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.

Retailer support

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.”

Banks strug­gling

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.”

Trend­set­ters

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.”

The future

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.