“The average [A]merican sends about 40 payments a month. It costs 2% every time you swipe your credit card (even if the merchant pays it, you’re also paying it in the higher price of the item). …. What will happen when the cost of a payment falls to SMS levels? What about free?”
Brian Armstrong, the cofounder and CEO of Coinbase, asked this thought-provoking question in a provocative twitter thread earlier this month. Comparing the cost of payments to messages, which have grown exponentially as the cost has fallen over the decades, Brian concluded that one day, “it won’t be uncommon for someone to do 40 transactions an hour” and that “we’ll see many types of new transactions that would seem strange to us today” including for changing lanes in a car, upvoting comments online, or exchanging virtual goods. Armstrong’s optimism is certainly compelling, but developers and policymakers will have to overcome both technical roadblocks and resistance from entrenched (US) regulatory interests before we reach his utopian vision of ubiquitous, near-free digital payments.
Technical Roadblocks to Widespread Digital Payments
As Armstrong notes, cost is one of the biggest barriers to extensive digital payments. In the current iteration of our global financial system, most of the cost associated with digital transactions stems from private, profit-minded corporate ownership of the payment “rails.” Firms like Visa, Mastercard, PayPal, Alibaba, and WeChat are ultimately owned by investors who want to see a return on their capital, leading these firms to maximize profits (read: raise “prices” for consumers and businesses) beyond the minimal costs needed to transfer funds and maintain the associated records.
While potentially cheaper, decentralized “Web 3.0” solutions for payments currently lack the speed, efficiency, and widespread adoption needed to dethrone the established global payment players. That said, thousands of inspired developers around the globe are working daily to improve nascent digital payment tools, and in our view, the key question is not if the current digital payment infrastructure will be disrupted, but when. As such solutions become more rapid, efficient, and user-friendly, the value proposition from using a purely digital asset instead of a more expensive profit-focused payment rail will become more compelling.
Beyond cost, the other major technical stumbling block for purely digital payments stems from verifying the identity of the parties in a transaction. On the topic of digital identity, Nobel Prize winning economist Milton Friedman noted over two decades ago, “The one thing that’s missing [from the internet] but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B without A knowing B or B knowing A.”
Under the current system, strict international anti money laundering (AML) regulations require digital entities to confirm their identity through onerous “know your customer” (KYC) requirements in an effort eliminate tax evasion, bribery, and sanctions. Incredibly for the 21st century, most major financial institutions still require prospective clients to fax identification and residence documents to meet these requirements; even more obnoxiously, individuals often must re-verify this information at every financial institution they use.
While noble in principle, these arduous identity-verification procedures create a negative user experience and are ripe for disruption, either through trusted industry consortiums or decentralized solutions. We analyzed Centrality’s SingleSource digital identity platform and the associated Centrapay service as an example of contenders in the digital identity and payment space last year. Looking ahead, these types of platforms offer a potential win/win/win scenario for existing merchants (who can save on transaction fees), developers (who can rapidly onboard and segment users to new digital applications), and consumers (who benefit from lower prices and a seamless experience.) As financial technology continues to advance, developers will eventually find solutions to these issues, paving the way for widespread, cheap digital payments with sufficient identity verification to satisfy regulators.
Headwinds from Entrenched (US) Regulatory Interests
Speaking of regulators, Facebook’s botched launch of its stablecoin Libra last year reminded the world that a successful digital payment network must keep regulatory compliance front and center. These regulatory headwinds are particularly strong in the United States, which benefits tremendously from the global financial system’s status quo and the US dollar’s status as the world’s reserve currency.
By contrast, China’s President Xi officially endorsed governmental support for blockchain technology late last year, and the People’s Bank of China will soon test its own digital currency with four state-owned banks in Shenzhen and Suzhou. According to a recently released Deutsche Bank report, China’s aggressive move into the digital currency space could “erode the dollar’s primacy in the global financial market.” Even Christine Lagarde, the former head of the International Monetary Fund (IMF) and current President of the European Central Bank (ECB) recently signaled she was open to the idea of a purely digital asset for payments, stating “[m]y personal conviction on the issue of stablecoins is that we better be ahead of the curve. There is clearly demand out there that we have to respond to” (see our piece from last year on Central Bank Digital Currencies for more on this topic).
As the chart above shows, central bank digital currencies may be able to offer advantages over traditional forms of central bank money. Interestingly, there may also be an opportunity for digital currencies that are backed, but not necessarily issued, by central banks. This situation would be analogous to the current monetary systems in Hong Kong and the UK, where central banks issue currency in concert with private banks; in this case, the central bank would focus on regulation and monetary policy while the private banks handle the day-to-day aspects of managing the money supply through loan issuance.
Regardless of the optimal path forward, it’s clear that rather than creating clear regulatory frameworks and investing into a digital currency of its own, the United States are focused on stifling growth and haphazardly playing “catch up” in the digital asset space. At last year’s congressional testimony, Facebook CEO raised this very issue, noting that “if America doesn’t lead on this, others will” and that “[f]oreign companies or countries may act without the same regulatory oversight or commitment to transparency.” Similarly, the Deutsche Bank report cited earlier stated on no uncertain terms that “Governments, particularly those in Western countries, need to wake up [to the need for digital currencies] before it is too late.”
Earlier this month, Fed Chairman Jerome Powell acknowledged that Facebook’s Libra proposal “really lit a fire” under the central bank, but that the Fed “had not decided” to pursue a digital version of the dollar, citing “cyber issues, privacy issues, many many operational alternatives.” Not surprisingly, the US Treasury Department agrees with the central bank, with Treasury Secretary Steven Mnuchin proclaiming that “in the next five years, we see no need for the Fed to issue a digital currency.” Disappointingly, if the currently-proposed US budget is approved, the US Treasury could see its supervisory powers over digital assets increase even further. For a government that prefers maximum transparency in private transactions, the US is ignoring arguably this century’s biggest breakthrough in tracking the money supply at its own peril.
Every empire eventually falls, no matter how powerful it appears at its peak. When innovation and altruistic cooperation are replaced by complacency and rampant self-interest, it’s often a sign that the ruling class’s power is waning.
After decades of looking to the West for financial innovations, it may be time to turn our eyes back to the East. With the world’s largest economy fighting the proverbial tide on digital asset regulation, it opens the door for more forward-looking countries to become leaders in the next iteration of the global financial system. In particular, many of the more technologically-advanced Australasian countries (including China, Singapore, South Korea, and New Zealand) have put forward sensible regulatory frameworks around digital assets and are actively investing in the industry, putting themselves in a strong position to lead the next evolution of the global financial system.