Tag Archives: digital money

China and America both need new fintech regulation

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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.

4th July!

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July 4th! Such an important anniversary! I look forward to it every year, and every year I spend the 4th reflecting on revolution and the course of history. I’m sure you know why, but if you don’t, well, here is a hint. It’s the front page of the Swindon Evening Advertiser from July 4th 1995, the day I finally made the front page of my home town newspaper.

(Got to see my picture on the cover, got to buy five copies for my mother…)


Mondex Launch 

Yes, I was there on 3rd July 1995 in Swindon town centre when the Swindon Evening Advertiser vendor Mr. Don Stanley (then 72) made the first ever live Mondex electronic cash sale.  It was a very exciting day because by the time this launch came, my colleagues at Consult Hyperion had been working on the project for several years! For those of you who don’t remember what all of the fuss was about: Mondex was an electronic purse, a pre-paid payment instrument based on a tamper-resistant chip. This chip could be integrated into all sorts of things, one of them being a smart card for consumers.

Somewhat ahead of its time, Mondex was a peer-to-peer proposition, which we’ll come back to later on. This meant that the value was transferred directly from one chip to another with no intermediary and therefore no cost. In other words, people could pay each other without going through a third party and without paying a charge.

Unlike Bitcoin, transactions were actually instant and were actually free. Click To Tweet

It was true cash replacement, invented at National Westminster Bank (NatWest) in 1990 by Tim Jones and Graham Higgins. Swindon had been chosen for the launch because, essentially, it was the most average place in Britain. Since I’d grown up there, I was rather excited about this, and while my colleagues carried out important work for Mondex (e.g., risk analysis, specification for secure transfer, multi-application OS design and such like) I watched as the fever grew out in the West Country.


Mondex Billboard 

Many of the retailers were quite enthusiastic because there was no transaction charge and for some of them the costs of cash handling and management were high. I can remember talking to a hairdresser who was keen to go cashless because it was dirty and she had to keep washing her hands, a baker who was worried about staff “shrinkage” and so on. The retailers were OK about it. For example here’s a quote from news-stand manager Richard Jackson: “From a retailer’s point of view it’s very good but less than one per cent of my actual customers use it. Lots of people get confused about what it actually is, they think it’s a Switch card or a credit card”. That’s if they thought about it all.

It just never worked for consumers. It was a pain to get hold of, for one thing. I can remember the first time I walked into a bank to get a Mondex card. I wandered in with 50 quid and had expected to wander out with a card with 50 quid loaded onto it but it didn’t work like that. I had to set up an account and fill out some forms and then wait for the card to be posted to me. Most normal people couldn’t be bothered to do any of this so ultimately only around 14,000 cards were issued.

I pulled a few strings to get my mum and dad one of the special Mondex telephones so that they could load their card from home instead of having to go to an ATM like everyone else. British Telecom had made some special fixed line handsets with a smart card slot inside and you could ring the bank to upload or download money onto your card. I love these and thought they were the future! My parents loved it, but that was nothing to do with Mondex: it was because, in those pre-smartphone days, it was a way of seeing your bank account balance without having to go to the bank or an ATM or phone the branch. You could put the Mondex into the phone and press a button and hey presto your account balance would be displayed on the phone. This was amazing a quarter of a century ago.

For the poor sods who didn’t have one of those phones (everyone, essentially) the way that you loaded your card was to go to an ATM. Now, the banks involved in the project had chosen an especially crazy way to implement the ATM interface. Remember, you had to have a bank account in order to have one of these cards and so that meant that you also had an ATM card. So if you wanted to load money onto your Mondex card, you had to go to the ATM with your ATM card and put your ATM card in and enter your pin and then select “Mondex value” or whatever the menu said and then you had to put in your Mondex card. But if you go to an ATM with your ATM card then you might as well get cash, which is what they did.

It is possible that I’m not remembering this absolutely accurately, but I do remember these were two places where the hassle of getting the electronic value outweighed the hassle of fiddling about with coins: the bus and the car park. My dad really liked using the card in the town centre car park instead of having to fiddle about looking for change but it often didn’t work and he would call me to complain (and then I would call Tim Jones to complain!). I remember talking to Tim about this some years later and he made a very good point which was that in retrospect it would have been better to go for what he called “branded ubiquity” rather than go for geographic coverage. In other words it would have been better to have made sure that all of the car parks took Mondex or make sure that all of the buses took it or whatever.

So why I am wallowing in this nostalgia again? Why should more people be celebrating the Mondex Silver Jubilee? Well, look East, where the first reports have appeared concerning the Digital Currency/Electronic Payment (DC/EP) system being tested in four cities: Shenzen, Chengdu, Suzhou and Xiong’an. DC/EP is the Chinese Central Bank Digital Currency (CBDC).

DCEP phone

with the kind permission of Matthew Graham @mattysino

The implementation follows the trajectory that I talk about in my book The Currency Cold War, with the digital currency being delivered to customers via commercial banks. The Deputy Governor of the People’s Bank of China, Fan Yifei, recently gave an interview to Central Banking magazine in which he expanded on the “two tier” approach to central bank digital currency (CBDC). His main points were that this approach, in which the central bank controls the digital currency but it is the commercial banks that distribute it, is that is allow “more effective exploitation of existing business resources, human resources and technologies” and that “a two-tier model could also boost the public’s acceptance of a CBDC”.

He went on to say that the circulation of the digital Yuan should be “based on ‘loosely coupled account links’ so that transactional reliance on accounts could be significantly reduced”. What he means by this is that the currency can be transferred wallet-to-wallet without going through bank accounts. Why? Well, so that the electronic cash “could attain a similar function of currency to cash… The public could use it directly for various purchases, and it would prove conducive to the yuan’s circulation”. How will this work? Well, you could have the central bank provide commercial banks with some sort of cryptographic doodah that would allow them swap electronic money for digital currency under the control of the central bank. Wait a moment, that reminds me of something because… yep, that’s how Mondex worked. There was one big difference between Mondex and other electronic money schemes of the time, which was that Mondex would allow offline transfers, chip to chip, without bank (or central bank) intermediation.

Mondex Paraphanalia

Offline person to person transfers. That’s huge. Libra can’t do it, and never will be able to. To understand why, note that there are basically two ways to transfer value between devices and keep the system secure against double-spending. You can do it in hardware (ie, Mondex or the Bank of Canada’s Mintchip) or you can do it in software. If you do it in software you either need a central databse (eg DigiCash) or a decentralised alternative (eg, blockchain). But if you use either of these, you need to be online. But with hardware security, you can go offline.

After all these years, the People’s Bank of China have decided to go down the Mondex route, so now seems a good time go to think back to those long ago days and see what lessons might be passed on to a new generation of electronic cash entrepreneurs. I’ll focus on three here.

The
first lesson is that banks aren’t very good at launching products that compete with their existing core businesses. Consult Hyperion’s later experiences with (for example) M-PESA, suggest that a lot of the things that I remember that I was baffled and confused by at the time come down to the fact that it was banks making decisions about how to roll out a new product. The decision not to embrace mobile and Internet franchises, the decision about the ATM implementation, the stuff about the geographic licensing and so on.  There were many people who came to the scheme with innovative ideas and new applications – retailers who wanted to issue their own Mondex cards, groups who wanted to buy pre-loaded disposable cards and so on. They were all turned away. I remember going to a couple of meetings with groups of charities who wanted to put “Swindon Money” on the card, something that I was very enthusiastic about. But the banks were not interested in anything other than retail payments in shops (shops who already had card terminals that didn’t take Mondex, basically).

The
second lesson is that the calculations about transaction costs (which is what I spent a fair bit of my time doing) actually really didn’t matter: they had no impact on the decision to deploy or not to deploy in any particular application. I remember spending ages poring over calculations to work out that the cost of paying for satellite TV subscriptions would be vastly less using a prepaid Mondex solution rather than building a subscription management and billing platform: Nobody cared, because reducing costs for merchants was no-one in the banks’ goal.

The
third lesson is that while the solution was technically brilliant it was too isolated. The world was moving to the Internet and mobile phones and to online in general and Mondex was trying to build something that was optimised not to use of any of those. Thinking about it now, it seems odd that we made cash replacement systems such as Danmont, Mondex, VisaCash and used them to compete with cards in the physical world rather than target them where cash was a pain, such as vending machines and web sites. I hope I’m not breaking any confidences in saying that I can remember being in meetings discussing the concept of online franchises and franchises for mobile operators. Some of the Mondex people thought this might be a good idea, but the banks were against it. They saw payments as their business and they saw physical territories as the basis for deployment. Yet as The Economist said back in 2001, “Mondex, one of the early stored-value cards, launched by British banks in 1994, is still the best tool for creating virtual cash“.

Now, at the same time that all this was going on at Mondex, we were working for mobile operators who had started to look at payments as a potential business. These were mobile operators who already had a tamper-resistant smart card in the hands of millions of people and so the idea of adding an electronic purse was being investigated. Unfortunately, there was no way to start that ball rolling because you couldn’t just put Mondex purses into the SIMs, you had to get a bank to issue them. And none of them would: I expect they were waiting see whether this mobile phone thing would catch on or not.

Well, here we are. Mobile phones have caught on, and the People’s Bank of China are using them to deliver two-tier central bank digital currency into the mass market. I am pretty sure that they will have learned from the Mondex experiments in Manhattan and Guelph, in Hong Kong and in Sydney. The Mondex Silver Jubilee will be celebrated in a way that could never have been imagined on 4th July 1995: with central bank digital currency spreading across Shenzen rather than Swindon.

Scrip and truck

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The Consensus Distributed virtual conference had some pretty interesting sessions this year. There was a lot of talk about disruption coming not just to the payments business but to money itself, and this time is wasn’t coming from the Bitcoin maximalists. Some of the fantastical futurists predicting a fundamental shift in the set of international monetary arrangements (eg, me) think that it isn’t simply about new technology enabling decentralised alternatives but about a confluence of economic and political factors that create an environment for new technologies to take root. Things really are about to change.

This may seem a radical prediction, but it really isn’t. People think about money as a law of nature, as a kind of constant, but the way that money works today is not only just one of many ways in which it could work, it’s a relatively recent set of arrangements in the great scheme of things. It wasn’t that long ago that the developed world was on a commodity standard (ie, gold) and there was no national fiat currency. Go back 150 years and America did not have a central bank and a century ago there wasn’t even a circulating medium of exchange.

Wait? No money? Yes. At the height of the
Great Depression, 1932 and 1933, when the interest rate on U.S. Treasury bills was negative, unemployment was 25 percent and bank runs and closings were common. With no money moving around the economy, Americans reverted to barter.

It’s hard to imagine this now, but at that time America literally ran out of money. Because there was no cash — no Federal Reserve notes — available, communities began to print their own money. This was known as “scrip” and it is by no means limited to this single historical case: it’s a common phenomenon. An often-used example (by me, for example, in my book “Identity is the New One“) comes from the more recent Irish bank strikes, when people in Ireland wrote personal cheques to each other and these were then passed on to form a community scrip as a cash substitute in local economies. British Postal Orders circulating on the Indian subcontinent performing a similar function.

The “depression scrip ” issued around America took many forms (there is a vibrant collectors’ market for this: just search on eBay) and was issued by communities, companies and individuals. And it became close to becoming the norm! As Bernard Lietaer points out in this 1990 article, Dean Acheson, then the Assistant Secretary of the Treasury, had been approached by Professor Irving Fisher with the idea of scrip with a high “negative interest” rate (2% per week) and was calculated so that the face value would be amortised over one year, and the currency withdrawn at that point. Acheson decided to have it checked by his economic advisor, Professor Russell Sprague at Harvard. The answer was that it would work, but that it had some implications for decentralised decision making which Acheson should verify in Washington.

(In “Monopoly: The World’s Most Famous Game and How It Got That Way”, author Philip Orbanes mentions in passing that in 1933, Parker Brothers used their printing presses to print scrip that was accepted in their home town of Salem, Mass. Games to the rescue! I wonder if next time the financial system fails, it will be World of Warcraft gold , not Monopoly money, or Monero, or cartons of Marlboro, that fill the breach as the means of exchange to keep the economy going.)

In many parts of America, scrip was already part of the local economy. My good friend Brett King reminded me just the other day that in the Appalachians, “coal scrip” issued by mining companies was common. The companies argued that the remoteness of mining operations made it complex and expensive to provide cash. (In addition, it has to be said, to managing their capital outflows.) Interestingly, while the mining companies themselves would not redeem the scrip for cash it naturally traded for cash at a discount within the nearby communities. Indeed, in 1925 coal company lobbyists managed to get West Virginia to pass a law prohibiting scrip from being transferred to third-parties (this would be much easier to enforce with Bitcoin today)) thus crystallising the companies power over their employees to a form of serfdom.

(There are some lovely pictures of depression era script over the Wall Street Journal.)

This was not an American phenomenon. During the industrial revolution, and driven initially by the lack of money in circulation, a variety of British companies created money to pay their worker. This was known as “truck”, which is why the measures passed by the British Parliament starting in 1831 regarding the money payment of wages were known as the “Truck Acts”. Under these provisions, employers were forced to pay workers in cash, laws that remained in place until 1960 where they were superseded to allow for payments by cheque.

Anyway, back to America in its cash-free depression. While Acheson’s discussions were going on, the “stamp scrip movement” as it became known, had created interest by no less than 450 cities around the United States. For example the City of St. Louis, Missouri, had decided to issue $100,000 worth of stamp money. Similarly, Oregon was planning to launch a $75 million stamp scrip issue. A federal law had been introduced in Congress by Congressman Pettengil, Indiana, to issue $ l billion of stamped currency. Fisher published a little handbook entitled “Stamp Scrip” for practical management of this currency by communities, and described the actual experience of 75 American communities with it.

It looked as if the U.S. might adopt a decentralised money system, but on 4th March 1933 FDR passed legislation to enforce bank holidays, end the convertability of gold and to force the population of to sell their gold to the Federal government. In addition to launching the New Deal, the administration prohibited the issue of “emergency currencies” and the experiment was over. But, I cannot help but wonder, is it over forever? Now that the technologies of blockchains, biometrics and bots mean that absolutely anyone can issue their own money, why not look at community scrip as way to reboot devastated economies?

I am hardly the only person to think this way. In virus-ravaged Italy, the town of Castellino del Biferno in southern Italy’s Molise region has started to issue its own money (the “Ducati”), redeemable in local merchants only, with a 100% reserve in euros. This kind of scrip (strictly speaking, a “currency board” rather than a “currency”) is intended to keep money circulating within the local economy but there’s no reason why an actual local currency might not circulate over a wider area. In the north of Italy, to continue with this particular example, anti-euro Lega nationalists and the alt-Left Five Star Movement were at one time planning to go around the euro and create a rival payment structure based on ‘IOU’ notes (a course of action I may well have helped to stimulate). If the COVID-19 crisis tips us into even more of depression, more regions may well decided to decouple themselves from national and supra-national currencies in order to manage their own monetary policy on the road to recovery.

(It’s surprising, I think, to Europeans to realise just how much passion these events still stir today: there are no end of books, magazines, pamphlets and web sites that still refer to FDR’s actions then as if they were yesterday.)

Smart banknotes, dumb banknotes or no banknotes?

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My good friend Chris Skinner comments on a report from Switzerland-based SIX on the likely trajectory of digital money. They identify the most likely scenario as “Digital Rules — But Cash Persists in a Fragmented World”, which they describe thus: Digital payments have substantially increased in convenience compared to cash as digital user interfaces expand into ever more human activities. At the same time, cash continues to be perceived and widely used as a ‘store of value’.

The use of a cash as as store of value in Switzerland reminded me of something that Larry White, someone who I always take very seriously in any such discussion, said a while back in the Cato Journal. Larry was writing about ceaselessness and he said that “some other writers and officials… do seek a cashless society… they want an audit trail for the law enforcement and tax authorities”. I think I’m probably in this category. While I appreciate the arguments of Larry and others about anonymity, I do not agree with them. This is because I do not see that the only two options as being anonymous physical cash or unconditionally traceable digital money. We have a wide variety of tools available to us to construct the next generation of digital money and some form of pseudonymous alternative is probably best for society as a whole.

Anyway, back to Switzerland. In his article, Larry noted that the Swiss National Bank (SNB) is “the most important central bank still bucking the trend”. It has said that it has no plans to withdraw its 1,000 Swiss Franc (CHF)  note. The highest-denomination banknote in the world, this is an inordinately profitable commodity. It costs about 40 centimes to make, generating a 250-fold seigniorage return.

I also read with interest the comments earlier in the year by SNB Vice Chairman Fritz Zurbruegg on the news that they are to continue production. Herr Zurbruegg said that there were “no indications” that criminals use the CHF 1,000 note more than any other note. So what are these notes used for? When I read the Swiss National Bank’s payment survey for 2017, the most recent at the time, I noted that is said that the 200-franc and 1000-franc notes accounted for a combined 23% of the total number
of Swiss banknotes in circulation, with 61 million and
50 million units respectively. These banknotes had a combined value of CHF 62 billion, or 76% of the value
of all banknotes in circulation.

Where are these banknotes? Apparently, three-quarters of Swiss households keep less than 1,000 Swiss Francs as a store of value, so obviously they aren’t using the CHF 1,000 that much. In fact, of the cash that is held as store of value, less than 5% is CHF 1,000 notes.

(The report goes on to say that “it should be borne in mind that respondents’ answers on this sensitive topic are likely to be not wholly reliable due to both security and discretion considerations”, which may point us in the direction of the actual use of the notes. It also notes the particular importance of the SFR 1,000 note in livestock trading. Presumably Swiss farmers find the payment facilities provided by the nation’s financial institutions to be inconvenient in some way.)

Still the main point is that less than a quarter of Swiss household have even one CHF 1,000, which given that they account for a substantial portion of the cash in circulation suggests a long tail: there are a few households with a lot of them.

Interestingly, in his comments on the continued production of the SFR 1,000, Herr Zurbruegg went on to say that should these notes be used for tax evasion, then “this is an issue for the legislators and authorities to prevent”. But as Cash & Payment News Volume 2, Number 3 (March 2019) goes on to observe about this perspective, in other industries the manufacturers are not allowed to wash their hands of the negative side-effects of their products (cars have to meet safety standards, for example). On the contrary, it is the manufacturers who are required to pay in some way for the potentail harrm that their product may cause.

The idea of making the producers of high-value notes (central banks) pay some sort of tax to compensate society for the damage done by those notes does, I’ll  admit, seem a little far-fetched. But the alternative, which is to considerably reduce the value of the highest-denomination notes, does not. Why not get rid of the US$100 (of which there are more “in circulation” than $1 bills) and the £50, for example. After all Denmark ignored a request by the European Central Bank and moved to ban 500-euro notes, as the country toughens it defenses against money launderers. Yay! Go Denmark! There really is no excuse for printing such high value notes in the modern world. Perhaps it was once a reasonable aspiration to displace the $100 bills stuffed into drug dealers’ mattresses with €500 bills and thus redirect the proceeds of crime (the seigniorage earned on those bills) from the Fed to the ECB, but no more.

(The head of Switzerland’s financial regulator, FINMA, is on record as saying that the Swiss financial system is susceptible to money laundering with the number of cases rising over the past five years, warns the head of Switzerland’s financial regulatory body, FINMA.)

So if the Swiss did decide to replace cash with a digital currency, then what digital currency should it be? Andréa Maechler, a member of the Swiss central bank’s board of governors, has already said that “private-sector digital currencies are better and less risky than nationally-issued versions”. So, Libra?

Interestingly the SIX report talks about the idea of smart banknotes with chips in them, an idea that was discussed by my colleagues at Consult Hyperion may years ago. Some of you may remember Paul Makin’s super presentation about “E-ink and smart banknotes” at the 13th Digital Money Forum in London back in March 2010. The presentation was based on some work that Consult Hyperion had been doing with the Bill & Melinda Gates Foundation all those years ago. At that time, we were thinking of a smart banknote as comprising four main technological components:

  • The note itself, made out of a plastic polymer rather than paper. This makes it durable and waterproof, important if it is to contain electronics.
  • The electronic ink display on the note. Electronic ink, as you’ll recall, only uses power when it is changing, so once the banknote display has been written then it will stay displaying the same thing until it changed.
  • The chip inside the banknote. Why do we need a chip inside the banknote? Well, we want the banknote to be secure: we don’t want it to be counterfeited or altered. And we need the banknote to be able to communicate intelligently with terminals.
  • The antenna connected to the chip. We wanted our smart banknote to be as convenient as a contactless card!

How would such a note be used? Well, we imagined that you would have a banknote that says “£10” on it. You to the coffee shop and spend £1.50 on a coffee. You tap the note on the till to pay, and the display now changes to say “£8.50”. When you get to work, your friend reminds you that you owe him £8 from the pub. You give him the note and he gives you a 50p coin in change. Your friend can absolutely trust that the value represented by the note is indeed £8.50 because the tamper-resistant chip and the cryptography it deploys make it impossible to counterfeit!

It was interesting to see these ideas come back after a decade! SIX say that “traditional cash infrastructure risks disruption from smart banknotes infrastructure” and they even go on to talk about a “smart Libra banknote”. Frankly, I doubt either of these propositions because, as far as I recall, the main reason for looking at the idea of smart banknotes in Africa many years ago was to provide for security for populations without mobile phones. I am not sure if that makes sense any more in Africa, but it certainly doesn’t in Switzerland where three-quarters of the population use smartphones, half of online purchases are made using bank transfers and (according to JP Morgan) “digital wallets are used to pay for 20 percent of online transactions, and the method is expected to grow to take a 24 percent share of the market by 2021… and local payment brands, including Twint and its domestic rival SwissWallet, are also popular”.

I don’t understand why anyone uses banknotes there, dumb or smart.

China’s digital currency may set the benchmark, not Libra

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As I wrote a while ago, the Chinese were first with the great transition from commodity money to paper money. They had the necessary technologies (you can’t have paper money without paper and you can’t do it at scale without printing) and, more importantly, they had the bureaucracy. In 1260, Kublai Khan became Emporer and determined that it was a burden to commerce and taxation to have all sorts of currencies in use, ranging from copper ‘cash’ to iron bars, to pearls to salt to specie, so he decided to implement a new currency. Then, as now, a new and growing economy needed a new kind of money to support trade and therefore prosperity. The Khan decided to replace copper, iron, commodity and specie cash with a paper currency. A paper currency! Imagine how crazy that must have sounded! Replacing physical, valuable stuff with bits of paper!

 

Just as Marco Polo and other medieval travellers returned along the Silk Road breathless with astonishing tales of paper money, so commentators (e.g., me) began tumbling off of flights from Beijing and Shanghai with equally astonishing tales of a land of mobile payments, where paper money is vanishing and consumers pay for everything with smartphones. China is well on the way to becoming a cashless society, with the end of its thousand year experiment with paper money in sight. Already a significant proportion of the population rely wholly on mobile payments and carry no cash at all, much as I do when heading into London.

The natural step from here is to create digital currency so that settlement is in central bank money and there are no credit risks. Now, the People’s Bank of China (PBoC) is run by smart people and as you might imagine they have been looking at this strategy since back in 2014. It now looks as if Facebook’s Libra initiative has stimulated or accelerated their tactics. I read in Central Banking [PBoC sounds alarm over Facebook’s Libra] that PBoC officials had “voiced worries” that [Libra] could have destabilising effects on the financial system and further stated that the bank would step up its own efforts to create an e-currency.

This is no knee-jerk reaction. Way back in 2016, the then-Governor of PBoC, Zhou Xiaochuan, very clearly set out their thinking about digital currency, saying that “it is an irresistible trend that paper money will be replaced by new products and new technologies”. He went on to say that as a legal tender, digital currency should be issued by the central bank (my emphasis) and after noting that he thought it would take a decade or so for digital currency to completely replace cash in cash went to state clearly that “he has plans how to gradually phase out paper money”.

(As I have written before, I don’t think a “cashless society” means a society in which notes and coins are outlawed, but a society in which they are irrelevant. Under this definition the PBoC could easily achieve this goal for China.)

What would be the impact of phasing out paper money? Yao Qian, from the PBOC technology department wrote on this subject back in 2017, noting (as I have done) that a central bank digital currency (CBDC) would have some consequences for commercial banks, so that it might be better to keep those banks as part of the new monetary arrangement. He described what has been called the “two tier” approach, noting that to offset the shock to the current banking system imposed by an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it is possible to incorporate digital currency wallet attributes into the existing commercial bank account system “so that electronic currency and digital currency are managed under the same account“.

I understand the rationale completely. The Chinese central bank wants the efficiencies that come from having a digital currency but also understands the implications of removing the exorbitant privilege of money creation from the commercial banks. If the commercial banks cannot create money by creating credit, then they can only provide loans from their deposits. Imagine if Bitcoin were the only currency in the world: I’d still need to borrow a few of them to buy a new car, but since Barclays can’t create Bitcoins they can only lend me Bitcoins that they have taken in deposit from other people. Fair enough. But here, as in so many other things, China is a window into the future.

Whether you think CBDC is a good idea or not, you can see that it’s a big step to take and therefore understand the PBoC position. There is a significant potential problem with digital currency created by the central bank. If commercial banks lose deposits and the privilege of creating money, then their functionality and role in the economy is much reduced. We already see this happening because “Alipay, WeChat Wallet, and other Chinese third party payment platforms use financial incentives to encourage users to take money out of their bank accounts and temporarily store it on the platform itself” [China’s Future is Definitely Cashless].

In summary, then, a couple of year ago I wrote that the PBoC were not going to issue cryptocurrencies and they were not going to issue digital currencies either (at least in the foreseeable future). What I said was that what they might do is to allow commercial banks to create digital currency under central bank control. And this indeed what seems to be happening. According to the South China Morning Post, the new Chinese digital currency “would be centrally controlled by the PBoC, with commercial banks having to hold reserves at the central bank for assets valued in the digital yuan“.

How will this work? Well, you could have the central bank provide commercial banks with some sort of cryptographic doodah that would allow them swap electronic money for digital currency under the control of the central bank. Wait a moment, that reminds me of something…

Yep, that’s how Mondex was structured 25 years ago. (If you don’t know what Mondex was, here’s something I wrote about it 20 years on.) There was one big different between Mondex and other electronic money schemes of the time, which was that Mondex would allow offline transfers, chip to chip, without bank (or central bank) intermediation. Would a central bank go for this today? Some form of digital cash that can be passed directly from person to person like Bitcoin rather than some form of electronic money like M-PESA, using hardware rather than proof of work to prevent double spending? Well, it was being tried in Uruguay, but I’m not sure how that pilot is going, although is was not quite the same thing as Mondex because the phones would not be exchanging fungible value but tokens that could ultimately be traced and tracked and monitored, but it’s interesting nonetheless.

 Mondex Paraphanalia

When I wrote about this back in 2018, I said that I thought it was unlikely that the PBoC would allow anonymous peer-to-peer transfers, so I was very surprised to see a Reuters report [6th September 2019] quoting Mu Changchun, deputy director of the PBoC’s payments department, saying about the proposed Chinese digital currency that “its ability to be used without an internet connection would also allow transactions to continue in situations in which communications have broken down, such as an earthquake”.

This would seem to mean that the system will allow offline transactions, which means that value can be transferred from one phone to another via local interfaces such as NFC or Bluetooth. If so, this would be truly radical. I wondered if something was mistranslated in the Reuter’s piece so I went to the source speech (albeit via Google Translate!) and I discovered that this is in fact precisely what he said. Talking about the project, which is called the DC/EP (digital currency and electronic payment) tool, he said that it is functionally “exactly the same as paper money, but it is just a digital form” and went on to confirm that

DC/EP can realize value transfer without an account. In the specific scenario, as long as there is a DC/EP digital wallet on the mobile phone, no network is needed, and as long as the two mobile phones touch each other, the transfer function can be realized… “Even Libra can’t do this,” Mu Changchun said”.

Wow. That’s huge. Libra can’t do it, and never will be able to. To understand why, note that there are basically two ways to transfer value between devices and keep the system secure against double-spending. You can do it in hardware (ie, Mondex or the Bank of Canada’s Mintchip) or you can do it in software. If you do it in software you either need a central databse (eg DigiCash) or a decentralised alternative (eg, blockchain). But if you use either of these, you need to be online. I don’t see how to get the offline functionality without hardware security.

If you do have hardware security and can go offline, then we are back to the question of fungibility again. Here the PBoCs principle is both clear and very surprising.

Mu Changchun said that the public has the need for anonymous payment, but today’s payment tools are closely tied to the traditional bank account system, can not meet the consumer’s anonymous payment needs, and can not completely replace the cash payment. The central bank’s digital currency can solve these problems. It can maintain the attributes and main value characteristics of cash and meet the demands of portability and anonymity.

Wow. They are serious. He goes on to say DC/EP will work the same way as banknotes.

Commercial banks open accounts at the central bank, paying 100% of the total amount, and individuals and businesses open digital wallets through commercial banks or commercial organizations. DC/EP is still replaced by M0 and is legally compensated. For users, just download an app to register, you can use a digital wallet, and recharge cash withdrawals need to dock traditional bank accounts.

I wonder if this will bring interoperability? If DC/EP is really to work as banknotes do then the e-RMB in my bank app and my Alipay app and my WeChat app much be interoperable. I must be able to transfer value from my Alipay app to your WeChat app. If PBoC crack that they will be on the way to one of the world’s most efficient electronic payment infrastructures.

There was a final part to the speech which I did not understand at all, so perhaps a Chinese correspondent more familiar with DC/EP can clarify the meaning. The speech covers “smart” “contract” by which I assume PBoC means apps that use the DC/EP to execute on the handset (since there is no blockchain), but this is my assumption.

Mu Changchun said on several occasions that the central bank’s digital currency can load smart contracts. However, if a smart contract that exceeds its monetary function is loaded, it will be degraded into a value-for-money ticket, reducing its usable level, which will adversely affect the internationalization of the RMB. Therefore, digital currencies will load smart contracts that favor the monetary function, but remain cautious about smart contracts that exceed the monetary function.

I am baffled by this, which I am sure reflects my ignorace of advanced electronic money technologies, but I don’t think that this deflects from my overall observation that if the PBoC goes ahead and launches a person-to-person offline capable CBDC then that will be not only a nail in the coffin of cash but an event as significant and momentous in monetary history as the paper notes of the Khan a millennium ago.

FaceCoin or FacePESA, Zuckbucks are a winner

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Around a decade ago my son was, as is rather the fashion with teenagers, in a band. With some friends of his, he arranged a “gig” (as I believe they are called) at a local venue. There were five bands involved and the paying public arrived in droves, ensuring a good time was had by all. All of this was arranged through Facebook. All of the organisation and all of the coordination was efficient and effective so that the youngsters were able to self-organise in an impressive way. Everything worked perfectly. Except the payments.

eden_first_gig

When it came to reckoning up the gig wonga (as my old friend Paul Pike of Intelligent Venues would call it), we we had a couple of weeks worth of “can you send PayPal to Simon’s dad” and “he gave me a cheque what I do with it?” and “Andy paid me in cash but I need to send it to Steve“ and so on. Some of them had bank accounts, some of them didn’t. Some of them had bank accounts that you could use online and others didn’t. Some of them had mobile payments of one form or another and others didn’t. I can remember that at one point my son turned to me and asked “why can’t just send them the money on Facebook?”.

As I wrote at the time, I didn’t have a good answer to this because I thought that sending the money through Facebook would be an extremely good idea and I can remember discussing with some clients at the time what sort of services they might be able to offer to Facebook or other social networks that were empowered through an Electronic Money Issuing (ELMI) license and Payments Institution (PI) licence. The rudimentary business modelling was quite positive, and so I naturally assumed that there would be some sort of Facebook money fairly soon, especially because I am something of a proponent of community monies of one form or another.

I also wrote at the time that Facebook money, or Zuckbucks ($ZUC), could easily become the biggest virtual currency in the world given that there are so many people with Facebook accounts and the ability to send value instantly from one account to another via Facebook would be so attractive. You’ll remember that Facebook launched “Facebook Credits” so time ago but they weren’t really a currency, just a way of prepaying for virtual goods with the service. A virtual currency is something more, it’s true electronic money that you can send from one person to another. Well, it looks as if this is coming, as I read in the crypto press that Facebook “is talking to exchanges about potentially listing a cryptocurrency” [CoinDesk]. It looks as $ZUC might be just around the corner, and people are getting excited.

As I understand things, Mr. Zuckerberg has already decided integrate the social network’s three different messaging services — WhatsApp, Instagram and Facebook Messenger — on a single unified messaging platform and, according to the New York Times, have that platform implement end-to-end encryption. This would naturally be an ideal platform for a universal currency so it’s no surprise to hear that the company is now looking at just such an enterprise. Even if Facebook couldn’t read the details of a transaction, it would know that I just paid a car insurance company and might find some use for the data in the future.

My suspicions that a Facebook money might me rather successful were further strengthened while listening to one of my favourite podcasts, Pivot with Kara Swisher and Scott Galloway, on a plane last week. Scott said that his biggest friction in the physical world is charging (I couldn’t agree more – battery life is the bane of my road warrior existence) and that his biggest friction in the virtual world is payment. He cited the example of trying to buy wifi on a flight and having to mess around typing in card numbers like it was 1995 and pointed out just how much Facebook could gain by adding payments to their platform. Scott is surely right, and since the people at Facebook are smart, they must be looking at the potential to develop a new revenue stream that is separate from advertising with some enthusiasm.

Barclays equity research note on the subject (Ross Sandler and Ramsey El-Assal, 11th March 2019) reckon that a successful micro-payment service could add some $19 billion to Facebook’s revenues, so clearly I’m not the only one who is a little surprised that they haven’t already leveraged the technologies of strong authentication to get something off the ground already. It also notes that one of the problems with the original Facebook Credits business was the cost of interchange, a problem that has a very different shape now with interchange caps in place in various parts of the world and open banking giving the potential for direct access to consumer bank accounts (so that exchanges between fiat bank accounts and $ZUC would be free).

Facebook Marketplace has just added card payments [91Mobiles], as shown in the screenshot below, so that marketplace users can pay for goods directly without having to come out of Facebook. I think this is, frankly, a window into a one possible future for financial services!

These are boring old Visa and Mastercard payments, but presumably $ZUC can’t be far behind. Unfortunately, since there are no details that I can find on what exactly “Facebook Coin” is going to be, I can’t really offer any informed comment on the chosen implementation. If, however, it is something along the lines of JPM Coin then it will be a form of electronic money and governed by the appropriate rules and regulations (which is good, and since they have very smart people at Facebook I’m sure they’ve already spotted the advantages of providing a trusted, regulated global payment service). You can kind of see the idea: your Facebook account sprouts an automatic, opt-out, wallet. You can buy coins for this wallet using a debit card and then send them to anyone else with a wallet (why this needs the blockchain is not entirely clear, by the way, but that’s another discussion).

Wallets that have been KYC’d (put to one side what exactly this might entail) could store up to say $ZUC 10,000, wallets without KYC would be limited to say $ZUC 150. I think this might be a great opportunity for banks to use their federated and standardised digital identity infrastructure* to provide an attractive service to Facebook that might relieve them of onerous regulatory burdens. All Facebook has to do is get me log in to my bank and have them return some cryptographic token (with no personal information in it) to Facebook to indicate that the bank has done KYC and knows who I am. A bit of a win win.

This, at a stroke, would provide teenagers with a means to settle gig wonga, provide online retailers with instant payment across borders and provide brands a mean to reward consumer behaviour. If Facebook make it free to buy ZUC$ and guarantee to redeem at par for consumers, they could be on to a real winner. In Europe, if the Facebook wallet is combined with PSD2 to deliver instant load and instant payout, it delivers a serious play that will give people are reason to use the Facebook platform to organise their gigs, lay out their online wares and promote their brands instead of messing around with Snapchat or Youtube or email or blogs or whatever else they are using now.

* Note: does not exist. Images not from actual gameplay. 

Not a cryptocurrency. End of.

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The media recently reported, somewhat breathlessly (eg, CNBC), that JP Morgan Chase (JPMC)is launching a “cryptocurrency to transform the payments business”. This sounded amazing so I was very excited to learn more about this great leap forward in the future history of money.

As CNBC reported, it seems to herald new forms of business. Umar Farooq, the head of JPMC’s blockchain projects, sets put this vision clearly, saying that the applications for this innovative use of new transaction technology “are frankly quite endless; anything where you have a distributed ledger which involves corporations or institutions can use this.“

Wow.

Now, many people took a look at this and pointed out that it is simply JPMC deposits by another name, and uncharitable persons (of whom I am not one) therefore dismissed it as a marketing gimmick. But it is more interesting than that. Here is the problem that it is trying to solve…

Suppose I am running apps (referred to by less well-informed media commentators as “smart” “contracts” when they are neither) on JPMC’s Quorum blockchain. Quorum is, in the terminology that I developed along with Richard Brown (CTO of R3) and my colleague Salome Parulava, their double-permissioned Ethereum fork (that is, it requires permission to access it and a further permission to take part in the consensus-forming process). I’m quite partial to Quorum (this is what I wrote about it back in 2017) and am always interested to see how it is developing and helping to define what I call the Enterprise Shared Ledger (ESL) software category.

Now suppose my Quorum app wants to make a payment – not in imaginary internet play money, but in US dollars – in return for some service. How can it do this? Remember that our apps can’t send a wire transfer or use a credit card because they can only access data on the blockchain. If the app has to pay using a credit card, and that app could be executing on a thousand nodes in the blockchain network, then you would have a thousand credit card payments all being fired off within a few seconds! You can see why this can’t work.

One way to solve this problem would be to have “oracles” reporting on the state of bank accounts to the blockchain and “watchers”  (or “custom executors” as Darius calls them here) looking for state changes in the blockchain bank accounts that they could then instruct in the actual bank accounts. But that would mean putting the safe-to-spend limits for millions of bank accounts on to the blockchain. Another more practical solution would be to add tokens to Quorum and allow the apps to send these tokens to one another. This is, as far as I can tell from a distance, is what JPM Coins are for.

I have to say that this is a fairly standard way of approaching this problem. A couple of months ago, Signature Bank of New York, launched just such a service for corporate customers — with a minimum $250,000 balance — using another permissioned Ethereum fork, similarly converting Uncle Sam’s dollars into ERC-20 tokens. If you’re interested, I gave a presentation to the Dutch Blockchain Innovation Conference last year on this approach and why I think it will grow and the video is online [23 minutes].)

Animal, vegetable or mineral?

These JPM Coins (I simply cannot resist calling them Dimon Dollars, or $Dimon, for obvious reasons) have attracted considerable discussion but I thought I might contribute something different to the debate by trying to reason my way through to a categorisation. I talked about this on the panel in the “Blockchain and Cryptocurrencies” session at Merchant Payments Ecosystem in Berlin today, and you can see my slides here:

 

On the panel, I said that the $Dimon is e-money. Here’s why…

Is it “money”? No it isn’t. It is certainly a cryptoasset – a digital asset that has an institutional binding to a real-world asset – that in certain circumstances exhibits money-like behaviour. Personally, I am happy to classify such assets as forms of digital money, the logical reason that they are bearer instruments that can be traded without clearing or settlement. 

Is it a “cryptocurrency”? No, it isn’t. A cryptocurrency has a value determined, essentially, by mathematics in that the algorithm to produce the currency is known and the value of the cryptocurrency depends only that known supply and the unknown demand (and, of course, market manipulation of various kinds). It is not set by an institution, government or otherwise.

Is it a “stablecoin”? No, it is isn’t. A stablecoin has its value maintained at a certain level with reference to a fiat currency by managing the supply of the coins. But the value of the $Dimon is maintained by the institution of JP Morgan irrespective of the demand for it.

Is it a “currency board”? No, it isn’t. A currency board maintains the value of one currency using a reserve in another currency. So, for example, you might have a Zimbabwean currency board that issues Zim Dollars against a 100% reserve of South African Rand.

In fact, as far as I can tell, the $Dimon is e-money, which is one particular kind of digital money. There are two main reasons for this:

First, according to the EU Directive 2009/110/EC, “Electronic money” is defined as “electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions […], and which is accepted by a natural or legal person other than the electronic money issuer”. This sounds awfully like, as Bloomberg put it, the $Dimon is “a digital coin representing United States Dollars held in designated accounts at JPMorgan Chase N.A.”. It is a bearer instrument (so “coin” is a reasonable appellation) that entitles the holder to obtain a US dollar from that bank and therefore seems to fall within that EU definition since people other than JPMC, albeit customers of JPMC, accept it in payment. (I would pull back from calling it digital cash because of this need to establish an account with JPMC in order to hold it.)

Second, because my good friend Simon Lelieveldt, who knows more about electronic money than almost anyone else, says so. Simon and I have long agreed that the trading of digital assets in the form of tokens is the most interesting aspect of current developments in cryptocurrency, a point I made more than once in my MPE talk.


Following my logic then, in European regulatory terms then, the $Dimon is “e-money” and I think that is a quite reasonable definition. Case closed.

Friday thought experiment: Mac-PESA

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I”m very wary of promulgating the “political correctness gone mad” meme, as it is so often a lazy reactionary knee-jerk response to changing times, but I could not resist tweeting about the news that a British police force launched an investigation after a man claimed he had been the victim of a “hate crime” when… a branch of the Post Office refused to accept his Scottish banknote. This incident has now indeed entered our official statistics as a hate crime.

Frankly, this is mental. Scottish banknotes are not legal tender, even in Scotland, as I have explained before. The Post Office is no more obliged to accept a Scottish Fiver than it is to accept Euros, gold or cowrie shells. The story did, however, cause me to reflect on what will happen when, post-Brexit, Scotland votes to leave the UK. Will Scotland then join the euro or create its own currency?

As supporters of Scottish independence insist, once Scotland becomes an independent country, it will be responsible for managing its currency in the same way that every other country that has its own currency is responsible for managing. But how should the Scots go about creating this currency? Surely messing around with notes and coins, other than for post-functional symbolic purposes, is a total waste of time and money.

A much better idea would be to go straight to the modern age and create Mac-PESA, which would be a digital money system rather like Kenya’s M-PESA with with a few crucial enhancements to take advantage of new technology. M-PESA, as a post on the Harvard Business School blog says, is “the protagonist in a tale of global prosperity to which we all can look for lessons on the impact of market-creating innovations”, going on to say that its “roots are far more humble”. They are indeed, and if you are interested in learning more about them, I wrote a detailed post about the origins of M-PESA (and Consult Hyperion’s role in the shaping of this amazing scheme) and the success factors.

The most important of these was the role of regulator: the Central Bank of Kenya (CBK) didn’t ban it. Conversely, one of the reason for the slow take-up of mobile payments (and the related slow improvement in financial inclusion) in other countries was the regulators’ insistence that banks be involved in the development and delivery of mobile payment schemes. The results were predictable. (Here’s a post from a few years ago looking at the situation in India, for example).

Anyway, back to M-PESA. It is an amazing success. But it is not perfect. In recent times it has gone down, leaving millions of customers unable to receive or send money. These failures cost the economy significant sums (billions of shillings), which not not surprising when you remember that M-PESA moves around 16 billion Kenyan shillings per day. So when it drops out, it leaves customers hanging, it leaves agents losing revenue and it leaves the banks unable to transact.

It is now vital national infrastructure, just as Mac-PESA would be.

So what if there were no system in the middle to go down any more? What if the telco, regulator and banks were to co-operate on a Enterprise Shared Ledger (ESL) solution where the nodes all have a copy of the ledger and take part in a consensus process to commit transactions to that ledger?

Do the math, as our American cousins say. Suppose there are 10,000 agents across Scotland with 100 “super agents” (network aggregators) managing 100 agents each. Suppose there are 10m customers (there are currently around 20m in Kenya, which has ten times the population of Scotland). Suppose a customer’s Mac-PESA balance and associated flags/status are 100 bytes.

So that’s 10^2 bytes * 10^6 customers, which is 10^8 bytes, or 10^5 kilobytes or 10^2 megabytes. In computer terms, this is nothing. 100Mbytes? My phone can store multiples of this, no problem.

In other other words, you could imagine a distributed Mac-PESA where every agent could store every balance. You could even imagine, thanks to the miracles of homomorphic encryption, that every agent’s node could store every customers’ balance without actually being able to read those balances. So when Alice sends Bob 10 Thistles (the currency of the independent Scotland), Alice connect to any agent node (the phone would have a random list of agents – if it can’t connect to one, it just connects to another) which then decrements her encrypted balance by 10 and increments Bob’s encrypted balance by 10, then sends the transaction off into the network so that everyone’s ledger gets updated.

You can have a 24/7 365 scheme without having a Mac-PESA system in the middle. When you make a transaction with your handset, it gets routed to a superagent who decrements your balance, increments your payee’s balance, and then transmits the new balances (all digitally-signed of course) to the other superagents.

 

It would be a bit like making an ATM network where every ATM knows the balance of every debit card. No switch or authorisation server to go down. And if an ATM goes down, so what? When it comes back up, it can resynch itself.

So please, someone challenge me on this. As a thought experiment, why not have Scotland grab a world-leading position by shifting to a Central Bank Digital Currency (CBDC) based on a shared ledger. I very much agree with the Bank of England’s view of such a thing, which is that the real innovation might come from the programmability of such a currency. This would be money with apps and an API, and I would hope that innovators across Scotland and beyond would use it create great new products and services.

Twenty Years Ago!

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………..the second Consult Hyperion seminar on……….

………….. D I G I T A L … M O N E Y …………….

The Tower Thistle Hotel London March 8-9th 1999

………………Confirmed Programme…………………

Day One: Economic & Business Issues

Chair Duncan Goldie-Scot Editor, Financial Times Virtual Finance Report

Keynote Address: European Multiple Currencies Sir Richard Body, M.P.

Digital Money is a Social Issue David Birch, Director, Consult Hyperion.

The European Digital Money Picture Dag Fjortoft, Deputy General Manager, Europay International.

Telecommunication Service Providers as Payment Operators Norman Bishop, Product Manager for Micropayments and E-Cash, BT.

Retailing and Digital Currencies Paul Arnold, Head of Tesco Direct.

The European Mass Market: Digital TV’s Requirements for Digital Money Richard Cass, Transactional Commerce Manager, British Interactive Broadcasting

Digital Money and Digital Phones: Europe’s Advantage Tim Baker, Wireless Marketing Comms. Manager, Gemplus

Transforming Businesses with Digital Money John Noakes, Business Manager for E-Commerce & Supply Chain, Microsoft UK.

Day Two: Regulatory & Technical Issues

Chair Ian Christie Deputy Director, DEMOS

A Legal Pespective on Digital Money in Europe Conor Ward, Partner in Computers, Communications & Media, Lovell White Durrant.

A View from the European Commission Philippe Lefebrve, Head of Sector in Financial Systems, European Commission DGIII.

The Technologies of Digital Money Marcus Hooper, Principal Payments Technologist, IBM United Kingdom.

Visa and Digital Money Jon Prideaux, Executive VP New Products (EU Region), Visa International.

Making Digital Money Work. Tim Jones, Managing Director of Retail Banking, National Westminster Bank plc.

Experiences from an Operational Micropayment Scheme Nigel Moloney, Senior Manager in Emerging Markets Group, Barclays Bank.

Mondex: A Status Report Victoria Mejevitch, Mondex Product Manager, Mondex International.

The Common Electronic Purse Specification (CEPS) Daniel Skala, Executive VP for Sales, Proton World International.

Trading and hard currencies

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Talking about central banks and digital / crypto / virtual (* delete where applicable) currency, I was interested to read (in the Russia Today Business News) of an initiative to create a joint digital currency for BRIC countries and the Eurasian Economic Union (EEU) that has been proposed by the Central Bank of Russia, according to its First Deputy Governor Olga Skorobogatova. She is reported as saying that “The introduction of a national digital currency seems to us not entirely justified from the point of view of macroeconomics” (presumably because as Russia is still quite cash-intensive the costs might not be justified and the benefits too concentrated). I can see why the alternative suggestion of a cross-border digital currency set up between trading partners would have much wider benefits.

This is not a new idea. As I discussed in my book “Before Babylon, Beyond Bitcoin“, some years ago the then-Chancellor John Major proposed a similar concept as an alternative to the euro which at the time was labelled the hard ECU (and ignored). The hard ECU would have circulated alongside existing national currencies. It would be used by businesses and tourists. It would never exist in physical form but still be legal tender (put to one side what that actually means) in all EU member states. Thus, businesses could keep accounts in hard ECUs and trade them cross-border with minimal transaction costs, tourists could have hard ECU payment cards that they could use through the Union and so on. But each state would continue with its own national currency — you would still be able to use Sterling notes and coins and Sterling-denominated cheques and cards — and the cost of replacing them would have been saved.

Thus, businesses could keep accounts in hard ECUs and trade them cross-border with minimal transaction costs, tourists could have hard ECU payment cards that they could use through the Union and so on. But each state would continue with its own national currency — you would still be able to use Sterling notes and coins and Sterling-denominated cards — and the cost of replacing them would have been saved.

(As an aside, it wasn’t John Major’s idea. It had it’s origin a few year before in a 1983 report of the European Parliament on the European Monetary System, the EMS. The proposal was supported at the time across the political and national groups in the parliament.)

The idea of an electronic currency union to facilitate international trade has new resonance. While Bitcoin captures the media attention, there are a great many other possibilities: new community currencies, brand-based plays, commodity baskets and goodness knows what else. All of these make it an exciting time to be in the electronic money business, but they also make it unpredictable, which is why it is fun. As I say in the book, we’re not looking at a world in which some kind of new global currency takes over, but a world in which a great many communities choose the currencies that are most efficient for themselves. At it happens, one of those communities could be the European Community! Noted political theorist Marine le Pen herself has said that she could see the EU setting up another currency “like the ECU”. I’m sympathetic, obviously, because the idea of restoring the Franc while simultaneously creating a new pan-European currency makes economic sense.

If anything, however, Ms. le Pen’s proposal is not really that radical. Why have nation-state control over money at all? Why not allow regions to have their own currencies? Why not use Normandy Money? Why not have pan-national currencies? Or Islamic e-Dinars? I’m on the same page as “The Futurist Magazine” here. In September 2012, as part of a compilation of pieces about life in 2100, they said that it is quite likely that we will still have money in 2100, but it may not be issued solely by nation states. I couldn’t agree more.

Madame First Deputy Governor Skorobogatova is, incidentally, far from alone in wondering about new digital currencies at this level. Christine Lagarde, head of the International Monetary Fund (IMF), gave a talk on “Central Banking and Fintech” in September last year in which she said that digital currencies (of the kind proposed by Madame Deputy First Governor) could actually become more stable than fiat currencies. She says that they could be issued against “a stable basket of currencies” ( a hard SDR?) but I would extend that suggestion to a token based on a basket of commodities (or, indeed, a mixture of both) or some other “root” with long-term stability.

It’s one thing to have crackpot technologists such as me talking about augmenting and perhaps even replacing national currencies, but when people who are actually in charge of money start speculating about the same, then you do have to suspect that some things are about to change.