Reflections on the Future of Digital Money and Payments
Who will not be disintermediated?
As I’ll be participating in a few financial technology focused events in the next few weeks, I thought it’d be a good idea to reflect upon the future of money and payments. It is a complex topic, but I’ll try to keep this blog post as focused as possible.
My broad — and possibly bold — statement is that with all things happening in the payments and financial services space, in the long run, there is no ecosystem player that can feel 100% safe in terms of not being disintermediated. I believe that the 2007–08 financial crisis and subsequent economic recession did a lot of damage to the trust that people had in the financial system. In this atmosphere characterized by eroding trust, the appearance of bitcoin was no surprise — well, at least from the perspective that our financial system needed disruption.
Decentralized Finance
More and more people are being drawn to the notion of decentralized finance (DeFi), where cutting out middlemen from transactions is a primary goal. But first, let’s talk a little bit about the concept of decentralization. In literature, you’ll find different definitions and classifications for decentralization, however, for the sake of this blog post, being ‘decentralized’ will mean that no one single entity has control regardless of the activity in question. The concept of decentralization — and open or free markets — is not new. The father of classical economics, Adam Smith, in particular, believed that if sellers and buyers were left free to pursue their own self-interests, it would lead to the greater good. Nobel-prize winner economist Ronald Coase was also skeptical about government regulations; however, he acknowledged that reality was complicated.
Does decentralization always work well? Probably not. In many cases, a hybrid approach may well be the optimal choice. Not all intermediaries are necessarily bad or inefficient. Fully decentralized marketplaces — where buyers and sellers transact directly — may disappoint in terms of customer experience and satisfaction. Also, if we think about bitcoin, Satoshi’s original idea of a purely peer-to-peer version of electronic cash that allows online payments to be sent directly from one party to another without going through a financial institution, became a highly speculative investment asset. Simply put, although there are businesses that accept bitcoin as payment, it’s not a currency that many people use on a daily basis, at least not for now. My point here is that human nature and behavior need to be factored in when it comes to decentralization.
CBDCs
Cryptocurrencies and the DeFi movement are putting a lot of pressure on the traditional financial system participants. Central banks around the world, in particular, have responded to the reality of digital currencies by assessing and trialing the implementation of central bank digital currencies (CBDCs), the digital form of fiat money. According to the Bank for International Settlements’ 2020 survey, 86% of central banks are in some way engaged in a CBDC project. In a previous blog post, I talked about CBDCs getting a boost throughout 2020. The Central Bank of The Bahamas rolled out its state-backed digital currency, the Sand Dollar, making it the first CBDC to go live in the world. One month later, the National Bank of Cambodia followed suit with the launch of the Bakong payment system. The People’s Bank of China has also been testing its digital yuan in different regions.
However, the key drivers for launching a CBDC differs among developed and developing countries. In a developing country, financial inclusion of the unbanked population may be a primary motivator for introducing a CBDC, while in a developed country, enhanced efficiencies and security considerations are most likely the top criteria. So, we are essentially differentiating between retail and wholesale CBDC approaches. While retail CBDCs are meant to be made widely available and serve as a complement or substitute for physical cash, wholesale CBDCs are limited to making interbank transactions more efficient and trustworthy.
Central banks are being prudent about implementing new concepts and technologies — especially in developed countries — as their primary mandate is to oversee monetary policy and safeguard financial stability. However, I believe they also need to be open-minded and forward-looking to enable a favorable evolution of money and payment systems. They also need to think globally rather than locally, as any initiative launched in isolation will be of limited utility.
From the consumer’s point of view, if a CBDC is less convenient to use than alternative forms of digital payment, it will not get adopted. Although the digitization of payments has accelerated during the coronavirus pandemic, and we enjoy a wider adoption of digital instant payment services such as Bizum and Venmo, we are also aware that these services are still closely tied to traditional financial market practices — you need to have a bank account. But, what about the unbanked population? Shouldn’t payments for them also be as easy as sending a text message? With retail CBDCs, we are hardly going all the way, but they could help lead the way towards a more open, equitable and inclusive, as well as efficient digital economy.
NFTs
I don’t think I will be able to get away with this blog post without at least mentioning non-fungible tokens (NFTs) and how they have the potential to transform a number of industries, including the creative one.
Broadly speaking, asset tokenization — whether that asset is a diamond, artwork, money or real estate — promises to improve the accessibility, efficiency, liquidity and transparency of existing asset markets.
In a keynote panel at the Hyperledger Global Forum 2021, British musician Imogen Heap talked about how she is using NFTs (and distributed ledgers), to help transform the music industry by making it a fair game where all participants get credited for the value they provide.
Digital tokens are divisible — imagine tokenizing a house and being able to sell fractions of it to unlock funding. Digital tokens are also programmable — you can bake access rights, regulatory compliance and other processes into the token. Digital tokens are also tradeable — imagine swapping shares of different companies without the involvement of money. It’s early days, but it is a promising and fascinating area. Let’s not ruin it with things like this https://twitter.com/elonmusk/status/1371549960030842893. It’s not about the technology, it’s about how we use it.
Conclusion
Exciting things are happening in finance and I can’t wait to see what sticks!
