We speak to FinTech Futures about the future of crypto and digital cash.
December 8, 2017
The recent World Economic Forum (WED) report “Sweden could stop using cash by 2023”, says that the country is moving towards favouring cards and mobile payment apps. Yet retailers are expected to accept cash for at least a couple of years afterwards.
They therefore ask: “Is cash dead?” The evidence is that people are using their cards and mobile payment apps much more frequently than cash. They say that mobile payments doubled in 2016, and so analysts predict that it won’t be long before Sweden goes cashless.
Niklas Arvidsson, a researcher in industrial economics and management at KTH Royal Institute of Technology, says the widespread and growing embrace of the mobile payment system, Swish, is helping hasten the day when Sweden replaces cash altogether.
Media reports also suggest that cash may become obsolete in China soon too. It is widely claimed that mobile payments more than doubled in 2016, surging to a total of $5 trillion. The market is dominated by two services in 2017: Alipay and WeChat Pay, with the former accounting for 54% of transactions, and the latter making up 40%, according to market research firm Analysys.
In contrast the WEF report comments: “Polling various Swedish retailers revealed that about half expect to stop accepting cash by 2025. Currently, 97% of all retailers accept cash payments, but only 18% of all transactions actually involve cash.”
The growing number of people who use apps perhaps feel that mobile payment apps offer a degree of convenience, trust and users are familiar with how to use them. The young are particularly comfortable with paying for their goods and services digitally, despite the fact they don’t see the money leaving their hands.
Cash is still important as a means of payment in many countries, but this rule no longer applies in Sweden. Digital currencies in Sweden, such as Swish, are proving to be quite popular too. The key to its uptake is persuading people to use digital currencies over traditional cash. Yet the WEF report claims that consumers are largely facilitating the change. Banks have also in their view done their part to “push people away from cash”. So digital payments are bound to grow.
KTH also states that: “Besides simplicity and lower costs, digital payments also add transparency to the nation’s payment system. Several banks in Sweden already have 100% digitalised branches that will simply not accept cash.” The WEF report offers another driver from a retailer’s perspective: the need to reduce robberies. Retailers also find that transactions are quicker when customers pay by card. Easier payments are good for everyone, leading to more sales and transactions that somewhere along the line will enable credit card companies and banks to increase their revenues.
Blockchain and cryptocurrencies
Kalypton CEO, Lars Davies, observes that digital payments have shown there is an appetite for digital payments services, providing they meet regulatory requirements. “Blockchain and cryptocurrencies such as Bitcoin are seen by some as a key part of the future of digital cash,” he says. He therefore believes this appetite has helped give rise to them both. “They have proven the desire, but their designs are sub-optimal at best,”.
He claims that Bitcoin is downright dangerous because it is not money, and that a common flaw in many of the current designs of digital money “leads to the uncontrolled creation of ‘money’ – banks create money, but within a regulatory framework. The flaw means that digital cash enables non-banks to create ‘money’ outside of the regulatory framework. They are not real money, but rather private contingent debt liabilities, and that presents a serious risk.”
In contrast to cards and mobile digital payments, Morgan Stanley payments analyst James Faucette finds that Bitcoin acceptance among retailers is really not there, and there are no signs of an increase in uptake. Most merchants just aren’t keen on the idea of accepting Bitcoin despite its recent gains.
Defining digital cash
Davies defines digital cash as being cash in digital form, but its very definition depends on who you talk to. However, his version of what equates to digital cash eliminates “cryptocurrencies because they are not cash, they are not money or even something resembling money”. He believes digital cash should be a digital facsimile of cash, such as USD or GBP.
“It should have all the features of cash, but in digital form – a digital dollar today, is a digital dollar tomorrow,” he explains. Traditional currencies, whether transacted with digitally or traditionally don’t change their form. In his opinion cryptocurrencies don’t have the attributes of cash, digital or otherwise. Even the Bitcoin Foundation recognises that Bitcoin is not money. Davies also stresses that there is no need to go through a blockchain to complete faster and securer payments: “In fact, blockchain is too slow to be able to support a true digital cash system; its low throughput is only one of a myriad of issues that means blockchain cannot form the basis of a true digital cash solution.”
With regards to online and mobile payments, he comments: “A payment through a portal is just a digital payment, a payment made through a portal that uses the existing rails. There is very little that is truly innovative in that”. He adds, however, that mobile phone-based money transfer, financing, and microfinancing services, such as M-Pesa is a debt liability.
He adds: “With M-Pesa you are relying on the liquidity of Safaricom – a telco that runs M-Pesa. With the designs of mobile money solutions, so much depends on the issuers’ liquidity; users will face a redemption risk and it is this risk that regulatory frameworks such as the EU’s electronic money regulations attempt to control.”
He thinks the question individual users will have is: “Can I redeem the tokens for real money if I need to do so? This is the contingent debt liability, a liability that crystalises when a user presents a token for redemption. If there is no collateral behind that token, then it cannot be redeemed.”
He adds: “There have been horror stories in some mobile money systems where people have generated tokens and taken them to a bank to redeem them, only for the banks to find out that those tokens are fraudulent. There was no money behind them. In one country this flaw lead to the equivalent of $4 million being extracted out of the banks.”
With banks reportedly struggling with the growing number of EU regulations and e-money directives, Davies says they have increasingly seen retail payment systems as a cost-centre, and as such the banks have failed to invest in their payments infrastructures.
This may seem contradictory when compared to the claim that Sweden will become a cashless society because of the popularity of card and digital payments, and the support for this system by the country’s banks. In most countries, the key struggle lies with DNS and RTGS settlement systems. Despite the growth of digital banking and digital payments, there are still some circumstances where it takes days rather than second or minutes to complete a transaction.
Davies explains: “In the UK, the faster payments system does not settle in real time. It settles transactions three times a day. This means that your bank account may credit your account immediately, or within two hours of a transaction, but you – if you are a business – may not have immediate access to the funds until the transaction transferring those funds has been settled.”
He concludes that a genuine real-time payment system “would avoid such delays; from the banks’ perspective it would expose liquidity positions and show up flaws in the banks’ cash management immediately, which would enable central banks and other parties to take action to forestall and problems before they become systemic. This would lead to a more robust and resilient system. From the users’ perspective, it would allow them to make use of their funds immediately.”
Why is this important? “Banks may have incentives of not having real-time settlement systems as they make money from the delays in the clearing and settlement system. However, not having a real-time settlement system means that the system and its users are exposed to costly settlement risks. But if you have an RTGS system you get rid of your settlement risks, and the costs of managing those risks”, he says.
The trouble is that the banks may look over their shoulder to their competitors and ask: “Why should I invest if the others don’t? Why should I invest if someone else will also benefit?”. However, they need to invest; today’s banking systems can’t handle the increasing transactional volumes, let alone the massive increase that true digital payments or digital cash will bring, and so Davies believes that a digital cash system “would put an immense strain on outdated banking systems. It is true that everyone will benefit in a real-time payments system, but the organisation or organisations that invest in it will gain the most.”
Competition and innovation
The banking and financial services sector are now facing competition from non-financial players, but Davies finds that these players don’t understand the regulatory requirements. “Many of the solutions are unfit for a regulated environment. If you need a regulatory sandbox, then you are effectively admitting that your solution cannot satisfy regulatory requirements. The regulations that relate to the security of information, transactions, and value are there for a reason.”
However, he argues that faster payments solutions such as Tereon can make it easier for financial services organisation to comply with regulations such as the EU’s General Data Protection Regulations (GDPR): “That’s what it’s designed to do, as against other systems are only trying to do it to the bare minimum. Meeting regulatory requirements, such as GDPR, requires more that technology, it requires an understanding of what it is that you do, but the right technology can help.” He therefore advises “to find organisations that are brave enough to innovate or to get a regulator to force banks to innovate”. The trouble is that banks are waiting to be told what to do.
“The banks are only innovating when they are forced to, as they feel they will be less profitable if they do invest than their peers who may not make a similar investment. It is a classic case of the prisoner’s dilemma”, he comments. He stresses that banks and financial services organisations “have to realise that innovation leads to economic efficiencies and a competitive advantage. True innovation will allow them to break from the mindset of the prisoners’ dilemma.”
For example, investing in an internal RTGS system would allow a bank to get rid of the cost and credit risks of settlement for internal transactions between departments, subsidiaries, or users. He says it’s also important to ask: “Where are your costs, and which of those costs can you cut out?” The problem is that banks and clearing houses have traditionally made their money from the clearing process. So, if you strip it out of the system, then their immediate view is that there is no means to make money from faster payments.
“So that’s the balance; some transactions will have delays as you may need more risk, and banks earn money from their transaction charges”, he says. He says a huge amount of cost is attributed to managing liquidity, credit, and settlement risks. This highlights that there is a need to motivate banks to innovate faster than they would typically wish to do. Even when it comes to talking plainly and simply about the future of digital cash, the same rule perhaps applies.
Put simply, banks must break out of the prisoners’ dilemma. Davies explains what he means by this: “Regulatory requirements are about how banks manage risk. You stay ahead by standing out, by succeeding unconventionally by removing the risks.”
When asked whether there are any exemplars and trendsetters of good digital cash practice, Davies responds that he doesn’t see any. “There was technology in 1995 that would have been a game-changer, but failed because it wasn’t marketed properly.”
With regards to Bitcoin and blockchain, he says: “They’ve captured people’s imagination with the most ludicrous and outlandish claims. However, not everyone has fallen for those claims. The US Federal Reserve’s Faster Payments Taskforcedid not fall for those claims. Instead, it asked what is it that we need to achieve for a modern faster payments system and how can we achieve it?” This led to several companies submitting their own proposals (including one from Kalypton) about its view of faster payments.
The problem is that the discussion around digital cash is beginning to generate similarly outlandish claims. One, for example, is that digital cash would allow users to earn interest on their cash. But as Davies says: “You can’t generate interest from digital cash, as by definition, that cash is no longer in a bank account where it would generate interest. That cash is in your wallet, your pocket, a tin, or where ever. People get their ideas about cash and money mixed up. I only get interest if I deposit the money in a bank account where I can earn interest. The true meaning of money and how it functions has been lost. Owning a bank account is not the same as holding cash. It becomes cash when I withdraw it. At that point, I don’t generate interest on it.”
With regards to the future of digital cash, he finds that there has been much “fevered excitement around blockchain and bitcoin”, but this will in time recede. Bitcoin will become nothing but a digital asset, if that, and it will no longer be talked about as being money.
“If the central banks get their act together, and say that blockchain and bitcoin don’t work, then we could see the development effort being re-focused”, he says. “The attention span directed towards blockchain will be diverted to look at the requirements for a solution, something that will deliver the requirements of a cash facsimile. It is possible to come up with a proper digital cash solution. The answer isn’t in a cryptocurrency because cryptocurrencies aren’t designed to be it, or to function as money.”
However, it does seem that digital cash in the form of card and mobile app payments do have a more promising future than cryptocurrencies. They will nevertheless need to be supported by traditional currencies and by banks themselves to work.