Closed money systems are still dominating economies. All the dollars that you don’t have in cash form is held at the N.Y. Federal Reserve. You can’t access that money unless you’re one of the member banks. Banks are inefficient middleware separating you from your money. Banks aren’t efficient at talking to each other, either. That’s why it takes days to move money internationally or $30 to send a wire from one bank to another.
Mobile money systems such as PayPal or telecom-based systems are closed, too. They are just an overlay on top of existing banks. It still takes over a day to move money from one of those systems to your bank account. Just like banks, these similarly closed systems sure have their limits. Ask my girlfriend, who still cannot access her Venmo account because she lost her password and Venmo customer support makes a sloth look like a sprinter.
Yet we have an alternative: open financial systems.
Secure transactions safeguarded by cryptography in the internet’s next generation — Web3 — provides an exciting, open alternative. As a global collection of computers connected through a common software protocol, these cryptographic platforms like Ethereum or Stellar can power an open financial system. Payment tokens are the currency of these systems. Economies can move from fragile currency propped up by fiat (dollars, pesos) to currency hardened by strong code (tokens).
We are ready for an Upgrade
Fiat money is like the now-discarded, closed intranets of the 1990s. Public blockchains are the public internet we use today. Although banks and mobile money operators have a short-term advantage in infrastructure, adoption, and name recognition, they already show their many limits:
High transaction friction: Closed money gatekeepers charge exorbitant fees. Cross-telecom and cross-border exchanges are cumbersome, slow, and expensive. Registering accepting retailers creates high overhead costs which then get passed onto customers while limiting utility.
Security: Closed money suffers from centralized data storage, making it vulnerable to hacking. In contrast, decentralized blockchains are virtually impenetrable.
Default and Systemic Risks: China’s mega financial payments company Alipay made scary changes to its in-house bank account, Yu’e Bao. Now, Alipay users can only transfer to a bank debit card 10,000 yuan ($1,579). While the company euphemistically called it an “ongoing risk management optimization process,” the single-company default risk should cause users some pause. In non-Basel-compliant countries, banks’ capital adequacy ratios can drop to less than 3% and thus extremely overleveraged and fragile.
Models of Exclusion: Closed money systems are still exclusionary. Up to 60% of Indonesians don’t have a bank account. Over 10% of Americans don’t have a bank account. In other words, those using closed largely match up with banks’ existing subscriber base. New users face the same minimum income/balance hurdles, geographic obstacles, and identity barriers. Lower-income users then go back to using loan sharks, whose predatory business practices keep users in a cycle of poverty. In Kenya, MPesa only became successful because of it tapped into the existing customer network of near-monopoly bank Safaricom. In the Philippines, only those who are familiar with banks will become easily versed in using a MasterCard linked with one’s GCash Mobile Money account. PayMaya’s KYC documentary checks still resemble those of banks — which are notoriously an obstacle for many Filipinos.
Massive Account Dormancy: Accounts opened by new customers of closed money systems — even if “mobile money” — quickly fall dormant without a single transaction. The Better Than Cash Alliance found that overall, only 3% of all mobile money subscribers actively used the Mobile Money service within a 6-month period in the Philippines, for example. GCash is the most popular Mobile Money service in the country, but only 14% of subscribers use it regularly, according to GCash CEO Albert Tinio.
Provider/User Disconnect: Often, closed money operators don’t understand the needs of new users and are ultimately unable to address confusion about how to use current systems. In the United States, less than 10 financial systems have Application Program Interfaces (API) to plug into the N.Y. Federal Reserve to access money. New financial operators cannot open and thrive in such an exclusionary environment.
No innovation in credit: Within countries’ financial systems, credit reverts to classic loan approval models. New, inclusionary financial product operators struggle to offer new forms of credit such as in open financial system products like BlockFi, where any U.S. citizen can start an account online with cryptotokens.
Inferior proofs of identity: In current closed money systems, subjective, badly-defined creditworthiness evaluations become barriers to entry. Many citizens are unable to prove who they are, what they do, and what they own in traditional channels.
Walled garden problem: Closed money is often not interoperable between systems, and thus money has limited uses inside closed systems, especially in spread-out countries. Mobile money customers can currently only transact with others who use the same service, limiting its reach. Closed money’s lack of interoperability limits its value in the Philippines, for example, where the country’s central bank has not granted permission for interoperability between the GCash and PayMaya systems, thus exacerbating the “walled garden.”
Classist transmission limits: Alipay maxes out at $450 for a single transaction, which does not go much farther than daily purchases. In the Philippines, PayMaya accounts have a maximum of just $961 a month of loading and spending while upgraded accounts have double those limits. While sufficient for daily transactions, these limits are far too small for financial activities of a middle-class Filipino — purchasing a car, buying an international airplane ticket, or funding school costs.
Open System Payment vs. Closed System Payment
Welcome to the future. We now have tokens, or digital representations of value exchanged on blockchains.
Payment tokens on blockchains help new users break out of the closed-loop fiefdoms, and encourage innovators to develop innovative blockchain services, including credit.
Payment tokens’ much lower transaction fees eliminate overdraft fees because over-drafting funds on the blockchain is impossible.
Payment tokens’ allow citizens to leverage a peer-to-peer banking economy where everyone has complete control of his/her assets in hand.
Payment tokens enable innovative, next-generation market infrastructure of both financial and non financial use cases:
- Crypto-cash: Blockchain tokens with stable off-chain value and recognized as cash-equivalent, enabling on-chain real-time payments and transactions settlement. Central Bank Digital Currency (CBDC), also known as “crypto-cash,” can be developed in the form of asset-backed deposit receipts or as new natively digital money supply.
- Digital identity: Unique, universal, and self-sovereign blockchain IDs and attestations enabling identity verification and authentication to access financial services and products.
- Tokenized assets: Digital and physical assets “tokenized” on blockchain ledgers, enabling to establish full provenance and transaction history, as well as facilitating real-time delivery-vs-payment (DVP) settlement.
Ventures such as Maker Dao and NZIA are already opening opportunities for those holding DAI or CBDC to transact with anyone, everywhere, at anytime. Future money will run on blockchain rails — the entire medium of exchange system, as Raoul Pal explains in a cautionary thesis.
Using unique blockchain identities, such as that offered by Civic, a bank can have the confidence that Enrique Rodriguez is who he says he is. Enrique does not need a government document to attest his identity; many sources from his community can attest it for him, and his identity becomes even more secure as he collects attestations. In stark contrast, Mobile Money does not support digital identities and thus relies on antiquated, already-failed methods of confirming users’ identity. In contrast, the blockchain can enable much more effective identity confirmation.
Cryptofinance products can enable billions to enter the banking system. Self-sovereign identity management decentralized application (dApp) through digital keys and using non-traditional trusted sources to prove the affected user’s identity. Peer-to-peer networks of smart contract compute services that serves as a key/identity management service that banks and individuals can use to underpin financial tokens. It permissions trusted entities to operate individual nodes, which host fiduciary applications such as asset custody, corporate treasury and fund administration solutions.
Payment tokens, such as tokens like XLM, DAI, or emerging CBDC such as the Sand Dollar in the Bahamas, could overcome the limitations mentioned above. Provided the payment tokens are freely exchangeable with other currencies, both digital and fiat, cross-border transactions would be seamless and not need to go through the hassles and potential obstacles of using a sole-point-of-failure private transmission channels such as PayPal. A currency backed by a Central Bank would receive universal acceptance, have transaction costs of virtually nothing, end the default risk of the banks issuing the Mobile Money, and be freely interoperable.
The future is here. So go ahead, plug into one of the now-proliferating payment token wallets, and experience the joys of an open financial system.