.

So customers will end up with hundreds of apps on their phones? I do not think so. I remember a Comscore survey that found thatover half of American consumers would be happy to have four or more retailer apps on their phone and I remember something I looked at for a UK client a around that same time. From memory, the overwhelming majority of household disposable income in the UK goes to a handful retailers per household. Put these approximations together and consumers will not have hundreds of apps on their phones to deal with every retailer. For the retailers they visit frequently (e.g., Starbucks) they will have the retailer app and use it. In other cases they will just use some third-party payment app (e.g., their bank) or a convenient wearable like a bracelet or key fob that is controlled by a third-party app. This will give retailers new opportunities to add value and new control over identity and payments.

(An edited version of this piece appeared on Forbes, 5th February 2021.)

The Transparency Machine

Most blockchain ideas that I hear about make no sense. In general, they do not involve blockchains (just some sort of shared database) and where they do actually involve blockchains they are used to emulate shared databases to deliver a slower and more expensive service. How is it then that even a blockchain grouch such as me thinks that the technology has something to offer?

Well, first of all, let’s stop talking about blockchains and use the more general terms shared ledgers to cover the spectrum of relevant technologies and enterprise shared ledgers to cover the particular use case of sharing data between organisations (and regulators etc) in a permissioned manner. I think that the use of enterprise shared ledger (ESL) software will transform business more than enterprise resource planning (ERP) did a generation ago because it will go beyond automating existing process and will instead create new ways to do business.

Transparency is a route to trust. Click To Tweet

Consider the recent case study of Wirecard. The auditors reported that the company was solvent because they thought that there were bank accounts with billions of euros in them. It turns out that there were not. What a simple problem to solve! If only there was some form of immutable record of transactions that companies could use to store account balances digitally-signed by their banks and that investors, customers, suppliers and regulators could use instead of auditors to determine that the assets of companies exceed their liabilities! Transparency is a route to trust.

Transparency

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Put the transactions on a blockchain and no more fraud then? It’s not that easy. Some of the information in the ledger is confidential: it should only be accessed by the customers, the banks involved in the transactions and perhaps the market where the transactions take place. There are many applications where the transactions must be private. Therefore we need mechanisms to exploit the beneficial transparency of the shared ledger in such a way as to preserve necessary privacy.

What sort of mechanisms? Well, many years ago Eric Hughes, the author of the “cypherpunk manifesto” in the early 1980s, wrote about “encrypted open books”, a topic that now seems fantastically prescient. His idea was to develop cryptographic techniques so that you could perform certain kinds of public operations on private data: in other words, you could build “glass organisations” where anyone could run software to check your accounts without actually being able to read every item of data in them.

It sounds completely crazy and in fact it is a perfect example of what I’ve previously labelled counterintuitive cryptography. The idea of open book accounting is to use homomorphic encryption to store records in a form where they can only be read by authorised parties but can nonetheless be subject to some basic computation while still encoded. In other words you can determine that (encrypted 2) + (encrypted 2) = (encrypted 4) without ever being able to read the “2” or “4” .

This means that you can prove certain assertions about data without ever revealing what the data actually is. One obvious use of this, and as far as I can remember this was central to Eric’s discussion of the topic, is to take a list of the encrypted assets of the company together with a list of the encrypted liabilities of the company and compute that the company’s assets exceeds liabilities. Thus you can, essentially, audit that the company is solvent without being able to read what any of the assets and liabilities actually are.

(In practice, for this to work, the assets and liabilities have to be encrypted by some trusted third party. If I show you my encrypted Barclays bank statement then you have to know it is authentic so it would need to be digitally signed by Barclays, but that’s a topic for another day.)

When you combine the idea of open book accounting with Ian Griggs’ idea about triple entry accounting that dates from around the same time, you can see the basis for a new and more efficient financial infrastructure that is simultaneously the doom of auditors everywhere. If you are interested, there is a very comprehensive review of the origins and taxonomy of the intersection between open book, triple-entry and shared ledgers in a paper from Juan Ignacio Ibañez, Chris Bayer, Paolo Tasca and Jiahua Xu.

Remember in a triple entry system each of the parties to a transaction has a record of the transaction but there is a corresponding entry in a shared ledger that is computationally infeasible to falsify. The entries in my ledger are private to me and the entries in your ledger are private to you but the entries in the shared ledger are available to a much wider range of stakeholders but encrypted so that anyone can use calculations to determine that our assets exceed our liabilities, crucially without being able to read either. Pretty cool.

Transparency and Translucency

The impact of encrypted open books and triple entry working together in this way could be huge, because the transparency and automation means that we will no longer need to wait until the end of the reporting period to conduct an audit and produce results with the help of skilled financial professionals. Instead we will find ourselves in an era of ambient accountability, where the technological architecture means constant verification and validation. If you want to check whether a bank is solvent before you deposit your life savings there you will do it using an app on your smart phone not by looking at a year old auditor’s report covering some figures from a year before filtered through levels of management.

(Ambient accountability is a term that I borrowed from architecture to describe this infrastructure. It describes perfectly how transparency can transform the financial services industry and serves as a rallying cry for the next generation of financial services technology innovators, giving it a focus and raison d’être beyond shifting private profits from banks to technology companies and other third parties.)

Since the regulators will be able to use the technology, they will be able to spot unusual or inappropriate activity. What’s more, the information stored in the ledgers in encrypted form has been put there by regulated institutions so should there be a need to investigate particular transactions because of, for example, criminal activity then law enforcement agencies will be able to ask the relevant institutions to provide the keys necessary to decrypt the specific transactions. In this way the shared ledger can bring the technology of open book accounting to bear to exploit the beneficial transparency of the shared ledger in such a way as to preserve necessary privacy.

In a paper I co-wrote a few years ago with Richard Brown, then at IBM, and Consult Hyperion colleague Salome Parulava [published as “Towards ambient accountability in financial services: shared ledgers, translucent transactions and the legacy of the great financial crisis.” Payment Strategy and Systems 10(2): 118-131 (2016).], we borrowed the term “translucent” from Peter Wayner to mean transactions that are transparent for the purposes of consensus (in other words, we can all agree that the transaction took place and the order of transactions) but opaque to those not party to the trade or the appropriate regulators under the relevant circumstances.

I gave this talk introducing these concepts at NextBank Barcelona back in 2015 (building on the talk about “The Glass Bank” that I first delivered back in 2011) and I’m very interested to see the continuing developments in the field. To give just one example, Richard Brown is now the CTO at leading Enterprise Shared Ledger (ESL) software provider R3. R3 recently released their Conclave product that takes an interesting step in this direction, allowing organisations to exploit Intel SGX secure hardware to remotely verify what other organisations can and cannot do with shared data.

It seems clear that for financial markets this kind of controlled transparency will be a competitive advantage for both permissioned and permissionless ledgers: as an investor, as customer, as a citizen, I would trust these organisations far more than “closed” ones. Why wait for quarterly filings to see how a public company is doing when you could go on the web at any time to see their sales ledger? Why rely on management assurances of cost control when you can see how their purchase ledger is looking (without necessarily seeing what they’re buying or who they are buying it from)?

A market built up from “glass organisations” are trading with each other, serving their customers, working with regulators in entirely new ways, is a very attractive prospect and suggests to us that new financial market infrastructure may be on the horizon and that the lasting impact of shared ledger technology will not be to implement existing banking processes in a new way but to create new kinds of markets and therefore new kinds of institutions.

In this world, whether it is Wirecard, Enron, Tether or anyone else, nobody will be required to rely on the word of auditors because they can simply calculate for themselves whether the company is solvent or not. No more relying on tips and whispers to find out whether the money in some remote bank account is sufficient to cover the liabilities in other jurisdictions: cryptographic proofs will replace auditing and apps will replace auditors.

[An edited version of this piece first appeared on Forbes, 17th January 2021.]

Crime, Coins, Cryptography and the Quantum Future

There are people who prefer to exist in a cash economy for reasons other than their negative economic analysis of central bank monetary policies or an attachment to the iconography of banknotes. Criminals and corrupt politicians, for example. Cash works rather well for them, but can sometimes be quite inconvenient.

Last year I wrote about two Californian working-from-home pharmaceutical freelancers who were arrested after police caught them dumping nearly $1 million in cash which was intended to buy Mary Jane for business purposes. Dumping a million bucks in notes is time-consuming and inconvenient, which set me thinking.

I can understand why the disconnected, marginalised poor in remote parts of the world eschew the benefits of electronic payments for the currency of choice for the global criminal on the go, the $100 bill. But in California? Don’t they have Bitcoin there? Given the huge hassle of counting, bagging and transporting the Benjamins, why didn’t these wacky baccy impressarios simply buy a few Bitcoins, drive to the drop zones and press the “giddy up” button when the goods were in place!

They stayed analogue. They packed up the greenbacks and set off in their car. It could have been that they’d read that quantum computers will be able to break Bitcoin’s cryptography next year and decided that the trunk of a car was the more secure alternative. The point is they were not interested in friction-free instant dollar dollars. So I must ask the obvious question: if drug dealers won’t use Bitcoin for purchases, who will? How can it be more convenient to cart around great wodges of cash than to zip some magic internet money through the interweb tubes?

It is important to note that Bitcoin is far from being a perfect solution for criminal on the go, though. Speaking at this year’s virtual Davos, Glenn Hutchin (co-founder of global technology investment firm, Silver Lake) said that Bitcoin is not the best choice for criminals and that “a drug dealer, for example, would not want to have to speculate on the price of bitcoin while selling his wares”. This clearly not true for all drug dealers: a counterexample being the Irish drug dealer who wisely decided to invest in cryptocurrency rather than euros and who amassed a fortune in digital loot. He hid the passwords to the digital wallets holding his ill-gotten gains in his fishing rod.

The drug dealer in question, Mr. Collins, was stopped but the Irish police in the early hours of the morning by chance. Unfortunately for him, he had €2,000-worth of weed in the car and he was arrrested. His properties were searched, and industrial scale cannabis farming was discovered.

He got five years.

Meanwhile, his 12 Bitcoin wallets, containing 6,000 Bitcoin (then worth $50m-ish but now worth $200m-ish) were seized by Ireland’s Criminal Assets Bureau (CAB). Unfortunately the fishing rod with the scribbled passwords had “gone missing” but CAB believes it is “only a matter of time” before computer advances allow them open the digital treasure chest.

Quantumvault

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Presumably, by “only a matter of time” they mean that they are waiting for the quantum computers to come along a unlock the wallets. They are in good company, because a great many other people (eg, organised crime, unscrupulous “whales” and the tax authorities of many nations) are waiting for them too. Now, code-cracking quantum computers will happen (as I wrote 15 years ago), but they won’t happen tomorrow. Professor John Martinis, who used to be the top scientist in the Google quantum computing team, says that Google’s plan in this field is to build a million-qubit system with sufficiently a low error rate that error correction will be effective. He says that at this point, about a decade away, then the system will have enough logical quits that the system will be able to execute powerful algorithms that attack problems that are beyond the capability of classical supercomputers.

By “only a matter of time” they mean that they are waiting for quantum computers to come along a unlock the Bitcoin wallets. Click To Tweet

For technical reasons to do with public keys and things, the accountants Deloitte reckon that about four million Bitcoins could be stolen by a quantum computer. With Bitcoin at $30,000 that means a pot of a hundred billion dollars or so is at the end of the quantum rainbow. Well worth spending a few billion to build such a device if you are a criminal, well worth spending tens of billions or even hundreds of billions on such a device when Bitcoin has taken over and has become the need digital gold worth $1m each or whatever.

It’s a serious threat, and plenty of people have already started work on plans to migrate Bitcoin to more quantum-resistant forms of cryptography (see, for example, “Committing to quantum resistance: a slow defence for Bitcoin against a fast quantum computing attack” from 2018) but these schemes still need access to the old, vulnerable wallets to transfer the cryptocurrency to the new, less vulnerable wallets.

The idea of using quantum technology to make better electronic money is not a new idea, b the way. As the Swedish Central Bank’s recent working paper on Quantum Technology for Economists points out, out the original concept of quantum money (dating back to the early 1980s) exploits “the no-cloning theorem” proven by Wootters and Zurek (1982). This means that it is not possible to clone an unknown quantum state so a counterfeiter with unlimited resources will still not be able to copy a quantum coin. Therefore quantum cryptocoins can act more like actual coins (that cannot be double-spent) and that opens up some pretty interesting thinking. As my digital currency technology tree (below) shows, this opens up an interesting third way to pan-galactic digital currency in the future: we can prevent double spending of person-to-person digital cash in hardware (using chips), in software (using blockchains) or in nature (using qubits).

Digital Currency Taxonomy with Quantum

Still, assuming that the Irish police get hold a quantum computer before the Mafia do, there is a tidy amount sitting not only in Mr. Collins wallets (as there is in Mr. Satoshi’s) and the next time the Gardai pull someone over in the middle of the night it will be in a Lambo.

[An edited version of this post appeared on Forbes, 10th January 2020.]

Legal and illegal tender

China is home to not one but two fascinating experiments in what people have taken to calling “stablecoins”. One of them is the public electronic cash system run by the People’s Bank of China (PBOC), known as the Digital Currency/Electronic Payment (DC/EP) or the digital Yuan. The other is the private electronic cash system run by Hong Kong-based Tether Limited, the cryptocurrency stablecoin known as the Tether. The main use case for the former is currently retail purchases whereas the main use of the latter appears to be market manipulation and money-laundering.

We can learn a lot from studying the dynamics of these to help us to understand how the world of digital currency might develop and whether cryptocurrency might one day become legal tender.

Let’s have a look at illegal tender first. In 2019, USDT surpassed Bitcoin as the most-traded cryptocurrency on the market by volume. This is not, as you might imagine, because consumers prefer to USDT to Visa for ordering a taxi to take mother to church on a Sunday. As reported by Nikkei Asia, USDT is widely used in money laundering, gambling and other illegal activities. China’s Ministry of Public Security has reported that in the first nine months of 2020, police cracked down on 1,700 online gambling platforms and 1,400 underground banks involving more than $153 billion in illegal transactions. Now, not all of this was in Tether, of course. But the number did catch my eye, because I am always interested in use cases for cryptocurrency other the speculation.

Illegaltender

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Now on to legal tender. Suzhou has long been spearheading trials of DC/EP and in a recent experiment the local municipal government gave away 100,000 digital “red packets”, each containing RMB 200 (around $30) in a lottery, to encourage resident and retailers to try out the electronic cash for themselves. The South China Morning Post reports on the roll-out of the digital Yuan with the example of “shopkeeper Ma” who said that he found the digital currency to be a convenient way to receive and make payments. Not that it matters whether he finds it convenient or not, to be fair, because according to an “operational guidance” document given to the retailers in the pilot programme, they are allowed to decline payment in Alipay or WeChat Pay, but they “cannot decline payment in e-yuan”.

You can see the trajectory. The PBOC published a revised draft of the People’s Bank of China Law in October, laying out the legal foundations for the e-Yuan. The law, in essence, already says that the e-Yuan has the same legal status as the Yuan. Indeed, last year the PBoC issued a formal notice clarifying that cash is legal tender in China and that refusing it is illegal. More recently, it has called for wider acceptance of cash in economic activities and “vowed to punish” those who refuse to accept cash payments. So in China, both the Yuan and e-Yuan will be legal tender and retailers will have to accept both.

Legal Tender

I remember a story about a schoolboy who was refused access to a bus in Wales for trying to pay with a Scottish banknote. The bus company was pressured and apologised, saying that “Scottish currency is legal tender”. Actually, it isn’t. Scottish banknotes are not legal tender in England or, for that matter, Wales any more than Bitcoins or e-Yuan are. Only Bank of England banknotes are legal tender in England and Wales. But there are Sterling banknotes printed by banks in Scotland and in Northern Ireland that are not. Scottish banknotes are not legal tender anywhere, even in Scotland. In fact, Bank of England banknotes are not legal tender in Scotland either, because Scotland has a separate legal system to England and has no legal tender law at all.

This quaint monetary arrangement might seem odd to Americans, but it helps me to make a point. In America as in Britain, legal tender does not mean what you think it means. wrote about this in some detail after someone on Twitter told me that Bitcoin was legal tender in Germany. It isn’t, of course. In fact, Bitcoin isn’t legal tender anywhere and it never will be any more than British Airways frequent flier miles will be (and I’ve bought more cups of coffee with British Airways frequent flier miles than I’ve ever bought with Bitcoin).

Let’s dive in!

Section 31 U.S.C. 5103 on “Legal tender” states that “United States coins and currency [including Federal reserve notes and circulating notes of Federal reserve banks and national banks] are legal tender for all debts, public charges, taxes, and dues”. Here is chapter and verse from The Fed commenting on what that means: “This statute means that all United States money as identified above is a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment for goods or services. Private businesses are free to develop their own policies on whether to accept cash unless there is a state law which says otherwise”.

So… would a U.S. central bank digital currency (e$, for short) might become legal tender in the future. Here, I think the answer is unequivocal: yes, and in unlimited amounts, because there is no credit risk attached. I predict that a transfer of e$ will be considered legal tender all debts, public charges, taxes and dues. In time, Section 31 U.S.C. 5013 will undoubtedly be extended to say so.

But so what if a digital dollar become legal tender? The physical dollar is legal tender in the U.S. right now and plenty of retailers won't take it. Click To Tweet

There is no federal law that forces people to accept dollars as it is, which is why you see municipalities passing local ordinances to force retailers to accept cash. (These ordinances are, by the way, a bad idea but that’s a story for another day.)

Would the U.S. amend legal tender law to go as far as China and force merchants to accept a CBDC? I doubt it. Would the Fed declare any digital currency that meets regulatory approval to be legal tender and retailers will have to accept both physical dollars and digital dollars? It seems unlikely. Would the US accept CBDC for the payment of tax? Actually, that day might not be so far away, as far I as am concerned what is or isn’t accepted for the payment of taxes is a much better measure of what is or isn’t a currency than outdated concepts of legal tender!

[An edited version of this post appeared on Forbes, 4th January 2020.]

Stablecoins and Soft Power

The Libra Association has rebranded as the Diem Association and plans to launch its first digital currency, a USD dollar “stablecoin”, early this year so it’s time to think again about the implications of stablecoins. But first of all… here’s wishing you Happy Holidays and all the best for 2021 from all at 15Mb Ltd!

Stable small

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

You’ll remember Libra, the global currency proposed by Facebook. It met with some pretty negative reactions from central banks, regulators and many other stakeholders. Visa, MasterCard and PayPal dropped out of the initial group of Libra Network members and things went a bit quiet. Then the Libra Association produced a revised version of their White Paper, adding “stablecoins” in national currencies to the original plan for a single Libra currency based on a basket of currencies and making an interesting offer from the consortium to the world’s central banks. It says that the consortium hopes that “as central banks develop central bank digital currencies (CBDCs), these CBDCs could be directly integrated with the Libra network, removing the need for Libra Networks to manage the associated Reserves”.

There’s no need to waste resources of your own on CBDC, Diem is telling central bankers. If a couple of billion people around the world are going to store digital currency in Facebook, Instagram and WhatsApp wallets, then why build an alternative? Use us. You set the policies on inclusion and so on, we’ll do the heavy lifting.

You can be the NASA of money, Diem is telling the Fed, and we'll be the Space-X. Click To Tweet

The Bank of England’s December 2020 Financial Stability Report devotes a section to stablecoins and says the bank is considering the potential effects on financial stability if stablecoins were to be adopted widely. It notes that if stablecoins were backed with central bank money in one form or another it would be “economically similar” to a CBDC. A member of the European Central Bank (ECB) board, Fabio Panetta, referred to this issue of at a recent Bundesbank-convened event about the future of payments noting that allowing something like Diem would be “tantamount to outsourcing the provision of central bank money”. But why is that such a bad idea? After all, as Simon Lelieveldt pointed out to me, while we might assume that the ECB would be the issuer of an electronic euro it is not currently in their mandate.

The truth is that stablecoins are coming. Whether provided by private companies or as a public good, the DC/EP cat is out of the bag, the USDC genie is out of the bottle, the Libra horse has bolted and the question for the world’s central banks is not whether there should be digital currencies or not but what is the best way to deliver them. In which context, outsourcing is a viable option. Recall the Mondex experiment of the 1990s: it was the Bank of England that controlled the issuing of the digital currency, but the Mondex system itself and the Mondex cards issued to consumers were provided by commercial banks.

Personally, I can see the attraction of using such an outsourced stablecoin such as Diem. The ability for me to send money to a cousin in Australia by sending a few Facebucks directly from my Facebook Novi wallet to her Instagram Novi wallet would be useful and convenient. The ability for me to buy shareware from a Swedish software developer and pay instantly by transferring Facebucks by WhatsApp would stimulate trade and the economy. Joking aside, with a good user interface, a good customer experience and a good API to satisfy regulators, Novi and Diem together could indeed provide a viable global alternative to SWIFT.

Dollars and Dominance

Perhaps more importantly, though, US dollar stablecoins — whether provided by central banks themselves as in China, by banks or mobile operators, or by other organisations such as the Diem Assocation — would also reinforce the global dominance of the US dollar ahead of digital competitors (including everyone’s favourite unstablecoin, Bitcoin) in the post-pandemic world where online transactions are the new normal.

The German Minister of Finance calls Diem “a wolf in sheep’s clothing”. If you look at it though, what Diem propose to do is basically that same as is already allowed under European electronic money regulation. Provided that Diem segregate the customer deposits and hold them in the form of bank deposits and other appropriate asset classes, then issuing a digital dollar (or euro or or pound) is no big deal. What the Minister and others are presumably concerned about is the loss of monetary sovereignty if European citizens opt to shift their cash holdings from euros to dollars whether intermediated by Diem, Circle or anyone else.

If you want to understand some of the bigger picture around currencies, competition and what the eminent historian and Hoover Institution senior fellow Niall Ferguson refers to as “Cold War 2”, then you should take the time to listen to this conversation between Ferguson and CoinDesk’s Michael Casey. As the author of one of the best books on the history of finance, The Ascent of Money, Ferguson has a very wide and well-informed perspective on the issues and I have quoted him more than once in my book on the topic.

In this conversation, Ferguson observes that one of the lessons of history is that with globalisation comes a tendency for a particular currency to become the dominant currency, the Prime Currency, for transactions for trade. In the 19th century it was the British Pound, in the 20th century it became the US Dollar, and in the 21st century it will be… well, who knows but as globalisation moves into a period of obvious crisis it is being talked about as it wasn’t before. Ruchir Sharma, Morgan Stanley Investment Management’s chief global strategist, recently wrote in the Financial Times that only five currencies had been top dog in post-medieval times: those of Portugal, Spain, the Netherlands, France and our United Kingdom. Those reigns lasted 94 years on average, by which measure the Dollar is overdue for overthrow.

Public or Private? Local or Global?

Many people think that the only thing keeping the Dollar in place is the lack of a successor. Ferguson points toward China as the place where the new world may be forged, saying that “if I’m right and that trend continues and they become more dominant in not just domestic consumer payments in China but increasingly in payments around the world” then we may start to see a shift in the “tectonic plates of the international monetary system” and I couldn’t agree more.

Ferguson also refers to former Bank of England governor Mark Carney’s call for a synthetic hegemonic currency (SHC), which he rates as more plausible than Diem as the future of the international financial system. It would be a victory for John Maynard Keynes from beyond the grave. Keynes, as you will recall, was in favour of an SHC (the “bancor”) from the very beginning of the current international monetary regime and (correctly) reasoned at the time of Bretton Woods that the lack of such an international reserve currency would deliver control to the United States (at the expense of the United Kingdom).

In Ed Conway’s excellent book on Bretton Woods “The Summit” he talks about how the dollar becoming top dog gave America what the recently-deceased former French President Valery Giscard d’Estaing called the “exorbitant privilege” of borrowing in its own currency. But finance is not the only reason why the coming currency Cold War is of vital importance to the US (and to the West as whole) and control over currency is important.

Currency competition is about politics, because the use of the dollar to settle global transactions gives the US unparalleled lever of “soft power”. As Ferguson puts it, “I think we probably mostly underestimate how extraordinarily effective this lever has been, it’s actually been a much more effective weapon of US foreign policy than the boots on the ground of the U.S. Army and Marine Corps”. Hence a digital dollar (whether a NASA Digital Dollar or a Space-X Facebuck) should be an important policy discussion in the United States right now. Should a future US administration with a global perspective accept the compromise of an SHC as a means to retain some control or can they launch a digital dollar into global orbit first?

[An edited version of this piece first appeared on Forbes, 14th December 2020.]

Show me the money

In the UK, a committee of MPs has said that the Bank of England should be trying to track down £50bn of “missing” UK currency. This is about three-quarters of all UK banknotes in existence! So where is all of the missing cash? Is it all being used by money launderers or people bribing government officials to obtains COVID-related contracts or are there more benign explanations?

Cashgone

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

It’s not only the UK that has lost track of its cash. In a many countries, for many years, the use of cash for purposes such as shopping has been steadily decreasing while the amount of cash “in circulation” has been steadily increasing. This is true in, for example, America and Australia as well as in the UK and Europe.

Down Plunder

Look at Australia as an example. The governor of the Reserve Bank of Australia (RBA), Philip Lowe, pointed out that “there are fourteen $100 notes in issue for every Australian, thirty $50s and seven $20s” before going on to ask where exactly the $3,000 per Aussie is, saying that “I, for one, don’t have anywhere near that amount”. Me neither, although I just checked and I do have A$25 in my travel wallet, so perhaps one explanation is that lots of visitors get some Aussie dollars out at the airport and then discover that they never need them because it’s an advanced nation where everywhere takes contactless and then forget to spend them before they leave. But that can’t account for anything but a tiny fraction of the billions “in circulation”.

IMG 2600

The main explanation given by the RBA is that some people choose to hold a share of their wealth in Australian banknotes. The RBA Research Discussion Paper 2018-12 “Where’s the Money‽” says that of the outstanding banknotes some 15–35 per cent are used to facilitate legitimate transactions (I’d actually be surprised if it was ten per cent by now) with the rest hoarded as a store of wealth or for other purposes. These other purposes are:

  • 10–20 percentage points to domestic hoarding (this now seems small to me, given the lack of transactional usage and the ban on cash transactions over $10,000) and up to 15 percentage points to international hoarding (which includes the A$25 in the draw in my study);
  • 4–8 per cent are used in the shadow economy. This seems low, given that more recent figures show that up to A$1 billion is held by drug dealers alone at any one time, and
  • and 5–10 per cent are lost.

Some good news for the RBA is that some of the missing banknotes turned up. A Mr. Simon Cross was pulled over in Queensland and when the police looked in his car they found $4.35 million in cash ($1.75 million in a suitcase and $2.61 million in a cardboard box). I don’t doubt, by the way, that Mr. Cross’ preference for cardboard boxes full of cash is legitimate and a wholly reasonable response to the low interest rates currently available on Australian savings accounts.

My point is that whether in the America or the United Kingdom or Australia, the use of cash for legitimate activities has been falling while the use of cash for drug dealing, money laundering, tax evasion, payments to corrupt officials and so on has been rising. Banknotes are, statistically, not being used to buy anything.

Cash is no longer primarily a means of exchange. Click To Tweet

The latest figures from the Bundesbank show that nine out of every ten euro banknotes issued in Germany are never used in payments but hoarded at home and abroad as a store of value. Not “rarely used”. Not “infrequently used”. Never used. The notes are not in circulation at all but are stuffed under mattresses where they are not even part of the shadow economy.

Cash Categorised

A few years ago I wrote about the Bank of England’s four-way categorisation of the demand for and I thought it might be interesting to integrate the RBAs research into this to help the committee of MPs to formulate policy. So let’s standardise on the categories of cash use and discuss them:

  1. Transactions. Here the trends are clear. Technology is a driver for change but that the impact is weak. In other words, new technology does reduce the amount of cash in circulation, but actually quite slowly (although the pandemic has accelerated the rate of decline throughout this year, of course).
  2. Hoards. These are stores of money legally acquired but held outside of the banking system. If the amount of cash that is being hoarded has been growing then that would tend to indicate that people have lost confidence in formal financial services or are happy to have loss, theft and inflation eat away their store of value while forgoing the safety and security of bank deposits irrespective of the value of the interest paid.
  3. Stashes. These are stores of money illegally acquired or held outside the banking system to facilitate criminal behaviour. My personal feeling is that in most countries stashes have grown at the expense of hoards.

    Prof. Charles Goodhart (London School of Economics) and Jonathan Ashworth (UK economist at Morgan Stanley), note that the ratio of currency to GDP in the UK has been rising and argue that the rapid growth in the shadow economy has been a key cause. Two rather obvious factors they highlight are the increase in VAT to 20% and the continuing rise in self-employment, both of which serve to reinforce the contribution of cash to the shadow economy.

  4. Exports. The amount of cash that is being exported is hard to calculate, although the Bank itself does comment that the £50 note is “primarily demanded by foreign exchange wholesalers abroad”. I suppose some of this may be transactional use for tourists and business people coming to the UK, and I suppose some of it may be hoarded, but surely the strong suspicion must be that at lot of these notes are going into stashes.

As you see, I distinguish between hoards and stashes. I have a strong suspicion that cash (in particular those $100 bills that the governor refers to) is a major component of stashes. In which case, the fate of the UK’s missing billions in £50 notes is not particularly mysterious. A couple of years ago, the UK Treasury said that these notes are “rarely used” for routine transactions and that there is a “perception” that they are used for money laundering, hidden economy activity, and tax evasion. This perception is pretty widespread, by the way, and not only amongst itinerant bloggers and crypto commentators . I remember when Peter Sands, the former head of Standard Chartered, said that the main use of the £50 was illicit and he’s about as much of a mainstream banker as you can get. In summary, therefore, I think think that central banks estimates of hoarding are generous and that it is the shadow economy fuelling the growth in cash “in circulation”.

The Gap

If the amount of cash being stashed has indeed been growing then central banks are facilitating an increasing tax gap that the rest of us are having to pay for. This why, given that no-one is using them for legitimate purposes, I thought it was odd when the Bank of England decided bring the £50 up to date and make it out of plastic. Robert Jenrick, then exchequer secretary to the Treasury, explained the decision at the time by saying that “people should have as much choice as possible when it comes to their money and we’re making sure that cash is here to stay”. Maybe the government was worried that tax evaders are an electoral force to be reckoned with. According to British tax authority estimates (see below) almost half of the tax gap is down to small businesses and they account for nearly three times as much of the missing tax as “criminals”. I’m not sure if all of these groups are voters, but they must in some measure account for the government’s reluctance to inconvenience those responsible for the lion’s share of missing taxes.

UK Tax Gap Customers 2017 Picture

Why do I keep going on about this? It’s because the people who benefit from the convenience of £50 notes (eg, tradesmen avoiding sales tax, crystal meth manufacturers avoiding social security taxes and so on) are benefitting at the expense of law-abiding tax-paying citizens (eg, me) and I have to fill in my tax form soon.

[An edited version of this post first appeared on Forbes, 7th December 2020.]

China and America both need new fintech regulation

In a recent episode of Professor Scott Galloway’s podcast, he talked with one of my favourite writers: the eminent historian and Hoover Institution senior fellow Niall Ferguson. The subject of the conversation was the relationship between the United States and China. Their fascinating and informative discussion ranged across many fields, including financial services and fintech. Ferguson touched on a particular aspect of what he calls “Cold War 2” in context of finance, saying that American regulators “have allowed the fintech revolution to happen everywhere else” by which I think he meant that the nature of financial regulation in America has been to preserve the status quo and allow the promulgation of entrenched interests while the costs of financial intermediation have not be reduced by competition. He went on to say that “China has established an important lead in, for example, payments”, clearly referring to the dominance of mobile payments in China and the role of (in particular) Alipay in bringing financial services. He made this comment around the same time that the Chinese government pulled the plug on the Alipay IPO, what would have been the biggest IPO in history.

Weareno1

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

As an aside, if you want to understand some of the big picture around the coronavirus, currency (and what I call “The Currency Cold War” in my book of the same name), then you might want listen to this Coindesk podcast with Ferguson and the journalist and author Michael Casey. They talk about the current state of the world and what it could mean for money. As the author of one of the best books on the history of finance, The Ascent of Money, Ferguson has a very wide and well-informed perspective on the issues and, indeed I quote him more than once in my book!

At a time when America is finally beginning to at least think about opening up financial services to allow real competition, China is heading in the opposite direction by clamping down on fintechs. Click To Tweet

Ferguson’s point about payments is particularly interesting to me. One way to provide more fintech competition to the incumbents would be to provide a more relaxed environment for payments. America lacks a regulatory construct equivalent to the EU’s “Payment Institution” and it really needs one if it is to move forward. The EU regulatory framework has just been battle-tested with the collapse of Wirecard following massive fraud. No customer funds were lost in the collapse of the badly-regulated non-bank because the customer funds were ring fenced in well-regulated bank and, as I will suggest later, this might be the right regulatory balance for new US regulation.

One place to look for this new regulation might be the OCC, which has developed the concept of the Special Purpose National Bank (SPNB) charter. I don’t want to sidetrack into the controversy around these charters, except to note that the OCC expects a fintech company with such a charter to comply with capital and other requirements that seem unlikely to generate the innovation and competition that America wants. This was obvious from the comments on the original proposals, when fintechs made it clear they would be reluctant to invest in such an OCC license unless such a licence would require the Federal Reserve to give them access to the payments system (so they will not have to depend on banks to intermediate and route money for them). The fees associated with such intermediation are significant (ie, top five) operating cost for many fintechs.

I agree wholehearted with Prof. Dan Lawry of Cornell Law School, Lev Menard of Columbia Law School and James McAndrews of Wharton Financial Institutions Center who in their response to the OCC’s proposal labelled it “fundamentally flawed” and called for the organisation to instead look at strengthening the regime for non-bank financial institutions. The focus on banking regulation, though, seems entrenched. I notice that Congresswoman Rashida Tlaib (MI-13), along with Congressmen Jesús “Chuy” García (IL-04) and Chairman of Task Force on Financial Technology Rep. Stephen Lynch (MA-08), have just introduced the Stablecoin Tethering and Bank Licensing Enforcement (STABLE) Act, which similarly propagates this outdated (and inappropriate) regulatory perspective by requiring any prospective issuer of a “stablecoin” (let’s not even get into what is or is not a stablecoin) to obtain a banking charter.

There is an alternative. The idea of another kind of federal charter that would allow regulated institutions access to payment systems, but would not allow them to provide credit, seems much more appealing for not only stablecoin issuers but almost all other fintechs as well. Such a charter would separate the systemically risky provision of credit from the less risky provision of payment services, a very different concept to the SPNB charter. The economist George Selgin, Senior Fellow and Director of the Cato Institute’s Center for Monetary and Financial Alternatives, recently posted a similar point on Twitter, arguing for the Federal Reserve to give fintechs direct access to payment systems (instead of having to go through banks). This was the approach taken in the UK when the Bank of England decided to give settlement accounts to fintechs, where examples of fintechs who took advantage of this opportunity to deliver a better and cheaper service to customers range from the $5 billion+ Transferwise money transfer business to the open banking startup Modulr (which just recieved a $9 million investment from PayPal Ventures). Interestingly, Singapore has just announced that it will go this way as well, so that non-banks that are licenced as payment institutions will be allowed access to the instant payment infrastructure from February 2021.

My good friend Chris Skinner was right to say that many US fintechs will follow the likes of Varo, apply for new licenses and become more and more like traditional banks, but that’s because the traditional bank licence is all that is on offer to them. But this is an accident of history that jumbles together money creation, deposit taking and payments. It’s time to disentangle them and to stop, as Jack Ma (the billionaire behind Alibaba and Ant Group) recently said, regulating airports the way we regulate train stations. He said this was shortly before Chinese regulators halted Mr. Ma’s IPO, following his comments  questioning financial regulation, clearly signalling that their relaxed attitude toward the growth of China’s financial giants is coming to an end.

The Chinese regulatory environment is changing. Whereas China was happy to see its techfins grow in order to help them scale while American enterprises were kept at bay, it is now beginning to rein them in. The new players are now having to build up capital and review business structures as those regulators focus on issues such as data privacy, banking partnerships and lending. With respect to that latter point, note that the concerns around the Alipay IPO were related to lending and leverage, not payments. Although heading towards half of Ant’s revenues came from the lending, facilitated by their vast quantities of data, but they only came up with 2% themselves (if they were were a bank, they would be required to provide something like a third) passing the rest of the exposure onto banks.

Meanwhile, in September, the European Commission (EC) adopted an expansive new “Digital Finance Package” to improve the competitiveness of the fintech sector while ensuring financial stability. The proposed framework includes a legislative approach to the general issue of crypto-assets, called Markets in Crypto-assets (MiCA). I’ll spare you the whole 168 pages, but note that it introduces the concept of crypto-asset service providers (CASPs) and defines stablecoins as being either “asset-referenced tokens” that refer to money, commodities or crypto-assets (although how this can be called “stable”, I am not at all clear) or “e-money tokens” that refer to one single fiat currency only.  E-money tokens (eg, Diem) are a good way to bring innovation to financial services because they are a way to bring genuine competition.

I think the EU may be charting a reasonable course here. China needs to regulate lending more, the US needs to regulate payments less. America needs more competition in the core of financial services and now is a good time to start. With the Biden administration on the way, they can tackle this core issue that, as The Hill says, the U.S. government has “ignored and neglected” the need for a regulatory framework that will support American technological innovation around cryptocurrency, setting aside an embarrassing and “outdated regulatory approach to fintech”. Prof. Lawry suggest a simple and practical response for the US regulators, which is to amend the state-level regulatory frameworks around money services businesses (MSBs), which they say “are the product of a bygone age”, and learn from M-PESA and Alipay where a 100% reserve requirement seems to have proved very successful. There is no evidence that such a requirement stifles growth. Congress need only introduce a uniform requirement that MSB hold a 100% in insured deposits at a bank that holds account balances at the Federal Reserve, which is in essence the same as an EU Electronic Money License and therefore ought to lead to mutual acceptance.

In short, China needs tighter regulation of non-bank credit, America needs lighter regulation of non-bank payments. The way forward is to separate the regulation of payments from the regulation of credit from the regulation of investments. This is the way to get competition and innovation in financial services.

May I interest you in a credit card *bleep*

In August this year, eight teams gathered for the three-day final of DARPA’s AlphaDogfight trials. The teams had developed Artificial Intelligence (AI) pilots to control F-16 fighter aircraft in simulated dogfights. The winner beat the human USAF pilot in five dogfights out of five. I’m not really sure what this means for the defence of the free world, partly because I don’t know anything about air combat (other than endless games of Falcon on my iMac years ago) but largely because it seems to me that there is a context error in the framing of the problem. Surely the future of air warfare isn’t robo-Maverick dogfighting with North Korea’s top fighter ace but $100m Tempest fighters (which as Sebastian Robin pointed out in Forbes earlier this year, might make more sense as unmanned vehicles) trying to evade $1m AI-controlled intelligent drones and machine-learning (ML) swarms of $10,000 flying grenades that can accelerate and turn ten times quicker. The point about budget is important, by they way. Inexpensive Turkish drones have been observed in Syria and Libya destroying enemy armour that costs ten times as much.

As is often said then, we plan for the battles of the next war using the weapons of the last one. This is true in finance just as it is in defence. A couple of years ago, John Cryan (then CEO of Deutsche Bank) said that that the bank was going to shift from employing people to act like robots to employing robots to act like people. They put this plan in motion and earlier this year announced big staff reductions as part of a radical overhaul of operations. At the same time, the bank announced that it will spend €13bn on new technology over the next four years. These investments in infrastructure “are already making some humans at Deutsche unnecessary”. The bot takeover in banking is already happening.

It is not surprising to see this takeover happening so quickly, because there are many jobs in banks that are far simpler to automate than that of a fighter pilot. In India, YES Bank has a WhatsApp banking service that uses a chatbot (a conversational AI with extensive financial knowledge) to help customers to check balances, order cheque books, report unauthorised transactions, redeem reward points, connect with help desks and to apply for more than 60 banking products. And this is only the beginning. The Financial Brand reported on research from MIT Sloan Management Review and the Boston Consulting Group showing that only one in ten companies that deploy AI actually obtain much of a return on ROI. This is, as I understand it, because while bots are good at learning from people, people are not yet good at learning from bots. A robot bank clerk is like a robot fighter pilot, an artificial intelligence placed in the same environment as a human: when organisations are redesigned around the bots, then the ROI will accelerate.

Maverick

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

The robots will take over, in banking just as in manufacturing. So will you be served by a machine when you go to the bank five years from now? Of course not. That would be ridiculous. For one thing, you won’t be going to a bank five years from now under any circumstances. You’ll be explaining “going to” a bank to your baffled offspring just as you were explaining “dialling” a phone to them five years ago. But you won’t be going to your bank in cyberspace either. Your bot will. As I pointed out in Wired this time last year, the big change in financial services will come not when banks are using AI, but when customers are.

The big change in financial services will come not when banks are using AI, but when customers are. Click To Tweet

Think about it. Under current regulations, my bank is required to ask me to make decisions about investments while I am the least qualified entity in the loop. The bank knows more than I do, my financial advisor knows more than I do, the pension fund knows more than I do, the tax authorities know more than I do. Asking me to make a decision in these circumstances seems crazy. Much better for me to choose an approved and regulated bot to take care of this kind of thing. And if you are concerned that they may be legal issues around delegating these kinds of decisions to a bot, take a look at Ryan Abbott’s argument in MIT Technology Review that there should be a principle of AI legal neutrality asserting that the law should tend not to discriminate between AI and human behaviour. Sooner or later we will come to regard allowing people to make decisions about their financial health as dumb as letting people drive themselves around when bots are much safer drivers.

The battle for future customers will take place in landscape across which their bots will roam to negotiate with their counterparts – ie, other bots at regulated financial institutions – to obtain the best possible product for their “owners”. In this battle, the key question for customers will become a question of which bot they want to work with, not which bank. Consumers will choose bots whose moral and ethical frameworks are congruent with theirs. I might choose the AARP Automaton, you might choose the Buffett Bot or the Megatron Musk. Once customers have chosen their bots, then why would they risk making suboptimal choices around their financial health by interfering in the artificial brain’s decisions?

Imaging the world of the future as super-intelligent robots serving mass-customised credit cards and bank accounts to human customers is missing the point — just as imagining the world of the future as F-16s with robot pilots duelling M-29s with robot pilots is — because in the future the customers will be super-intelligent robots too.

[An edited version of this article first appeared on Forbes on 24th November 2020.]