Deep in the mists of time (that is to say, the early-1990s), I led the team from Consult Hyperion responsible for Mondex specification, design and development. For those not familiar with paleo-payments, it was one of a clutch of (contact) smart card based electronic cash systems, none of which survived beyond, let’s say, early adolescence. There were two main reasons for their demise, one technological and one business. The concept was ahead of the capabilities of the underlying technology. Transactions took about the same amount of time as cash plus change, which wasn’t a compelling reason for anyone to leave their wallet behind. The promoters of the schemes (retail banks and payment brands) did not target particular niches where there may have been a business case (I always thought car parking might work) but instead blanketed retail outlets in particular cities or small countries. So, mostly unused devices were put under the counter, and people forgot about the schemes after an initial blaze of publicity.
The Bank of England and the UK Treasury have announced a Central Bank Digital Currency (CBDC) Taskforce to coordinate the exploration of a potential British CBDC. But how could a digital Pound actually work? As it happens, this is something that Consult Hyperion knows rather a lot about. Apart from our work on the first British central bank digital currency (Mondex) back in the 1990s, our work on the first population-scale mobile money scheme (M-PESA) in the 2000s and our work on the most transformational contactless payment roll-out (Transport for London) in the 2010s, our practical experience across implementation platforms means that we understand the architectural options better than anyone.
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, Genghis’ grandson 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. 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 stuff with printing!”
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) are tumbling off of flights from 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.
“14% of China’s population relies on mobile payments to get around, carrying no cash, according to a survey conducted by Renmin University of China”
The natural step from here is to create digital currency so that settlement is in central bank money and there are no credit risks. Last year, the Governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, set out their thinking about digital currency. He said:
[Zhou] said 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 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. But should they do this? Yao Qian, from the PBOC technology department wrote on the subject earlier this year.
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.
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.
You can see the potential problem with digital currency created by the central bank. If commercial banks lose both deposits and the privilege of creating money, then their functionality and role in the economy is much reduced. Whether you think that is a good idea or not, you can see that it’s a big step to take and therefore understand the PBOC position.
Following this line of thinking, then, central banks are not going to issue cryptocurrencies and they are not going to issue digital currencies either (at least in the foreseeable future). But what they might do is to allow commercial banks to create digital currency under central bank control. You could have the central bank provide commercial banks with some sort of tamper-resistant smart chip that would mint commercial bank money under the control of the central bank. Wait a moment, that reminds me of something…
Would a central bank go for this? Some form of digital cash that can be passed directly from person to person like Bitcoin rather than some form of digital money like M-PESA, using hardware rather than proof-of-work to prevent double spending? Well…
“It’s not that you use the phone to order money transfers, as is done today, but having bills in the cellular and being able to pass them on from one user to another,” he said.
Clearly at least one of them would! So here’s a “what if” and I’m genuinely curious as to your comments…
What if we dust off the old Mondex specifications (not difficult for us because some of the people who wrote them still work at Consult Hyperion) but this time implement it in SIMs and Secure Elements instead of contactless smart cards? Then we would have genuine digital currency that could work online and offline, work for inter-personal transactions as well as business transactions and allow things to pay other things. With the 20th anniversary of Multos just gone, maybe Mondex’s time has finally come!
In the speech that the Governor of the Bank of England eh, Mark Carney, didn’t give to the Mansion House in June he devoted some considerable time to the general topic of shared ledger technology, even going so far as to say that
In the extreme, a [shared ledger] for everyone could open the possibility of creating a central bank digital currency.
I am not sure that I completely follow Mr Carney’s logic here and I don’t have the benefit of the expert advice that he must have received in connection with this statement but as far as I can tell, there are two entirely separate issues to examine here. The use of the distributed ledger for RTGS, which is the context in which it is mentioned earlier in Mr. Carney’s speech, is wholly unrelated to the provision of a central bank electronic currency and whether it might or might not be a good idea for the Bank of England to create such is nothing to do with the technology.
I suspect that the confusion may have arisen because of the tendency amongst management consultants (and others) to conflate the two entirely different kinds of electronic money: a crypto currency and a digital currency are very different things. If Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it abandons its responsibility for managing the creation of money and instead turns to a crypto currency, even if it is a crypto currency that is produced as a byproduct of a double permissionless shared ledger spawned by the Bank of England itself, then the value of that currency would not only be beyond political control it would be beyond the Bank’s control and one might imagine the Bank to be somewhat redundant in such circumstances.
The Bank of England is absolutely right to be exploring this new technology and I certainly think that it has something to offer. But that does not mean that the Bank of England is going to start using Bitcoin as a settlement system or that bitcoins will replace Sterling!
On the other hand if Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it creates a digital currency, then I say more power to him. I cannot think of a single reason why such a digital currency would be a crypto currency or why it would be in any way related to the shared ledger used to process the payments, but that doesn’t mean it wouldn’t be a cracking idea. A digital currency platform with right APIs in place (providing risk-free, genuinely instant and zero-cost transfers between accounts with final settlement in central bank balances) would be an amazing platform for a Digital Britain.
[Zhou] said that “it is an irresistible trend that paper money will be replaced by new products and new technologies.”
Couldn’t agree more. I am in complete alignment with the Party about this. I do not understand why reactionary forces defend physical cash against the march of progress. The governor goes on to set some broad parameters around just how such a digital currency might operate and, let us simply observe, it’s no bitcoin.
From the central bank’s perspective, a digital currency should be designed in a way that can best protect people’s privacy, but we also need to pay attention to social security and social order
Couldn’t agree more. Society should set the dial, not technologists, no matter how much we think we know better. The governor’s argument here isn’t about where the privacy dial should be set (I expect I might disagree with his position on the precise setting), but about who should set it. And I agree with him that society is the right answer. Whether this means through democratic vote or some other mechanism I leave as an exercise for the reader. (Yes, it is true that a great many voters are ignorant and easily swayed by propagandists, and I for one think some form of permissioned voting is crucial if we are stave off economic doom in the long run, but I am just one voice in this matter
We think, therefore, as a legal tender, digital currency must be issued by the central bank.
Couldn’t agree more. It looks as if the Chinese Communist Party read my blog about the new report from Positive Money. If a country wants a digital currency, then it makes complete sense for the central bank to provide it.
Xiaochuan believes it will take about ten years for a digital currency to fully replace cash in China but he has plans how to gradually phase out paper money
Couldn’t agree more. We need a national plan to deal with this, and I only wish the stooges of post-imperialist corporatism at the Bank of England had such vision. We too need a plan on how to gradually phase out paper money.
What I don’t understand is why this announcement by the PBOC governor attracted so much attention in cryptocurrency circles. This is for two reasons. First of all, the whole point of a cryptocurrency is that it derives its value from cryptography not from some external unit of account. There is actually no point in a central bank issuing cryptocurrency, whether it’s BritCoin or Remibicoid, when what they should actually be doing is issuing a digital currency that they are responsible for managing the value of. (Well, whether they should be issuing digital currency or not depends on your macroeconomic perspective and I don’t propose to sidetrack into that here: let’s just say that they should for the sake of argument.)
Governor Zhou Xiaochuan is clear in his reasoning. He says that the PBOC spent a lot of effort researching blockchain technology and has concluded that blockchains are too resource intensive and too limited in throughput to form a practical mechanism, for exchange. This does not mean that some future blockchain technology that is based on some cryptocurrency, that is based on a double-spending solution that is not based on proof-of-work, might not be suitable. That’s entirely possible, although it seems to me unlikely that any such cryptocurrency would offer cost or efficiency advantages over account-based systems because, apart from anything else, that’s not a design goal.
To reiterate: the governor said that he has plans to gradually phase out paper money. Wowza. The costs for cash transactions will increase, as the banks start charging fees for accounting physical cash, but he is realistic in saying that digital currency and physical currency will coexist for a long time. 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 and with the guidance of the central bank, China could easily achieve this goal.
I say this with complete confidence, because they were able to affect the transition from specie to paper money effectively and in a short time. In the mid-13th century, Kublai Khan instituted a system of paper money (I refer to Marco Polo’s description of the system here). The Khan had a robust acceptance policy: if you didn’t take the paper money at par, he would kill you. In a short time, paper money overcame the inconvenience of coins with the very positive effect that trade (and therefore the economy) grew. I won’t mention how the story ended (that’s in my forthcoming book) except to note that it didn’t end well, a reflection of the problems occur when the central bank succumbs to the temptation to over-issue.
Obviously I’m not suggesting that we adopt Kublai Khan’s stern but clear policy on the acceptance of new payment instruments. Personally I would favour executing people who do not accept electronic payments only as a last resort, but it does seem to me that if the Chinese government were to go down the digital currency route, it really would not take that long to have the world’s first large-scale national digital currency up and running. If the Chinese can abolish cash, so can we.
Are central banks artefacts of the Industrial Revolution, like canal networks or newspapers, or are they indispensable to the operation of the modern economy? To be honest, I tend to the more revolutionary perspective. National currency and central banks were of their time. We didn’t used to have them and we won’t have them in the future. (I’m writing a book about this at the moment.) But in the short term, should these relics of a bygone monetary era embrace digital cash? Here’s why I’m asking, as summarised nicely in the Deutsche Bank Research note on the “Instant Revolution of Payments”. They say:
When looking at the potential long-term effects of payment market evolution, a new question arises: which money will we pay with? Today, we mostly pay with commercial bank money… Given the wide range of potential instant payment services, bank deposits as the main form of money could lose importance if non-bank providers gain a dominant position in the retail payments market.
You can see the broad outline of the debate forming. Should central banks issue their own digital money? Should they allow commercial banks to continue to do it? Or should they sit back and let a thousand flowers bloom as Facebook, Amazon, Verifone and Apple issue digital money? They have to do something. After all, there is a steady decline in the use of physical cash. If the Bank of England does not replace physical cash with its own electronic equivalent then it is in effect supervising the slow motion privatisation of the nation’s currency.
Let’s examine a case for central banks to stay involved. The new Positive Money report on Digital Cash recommends that central banks should issue digital cash for six main reasons: it widens the range of options for monetary policy, it can make the financial system safer, it can encourage innovation in the payment system, it can recapture a portion of seigniorage, it can help to develop alternative finance businesses and it can improve financial inclusion.
(They use the term digital cash to refer to electronic central bank money, whereas I would prefer the term digital currency to distinguish the unit of account from other forms of digital cash.)
At the heart of the Positive Money argument is the idea that digital currency should be the province of specialist payment service providers rather than banks, because banks are primarily lenders and should be focused on that. How would banks compete with specialist providers? Until now banks have had an effective monopoly on payment services. Consequently, banks have had very little competition for the provision of basic payment accounts. In my opinion, it’s a business they might not want to be in at all, frankly, and they could focus on their core banking businesses instead, leaving payments to the specialist providers (that might, of course, include their own subsidiaries operating under Payment Institution licences).
What would the business model of the specialist providers be? Should digital currency be remunerated? Should these specialist providers be paid by the central bank? The Positive Money people feel strongly that it should not, which means that other players in the digital currency supply chain would need to find their own ways of raising revenue. I doubt this would ever come from fees so it would be more to do with the information around payments and flows, but that’s not really what I wanted to talk about here, which is the question of issuing the digital currency.
Why have these specialist providers at all? Why not just get the Bank of England to do it? The report notes digital that digital currency does not mean cryptocurrency or require the distributed ledger, there a plenty of existing technologies that could do the job. As I wrote recently, the Bank of England could provide accounts for all citizens, along with payment cards and Internet access and so on.
imagine something like M-PESA but run by the Bank of England. Everyone has an account and you can transfer money from one account to another by a mobile phone app (that uses the secure TEE in modern mobile phones) or by logging in with two factor authentication to any one of a number of service providers that use the Bank of England API to access the accounts or by phoning a voice recognition and authentication service.
However the Bank of England, the Positive Money report says, is likely to see this as something of a burden. Personally I’m not sure about that line of thinking. I’m not sure it would be that much of a burden because if everyone had such an account, that you wouldn’t need payment cards or checks or giro payments or anything else, because all payments would be transferred between these accounts through transactions that would be initiated in most cases by a mobile app or through a call centre. The Positive Money guys prefer the idea of digital cash account providers, which would essentially be something like Electronic Money Institutions (ELMIs) are now but with a 100% reserve in central bank money.
(In the report they also talk about the concept of helicopter drops of digital cash to citizens via these accounts, as an alternative to “traditional” quantitive easing., but that’s a topic for another day.)
Anyway, on to a quick run through the key points.
Why might central banks choose to issue digital currency?
The six main reasons that are presented in the report are:
- Overcoming the zero lower bound on interest rates. Enabling new instruments of monetary policy such as that helicopter money.
- Promoting innovation in payment system. I’ve written a couple of times before, both when looking at the options for central-bank digital cash and also when reflecting on our experiences with population scale schemes such as M-PESA in Kenya, that providing a good API on top of the system and allowing innovators to build new products and services on top is transformational and, to my mind, much more likely to lead to real innovation, making the payment system serve the wider economy more efficiently and more effectively.
- Increasing financial stability by providing a risk-free alternative to bank accounts. Increasing financial stability by reducing the concentration of liquidity risk and credit risk. Non-bank financial institutions, in particular, would benefit from being able to hold funds in central bank money rather than the form of uninsured bank account. The implications of having competing currencies might be uninteresting in usual times, just as the competition between cash and bank money is uninteresting in usual times, but it will be important to understand the implications in times of crisis to make sure that the system would not collapse. This is because the existence of digital cash might well exacerbate bank runs as people, for whatever reasons, retreat from other forms of liquidity to risk-free central bank money. The existence of risk-free digital currency in the UK could plausibly lead to an inflow of funds from foreign banks into sterling digital cash and that could push up exchange rates.
- Recapturing a portion of seigniorage. In the UK, the interest earned on physical currency peaked at £2.4 billion just before the financial crisis. I see this as a kind of stealth tax although although I suppose it might be fairly argued that it’s a pretty reasonable stealth tax as it falls largely on drug dealers and money-launderers. In the current year seigniorage will be in the region of only 500 million or so. Cash in circulation in the UK currently stands at around £67 billion (and it’s increasing about £15 million per month) of the total amount of cash in circulation at any one time around £10 billion is sitting in bank tills and in ATMs (in the UK about £15 billion is withdrawn from cash machines every month). This suggests that the other £42 billion is circulating hand-to-hand outside the banking system (in the Bank of England classifications this money is either being hoarded, stashed or exported). The banks cash flow to £10 billion can be taken as the best estimate for the population’s preference for cash over above immediate spending needs. All things considered I think that the seigniorage argument is not terribly persuasive one way or the other. It is plausible that the Bank of England might roughly double its seigniorage revenue if most people switch most of their spending from bank accounts to digital cash.
- Alternative finance. Separating the creation of money from bank loans might mean a reduction in lending which would have implications for the economy. There are implications for banks in the supply of credit but also implications for the potential for alternative finance to fill the gap.
- Increasing financial inclusion. I don’t want to get into the complexities of the relationship between financial and social inclusion, and the implications for other regulatory frameworks such as KYC and AML, but I see financial inclusion through ready access to low-value digital currency accounts as one of the main reasons for wanting to do it. Remember people who are trapped in a cash economy on the margins are the people who suffer most from its existence.
Well, I thought the report was very interesting and thought provoking, so I am very happy to say that Ben Dyson from Positive Money will be giving a talk based on the report at this year’s 19th annual Consult Hyperion Tomorrow’s Transactions Forum in London on 20th-21st April 2016. Thanks to the amazing generosity of our sponsors, this year the tickets for the Forum are only £295 + VAT. Not a misprint: I really do mean the negligible sum of only two hundred and ninety five great British pounds Sterling.
As always, the Forum will be limited to 100 places, so book your place now!
News arrives that our Scandinavian cousins are getting serious in the war on cash.
The Danish government has proposed getting rid of the obligation for selected retailers to accept payment in cash, moving the country closer to a “cashless” economy. Nearly a third of the Danish population uses MobilePay…
Actually half of the adult population of Denmark use MobilePay, the mobile-initiated account-to-account (mA2A) immediate payment services, the equivalent of Barclays’ PingIt, that is offered by Danske bank in Denmark. It was launched two years ago and has attracted more than two million users out of a population of 5.5 million which, when you look at the demographics, means that already has around two thirds of its total addressable market (i.e., Danish smartphone users aged 13 and up). Right now it is processing around 200,000 transactions per day with an average value of around €33.
The mobile phone provides a secure and convenient A2A initiator.
MobilePay has over 7000 merchants signed up and has an “small business acceptance” app in place so that merchants can accept electronic payments without a POS terminal. They charge merchants a flat 1% fee (with a maximum of five Danish Krone, or abut 50p) for payments and I’m told (by a very reliable source) that the fraud levels through this channel are significantly lower than they are on cards. They are now extending the app to provide a contactless NFC and Bluetooth option for point of sale. What interests me most about their roadmap is that they have a very good API and are now trialling it with some merchants because, as we all know, merchants want on their own apps to deliver the best customer service and the future is “app and pay”. I saw a very good example of this using a Copenhagen coffee shop app.
Direct A2A payments from inside merchant apps look set to grow.
In the UK, we have two mA2A mobile-centric front ends to the faster payments service (FPS). These are the aforementioned PingIt, offered by Barclays, and Paym, offered by everyone else. Paym has around two million people registered and transferred around £26m in 2014, We happen to be a Barclays-centric household, so I use PingIt all the time and find it very convenient. Therefore I was very excited that they decided to extend their addressing from mobile phone numbers to Twitter names!
Barclays has declared on 25 February that it will be the first British bank to allow people to pay each other and small business through their Twitter handles from 10 March.
If you want to try this out for yourself by supporting a good cause, by the way, then simply fire up the PingIt app on your mobile phone, select a modest amount for test purposes (say, £250) and send it to @dgwbirch. I will let you know as soon as your payments reaches the Dave Birch Holiday Home in the South of France Emergency Appeal Fund. Both PingIt and Paym are a long way from being used by half the adult population of the UK and edging cash out of the way for the person in the street but, back across the North Sea, Mobile Pay is playing a key role is edging Denmark closer to cashlessness.
The Danish government said as of next year, businesses such as clothing retailers, petrol stations and restaurants should no longer be legally-bound to accept cash. The proposal is part of a pre-election package of economic growth measures aimed at reducing costs and increasing productivity for businesses.
They are doing this because to try to get the total cost of the payment system in Denmark down to the lower levels that are seen in, for example, Finland and Norway.
if you include household costs, the total social cost of payments in Denmark is calculated at 0.55% of GDP, of which 0.35% is attributed to cash and 0.15% to the domestic PIN debit scheme.
[From I trashed my cash]
The context here is specific to Denmark. In common law countries (e.g., the UK and the USA) there is no requirement for retailers to accept any form of payment at all, cash included. It’s a misunderstand of what “legal tender” means to imagine that they do. But in Denmark, the law says that certain types of retailer must accept cash and so the law is being changed so that they don’t have to.
The Danes are very welcoming to visiting consultants.
I think it is really interesting to see this approach to national payment strategy – that is, one based on productivity and economic efficiency – in contrast to the UK’s where the mere idea of ending cheque clearing in a decade was enough to induce apoplexy in the shires and a shake up of the UK payments industry governance.
Gift certificates and gift cards are going virtual, in which mode they are becoming money. Where might they go in the future?
We see currency as a national concept. By why not regional, or even city-based currency?
There are good reasons, other than good clean fun with new technology, for a country to shift to electronic currency. Don’t listen to the techno-booster digital cash fanboys like me, listen to economists.