Wednesday, November 14, 2018

Digital money and payments

New technologies in the financial sector are opening the door for potential disruptions: cryptocurrencies, M-Pesa, WeChat,... Many of them are seen as alternatives to either traditional currencies issued by central banks or to the intermediation role played by commercial banks.

In this discussions, there is often the assumption that "money" and "payments" are features that always come together, they cannot be separated. The confusion originates in the standard definition of money: It is the asset that allows us to purchase goods and services, the "medium of exchange". The ultimate example is physical currency where a piece of paper that says €50 or $100 is both the asset (where the value is being held) and the medium of exchange (the payment vehicle of the payment technology). Transfer of the asset cannot be separated from the "technology" used to make the payment. By giving the note to a seller, you get in return goods and services for exactly that value.

But the moment we think about electronic forms of money, there is a clear separation between the asset and the payment technology. The asset is a balance typically held in a bank (but it can also be in a mobile operator as in the case of M-Pesa). The payment technology is the way I can transfer the value of that asset to someone else. This technology can be a debit card or an NFC chip inside a watch combined with a terminal at a store or it can be a messaging application via an app in your mobile device that connects your balance with the balance of the seller via a network where all institutions operate.

In theory the two features can be treated as separate. A commercial bank can move from a cumbersome and costly payment technology of cheques and inefficient wire transfers that take days to a modern technology where payments and interbank transfers are immediate through a real-time gross transfer system. The nature of money has not changed (the balance in your bank account) but the way money is being used as a medium of exchange (the payment technology) has become much more efficient.

In the real world the two features might come some times together. For example, the case of M-Pesa in Kenya where a mobile phone provider offers a form of money that combines a balance within their systems and a technology to make the payments (via the mobile phone). This is of course more likely to happen in a country where bank accounts are rare so the only way to offer an efficient payment technology was to combine it with a provision of the asset through these balances.

Here is another example where money and payments are being mixed: Christine Lagarde, IMF managing director, speaking at the Singapore Fintech Festival, discussed the benefits of digital currencies issued by central banks (i.e. allowing individuals to hold accounts at the central bank). One of these benefits is "Privacy". Quoting from her speech:

"Consider a simple example. Imagine that people purchasing beer and frozen pizza have higher mortgage defaults than citizens purchasing organic broccoli and spring water. What can you do if you have a craving for beer and pizza but do not want your credit score to drop? Today, you pull out cash. And tomorrow? Would a privately-owned payment system push you to the broccoli aisle? Would central banks jump to the rescue and offer a fully anonymous digital currency? Certainly not. Doing so would be a bonanza for criminals."

In this debate, in order to discuss the benefits and costs of different solutions we also need to separate money from payment technologies. Governments might want to have all the relevant information about the identity of individuals holding money accounts. But they might not care about whether you buy pizza or broccoli; the information about the actual payment. One could imagine a system where the institutions that are holding the assets (money) are highly regulated and compliant with KYC (know your customer) regulations. But the companies that have access to that balance to execute payments do not need to share any information with governments. In fact, we might want them to be required to maintain strong privacy rules regarding the information they collect or sell. No need to create central bank digital currency for all.

Antonio Fatás
on November 14, 2018 |   Edit