In our December faiVLive webinar, FAI’s Tim Ogden sat down with financial policy expert Jesse McWaters, Head of Global Digital Public Policy at Mastercard, to demystify some basic questions around digital money and its evolving role in financial inclusion. What’s the difference between a digital payment system and a digital currency? What is blockchain really and how should we use it? Who makes the rules in a decentralized digital money system? Do those rules protect or expose consumers? Can the offerings and their regulations be designed to be pro-poor?
This two-part blog post distills the conversation from that webinar. This one covers some basic frameworks for thinking about these concepts. The next will cover the regulatory environment around digital systems.
What’s the difference between a payment system and a digital currency? Because when we in the financial inclusion space use the phrase “mobile money,” we’re actually talking about payment systems, not money. Is that right?
I think about these systems as 3 layers in a stack.
At the base of that stack you have the store of value: what’s the thing that we are actually exchanging that is representative of its value? It might be a claim on a central or commercial bank, or even next month’s harvest.
The next layer is the payment network itself: how are you and I exchanging that value? If it’s a $100 bill (a claim on a central bank) I might pass it to you. If it’s a claim on a commercial bank deposit, it might move through some sort of bank-to-bank payment network. Many things that are referred to as “mobile money” (like M-PESA, or Apple Pay) fit into this part of the stack.
The last layer, which I think is crucially important, is regulation: What is it that provides governance around those transactions? What gives counterparties confidence in that transaction? This layer includes both regulation and what we call “scheme rules.” If you think about your ability to get your money back if someone steals your debit card, that is an example of governance. It’s not regulation, but it’s a part of the value proposition of the particular payment network.
It’s really important to distinguish between new stores of value and new ways of transporting that value. When things are new, we have to ask ourselves whether regulatory and governance systems are fit for the new underlying technology or store of value.
There’s also the question of what makes something digital. In a sense all of my money is digital because there’s virtually never any physical cash involved in my life. But, the dollar is not a digital currency.
Well, it is! Here we have to dig into a bit of economic minutiae. Everything we interact with today, in the US for example, is one of two things.
First, you have cash, which is a direct claim on the central bank, good for settlement of all debts, foreign and domestic. You can only pay your taxes using USD. Ultimately that is a direct guarantee from the government—but it’s not digital.
Then you have everything else: Venmo, PayPal, Applecash, CashApp, etc. It’s all digital, but none of that is “central bank money.” Instead, if you have an account at Citi, it is actually a liability of Citibank. When you take a $100 bill and deposit it at Citibank, you’ve shifted from having a central bank liability to having a commercial bank liability. The reality is that the average person doesn’t know, or need to know, about the difference between central and commercial bank liability. That’s because there are adequate regulations and protections in place.
But when we talk about a central bank digital currency, it’s about taking those two things and putting them together. We take this digital asset, and the central bank guarantee, and put them together. That’s all a CBDC needs to be—it doesn’t need new technologies or need to offer any new features.
Let’s talk about blockchain, what it actually is, and is it really any different than “a bunch of copies of a spreadsheet”?
When people talk about blockchain, they often start by trying to explain how it works. This is maybe wrong! Think about a smartphone, you don’t start with how it works, you start with what are the features.
I see this as really three questions: What is blockchain? What can you build with it? And what do you want to get out of it?
So, what is blockchain? The core feature of blockchain is that it allows you to run the payment network layer in a decentralized fashion. Before, if you wanted to run a secure payment system, it had to be hub and spoke—a central party in the middle making sure that everyone’s “spreadsheets” were in line with each other, and no one is cheating. Now, blockchain allows us to do that in a decentralized way, where the responsibility of making sure no one is cheating gets broken up and handed off to all of the participants in the network. That is a really neat trick—something you could not do before.
However this led to a lot of people saying there’s no need for centralized parties anywhere. But that’s a question of the right tool for the job. What people miss is that moving away from centralization has tradeoffs. Instead of having one trusted party in the middle doing everything at once, you need many parties doing things many times to ensure it’s secure. The more secure you want the network to be, the more redundancy you need for that processing. Bitcoin is a very secure, decentralized blockchain, which is why it costs so much electricity to run. You need many people to participate in the processing of it, and this results in the fully loaded cost of the bitcoin blockchain being quite expensive, upwards of $30 per transaction.
That’s blockchain. It is a new option for the design of the network payment layer. It’s a new tool in your toolbox.
Now, what do you build with that? You can build a lot of different things. One of the worst things that has happened in the crypto space is the generic term of “cryptocurrencies.” The reality is that most things in the crypto asset space are not intended to be currencies. It’s people issuing tokens to build exciting new decentralized projects, like a cloud storage facility or social media network. It’s interesting and exciting, more like speculation, securities and commodities. Most of it is not intended for payments. That said, we do see some sets of payments emerging. An example is a stable coin, which lives in a decentralized network but is a claim on a dollar or euro.
Finally, what do we want to get out of it? The interesting thing about the design of Bitcoin and other crypto assets is that it’s pseudonymous. I might have an account with half a bitcoin in it, but it isn’t personalized to my name. It is a string of digits, and that long hash is then associated with me.
This can be either a bug or a feature. A lot of the vision around bitcoin comes from crypto libertarianism—it’s about being censorship-resistant and not wanting the state to impose restrictions on you. I don’t subscribe to that political view, but it’s a legitimate political view held by some.
You could design a system that uses blockchain but also incorporates a governance structure that enforces identity. We have to think about how we can create systems to serve the actual consumer, instead of making them victims of fraud and inadvertently enabling criminal activity.
One of my ongoing frustrations with the tech world is that people assume everyone has good intentions. The only people who innovate more quickly than social entrepreneurs are criminals. Some people need protection from predatory centralized authorities—governments who deny them access, shut them out of the payment system, who prey on their people. But there are also a lot of people who need the government to protect them from other people doing that. And if the bad actors are able to hide their identity, that creates a problem.
Again there’s a question of fit-for-purpose here. There are societies where trust in government and the currency is high. I don’t think you need to reinvent the wheel in those societies, you can rely on those bodies to provide that security and protection. There’s a role for private actors to support those governments in developing the types of regulations that can get them where they need to go.
Unfortunately in a minority of other societies that is not the case, and this toolkit of crypto assets does provide some exciting opportunities in that space. If we think about this from an international perspective, most of us want to get to a place where there are strong, trusted governments in charge to provide great regulatory frameworks.
Even if you put aside the question of fraud, the people who invent the technology are often looking to fix the problems that they perceive, not problems that the target user base perceives. There is a real danger if we presume to know the needs of people who are financially excluded. Even more broadly, the folks driving crypto have a completely different idiosyncratic set of wants. I remember in the early days of crypto, talking to all kinds of people excited about how fantastic it is that you can be your own bank. I would say to them, that sounds awful! I don’t want that responsibility, that sounds like an enormous headache. I’m very content trusting my banks, and—as a fallback—the regulatory structure they exist within.
Yes, from the financial inclusion perspective, there are huge advantages to not being your own bank, not having to worry about all that money being in your house, and having some financial tools and services available to you.
Crypto and blockchain are powerful new tools that get added into how we attack the problems of how we digitize, and how we establish trust around digitized stores of value and digitized networks to move value. But just because we have them, doesn’t mean we should throw everything out, but rather that we should bring it all together.