Posts in Cryptofinance technologies

Building Crypto Valley: Founder and CEO Johann Gevers at Sibos

November 1st, 2016 Posted by Crypto Valley, Cryptofinance technologies, Switzerland 0 comments on “Building Crypto Valley: Founder and CEO Johann Gevers at Sibos”

“Traditional fintech does not change the core functionality of the legacy financial system works they are merely increasing user friendliness. We need fundamental innovation. This is only done by cryptofinance; currently only a small part of the fintech ecosystem.”  — Johann Gevers

A SWIFT Response

September 22nd, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “A SWIFT Response”

The SWIFT Institute recently published a working paper titled, “Virtual Currencies: Media of Exchange or Speculative Asset?” It examines whether or not virtual currencies–most prominently Bitcoin–posed a threat to macroeconomics or fiat currency.

The paper, however, illustrates the analysis of an innovative technology from the perspective of those with experiential bias mired in years spent in the industry and hinders the ability to see the “full picture.” In this brief, I will analyze some of the points brought forth by the SWIFT Institute and add the missing perspective needed to realize the full potential of this technology.

“An empirical analysis of prices and user accounts (wallets) of Bitcoin supports the theoretical result and finds that Bitcoin is mainly used as a speculative investment rather than a medium of exchange.”

Keywords: Bitcoin; virtual currency; digital currency; alternative currency; medium of exchange; asset class; safe haven”

Vocabulary is key to communicate anything and especially so when attempting to convey the specifics of such an innovative technology. Now, let’s talk about whyaccounts, virtual currency, and digital currency are misleading, or outright wrong when describing both the currency and technology of Bitcoin.

Digital (and virtual) currency has been around since the digitization of communication. Today, nearly all currency is digital; only a fraction of sovereign currency exists in the physical medium. Although Bitcoin is considered a digital currency, it is more accurately described as a cryptocurrency. Cryptography is what makes Bitcoin unique; it is where the differentiation between every other virtual or digital currency becomes apparent. Cryptography is what controls nearly every aspect of Bitcoin–from the production to the distribution. As there is no central entity or bank controlling the production of Bitcoin, one of the greatest values comes from trusting the math and not the centralized institutions’ policy decisions.

Referring to where one stores their Bitcoin as an account is akin to saying that you have a leather account in your back pocket or purse. A key differentiation between cryptocurrencies and digital currencies (the digital value held in your online checking account) is not the medium in which it exists, but instead the platform it exists on. Moving from a liability-based system (one which is based on account management) to asset-based (in the form of bearer instruments), trade has the potential to usher in even more substantial and advantageous differences.

An account is managed by a third party, a bank. A wallet holds value directly and is only accessible by the person who is in control of it. Although a seemingly inconsequential word choice, the reality of the difference is of crucial importance.

“Virtual currencies open up a new type of dual currency regime in which two currencies with no intrinsic value, virtual currency and fiat currency, coexist.”

Intrinsic value refers to the actual value of an asset based on an underlying perception of its true value. In terms of both tangible and intangible factors, intrinsic value is subjective and only determined by the value someone is willing to pay for an asset at a given time. How valuable is a glass of water to a man sitting in a boat in the middle of an alpine lake? How valuable is that same glass of water to that same man after being stranded in the middle of the Sahara for 4 days, without another glass in sight?

Value is based on circumstances. The authors of the paper are blinded by privilege and sit on top of crystal clear alpine lake, with more water to drink than is imaginable by most. Not only can they already complete their day-to-day transactions digitally, but they can access financial products custom made to fit their financial needs. Their investment portfolios are tailored to reduce risk and allow for steady growth over a lifetime, guaranteeing stability upon retirement. They make monthly contributions to different investments, automatically, based on the risk they want to assume and the return they seek.

This reality is a given for those privileged enough to be born in a geographic location with institutions in place. For the vast majority of humans, however, the possibilities of financial security are completely unimaginable. As of writing this article, there are 18 countries in Africa alone that have inflation rates over 7%. Financial services are not yet accessible to billions of people on earth, an opportunity that is many times greater than the userbase of Facebook.

There is intrinsic value in a technology that has the potential to help someone escape generational poverty, especially in countries where the national value evaporates at 7%+ per year.

The final point misidentified by the SWIFT Institute is the presence of a Central Bank Digital Currency. We’ve recently seen Adam Ludwin of Chain address over 100 central bankers at the Federal Reserve about why they should be racing to adopt new cryptofinance technologies. The World Economic Forum  states that there are working groups at 90 central banks around the world looking into the topic.

In July, the Bank of England (BoE) published a report on the macroeconomics of central bank issued digital currencies which fleshes out the pros and cons of central banks issuing their own digital currencies. The BoE concludes that there are numerous benefits, which you can read in detail in an earlier post.

Upon the introduction of a CBDC, the BoE predicts many consumers will switch from storing value in bank deposits to holding it in a digital currency.

This is the analysis that the SWIFT Institute should be conducting. When our assets and national currencies go digital, they will compete with their counterpart- liabilities. The digitization of legal tender will have widespread impact on macroeconomic conditions. Today’s financial services are liability and account-based. They require central switches, reconciliation between institutions, and plenty more on top of counterparty risk. An asset-based system changes all of this however, as people start transacting as they do with cash today, except in a completely digital medium that reduces costs to near-zero.

Bitcoin may not be a threat as a transactional medium to national currencies, but how will the digitization of national currencies impact fractional reserve banking and consumer deposits?

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas

Next Generation Digital Financial Services Will Drive Internet Use in Africa

August 30th, 2016 Posted by Central Banks, Cryptofinance technologies, Mobile money 0 comments on “Next Generation Digital Financial Services Will Drive Internet Use in Africa”

Last week, the Internet for All initiative by World Economic Forum (WEF) presented their objectives in Nairobi, Kenya. Over the next 3 years, they plan to incorporate an additional 25 million internet users in Northern Corridor East African countries (Kenya, Uganda, Rwanda, South Sudan) and bring total internet adoption to 70%.

The group determined to make this ambitious goal a reality by including stakeholders from Information and Communications Technology ministries, mobile network companies, hardware manufacturers, software and content producers, multinational NGOs, entrepreneurs and innovators. Their approach is to target broad sectors that are helping to drive demand for internet access and lobby infrastructure providers to help curtail high barriers to entry.

So, why is the WEF focused on increasing internet usage in countries that are also busy trying to increase food security, gender development, and basic healthcare?

Well, the internet is more than cat memes and a way to follow your favorite celebrity on Instagram. The internet democratises communication, education, and enables even the poorest and most vulnerable to be heard. Not long ago, information was held in libraries and universities. Only those with the privilege and means had the ability to access that information. The internet, however, opens the library doors and allows anyone to benefit from the knowledge humanity has created over thousands of years. Now, a girl in a remote village in Kenya can use her smartphone to stream a lecture at MIT to learn computer science and a mother in rural Uganda can learn about proper nutrition without have to spend money or time traveling to a health center to talk to a nurse.

The projects underway in the Northern Corridor are impressive. Many aim at increasing digital literacy across all segments of the population. To generate demand and gain awareness for those not yet connected, new programs teach students how to access the internet for things as simple as opening a social media account. A Facebook profile piques youth interest and teaches the value of the internet at a young age. The interest gained from gratification on social networks can be leveraged to learn job skills, e.g., software coding via gamification.

In a digital world, national borders dissolve and people become more connected. The global nature of the internet shatters location and geographic glass ceilings. As more citizens of the world learn to utilize digital skills, the ability to access education materials and make income from global sources becomes less of an ambitious goal and more of a reality.

The WEF released a favorable and forward-thinking report 2 weeks ago titled, “The future of financial infrastructure: An ambitious look at how blockchain can reshape financial services”. The key takeaways are very much in-line with the vision ofMonetas:

Distributed Ledger Technology (blockchain) is not a panacea. Instead, it should be viewed as one of many technologies that will form the foundation of next-generation financial services infrastructure.

Cryptofinance consists of many different technologies that utilize and complement different technologies in order to deliver an optimal final product for the end customer. The hammer isn’t the ideal tool for every job, and blockchain technology isn’t ideal for every user story. At the WEF, many people spoke about the use of  cryptofinance and blockchain tech in various cases from digital identity management to better sharing health records. Even though I was the only person in the room from the cryptofinance sector, I sat back and listened to an array of stakeholders speak about what is needed to allow for widespread uptake of digital financial services. The three factors consensually agreed upon were straight forward:

  1. Interoperability is vital. Today, users in most markets can’t send value from one mobile network to users of another. We need to unify financial service providers so users can send money to anyone they want, regardless of what bank or mobile network they use. Sending and receiving money internationally will also further increase usability.
  2. Low value payments must be able to be made at affordable levels. With 50% of payment volume taking place below USD 1 in Kenya, users today face fees in excess of 10%. With the inability to complete day-to-day transactions, all mobile money platforms today require users to immediately withdraw funds and leave the digital medium.
  3. Mobile money today barely qualifies as financial inclusion. Financial inclusion isn’t just payments; it’s financial products, savings, loans, investments, and more. Products like M-Shwari offered by MPesa are a start, but users only receive between 2%-5% in interest in a market with +7% inflation.

The speakers at the WEF who thought they were addressing mobile money needs were actually (perhaps not even to their own knowledge) describing the benefits of cryptofinance. It’s encouraging to know that a product our engineers have been making for the last 3 years fulfils these requirements plus much, much more. Monetas looks forward to further participation in working groups at the World Economic Forum to help drive awareness of the capabilities and benefits of cryptofinance amongst the stakeholders, central banks, and financial service institutions.

Bank of England Sees Potential of a Sovereign Digital Currency

August 15th, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “Bank of England Sees Potential of a Sovereign Digital Currency”

In July, the Bank of England published a report on the macroeconomics of central bank issued digital currencies which fleshes out the pros and cons of central banks issuing their own digital currencies. It’s not often that we see these bastions of conservatism speaking out about innovation, but the technologies made possible by Bitcoin have created the toolbox that will allow a sovereign monetary policy to continue to flourish in our increasingly digital world.

The BoE report concludes that the issuance of a Central Bank Digital Currency (CBDC) could permanently raise GDP by as much as 3 percent–from a reduction in real interest rates, distortionary taxes, and monetary transaction costs. Their position puts forward an opportunity for central banks to digitally stabilize the business cycle within an economy.

The world’s financial institutions, which haven’t yet truly joined the digital revolution brought forth by the internet. Over the last century, our banking system has seen innovation, however, the technology it is built upon an antiquated foundation. Continuing to embellish outmoded technology is akin to attempting to increase the performance of a candle. If we had spent our time improving the candle, we would never have created the light bulb. Today we have the ability to start fresh and deliver incredible, new functionalities. With the near elimination of production, replication, and distribution costs, these functions are only possible in a digital medium. They will drastically reduce barriers to financial services and enable the transfer of value as simply and quickly as sending a WhatsApp message.

If you’re holding a paper note in your hand, you’re holding a contract between yourself and a central bank. The value held in your consumer checking account (or any other digital medium), isn’t cash in your possession. Depositing your cash into a checking account, you are lending your money to a financial institution. The number representing this amount in your online checking account is a promise from the financial institution that they will pay back the value which you have lent them. In this relationship, the bank is a trusted third party keeping your value safe. They have been doing this for thousands of years because it works for them. The model enables fractional reserve banking, which increases systemic risk and leaves consumers at the fate of the institution. Banks create new money and are only required to have a fraction (1/10th) of money lent in their physical reserves. If too many people withdraw money from their checking accounts, the bank will become illiquid due to the fact that most of their liabilities have been lent out in the form of debt. We’ve seen this problem countless times before, but most recently in Cyprus, Greece, and Kenya.

With a CBDC, anyone is able to safely hold and transact their wealth as if it were physical cash and without the necessity of a third party. The BoE sees tremendous benefits in this model which allows more base money to circulate in a economy and in turn reducing liabilities in commercial banks. With the ability to transact cash digitally, the need for reconciliation between financial institutions and their associated counterparty risks, as well as the capital required to insure these risks, can be eliminated. There is always the option for central banks to print more physical cash. However, banknotes require storage and a physical exchange for payment. Their very nature makes them expensive and impractical for a globally-connected and digital world.

Bank of America alone spends $1 billion a year to “shuffle paper (cash) around and transport money in armored trucks.”  While speaking at “The Future of Global Trade” event in Worms, Germany, I asked a crowd of 200 university students how many of them had been inside their bank in the last 6 months. No hands. Customer support? They do it online. Writing a check? That’s a thing of the past. It’s not only young people who have no need for a bank building. The infrastructure costs of today’s retail networks are so huge that they have raised the barriers to financial services to a level which excludes over 2 billion people worldwide.

Upon the introduction of a CBDC, the BoE predicts many consumers will switch from storing value in bank deposits to holding it in a digital currency. As consumers don’t keep their money in a checking account for the sole perk of a 2% annual interest, they may find greater value in keeping their money in their pocket. In the near future, commercial banks will be looking to the wholesale market to finance a growing portion of their banks. Relying on lending directly from central banks would reduce the spread between the wholesale interest rate on government bonds and that of consumer checking accounts. This offers central banks a more precise tool to better manage economic cycles.

With this report, it’s safe to say that there is now widespread attention paid by central bankers toward the possibilities of issuing their own digital legal tender. It will be intriguing to see the innovations brought forth by institutions best known for their obstinate conservatism. We’ve recently seen Adam Ludwin of Chain address over 100 central bankers at the Federal Reserve about why they should be racing to adopt new cryptofinance technologies. There are now working groups within central banks around the world looking into how it can happen and why it must happen.

In keeping with their history of intransigence, each central bank prefers to be the second to make a move. Who will be first? Innovations in emerging markets are already leapfrogging policy makers in mature markets. In East Africa, for example, policy makers have created an innovative fintech climate where friendly telco policies have lowered the barriers to financial services and demonstrated their commitment to foster a more inclusive economy. In Kenya, there is “an emerging pattern suggesting widespread systemic challenges: questionable governance practices, weak supervision and rampant fraudulent activities.” Kenya and countries like it are fertile ground for such inclusivity. Uniting all financial service providers–banks and the networks that offer mobile money–under a CBDC and reducing systemic risk, emerging markets are enabling their citizens to hold national currency directly and digitally in their pocket.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

An Audience of Innovators. A Stage of Incumbents.

August 4th, 2016 Posted by Cryptofinance technologies, Mobile money 0 comments on “An Audience of Innovators. A Stage of Incumbents.”

The recent GSMA360 event held in Dar es Salaam, Tanzania highlighted the great progress in mobile tech on the African continent. With the world’s first global distribution platform now at the fingertips of hundreds of millions of Africans, companies–small and large–are delivering new tools that help add value and stability to people’s lives digitally. Companies are utilising mobile for a variety of cases: from digital health products, risk profiling and lending, to digital recruitment tools that aid growing enterprises perfectly match with prospective candidates. At the event, it was apparent that one thing was missing, however: a clear look towards the innovations of tomorrow.

Today’s digital revolution is changing the way we see and use technology and it’s changing fast. We have seen the cost of phones drop drastically allowing the long tail of the population to now find value in a device that until recently they didn’t even know they needed. WhatsApp managed to cut the predatory costs of the SMS message and allowed users to communicate globally at nearly no cost. Other tools, such as health applications, have seen their user base grow by millions while distribution costs drop. Now there’s no need to go visit a hospital hours away to ask a basic medical question. Other innovators in the room, such as Branch.co, have solved a problem that local banks have been failing to do for a century: they can now create accurate risk profiles of unbanked customers. Collecting a wide array of data points across various mediums, including social media and phone usage, Branch uses machine learning to accurately assign a risk profile to be used in lending for someone with only a smartphone. Adoption has been rapid. Branch issued more than 70,000 small loans in their first few months of operation. To solve the age old problem of how to connect the labor market with companies looking to expand, Duma Works has connected over 3,000 candidates to 350 companies in East Africa via an innovative SMS platform that matches talent with employer.

These are examples of real progress. Presentations on innovation at GSMA360, however, were less than inspirational. A panel on the “Next Generation of Mobile Money,” focused on front-end changes and the need for regulatory support to better make things work. In regards to ecosystem development, the presenters believe it’s the responsibility of the operators to work together and increase the usability of mobile money platforms. At a time where we see Orange charging double digit fees to their customers for low-value transfers, it’s hard to imagine them innovating to the extent necessary to create the inclusive digital ecosystem that so far has been unachievable.

When asked about how a Central Bank issued Digital Currencies (CBDC) will impact mobile money, many incumbent presenters were unaware of developments that occurred in the last few years. Sagaciously, the impact investment fund Omidyar Networkexpressed interest in the subject and seemed to be making bold steps in the right direction with their financing of eCurrency, a company that develops software for central banks. The impact of a CBDC will solve the problems faced today in mobile financial services by reducing the transfer cost to a negligible level, allowing for $0.01 transactions, and facilitating global network agnostic transfers (a WhatsApp, for value). Most incumbents still see this as science fiction, but they are unaware that even theBank of England’s report on this exact subject determined–amongst the many benefits–a 3% uptick in GDP. Mark Carney, Governor of the Bank of England, is a strong proponent of this digital future. He recognizes its potential to deliver “a more inclusive financial system, domestically and globally; with people better connected, more informed, and increasingly empowered.” In addition, Adam Ludwin of Chain recentlyspoke on the subject at the Federal Reserve in Washington DC with over 100 interested central bankers; swift developments in this arena are already happening.

These technologies aren’t a dream of the future. Most people can’t imagine how fast things develop and the speed of which creative destruction occurs with the introduction of software. Ten years ago, there was no iPhone. Today, over 127 million Africans have a Facebook page. Watching a panel of established players is certainly compelling, however it is important to understand that their experiential bias can result in an underestimation of the speed and scale at which technologies and societal practices can change. GSMA360 offered attendees an enthralling insight into the current state of the industry, however, we can be certain that the incumbents on the stage will not be the sole drivers of our future digital financial services. Partnerships and collaboration with the innovators in the audience is vital.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

Four Reasons Why Cryptofinance is Replacing Physical Cash

August 3rd, 2016 Posted by Cryptofinance technologies, Mobile money 0 comments on “Four Reasons Why Cryptofinance is Replacing Physical Cash”

Cryptofinance has a huge number of high-impact killer apps, from censorship resistant value exchange (Bitcoin and its blockchain) to business automation (Monetas and its digital contracting technology). These technologies, and Monetas technology in particular, will have a significant impact on the most fundamental tool of exchange: physical cash and coin. Here are the four big reasons why cash is going the way of the dodo right now:

Cash creation is costly

Today a central bank will order, print/mint and deliver physical cash and coin to the banks in its network. This involves a lot of resources: cotton or polymers, ink, gasoline, trucks/lorries, armed guards, warehouses, manual and office labor, and probably much more. The process takes weeks or longer, and you might be paying $0.40 just to create a $50 note.

Book printing used to be almost as complicated and expensive, until e-books came along. And just like the cost to print an e-book, the cost to mint a digital note drops the production cost to near zero. With Monetas technology, a central bank uses an “issuing device”, a small hardware device, to create digital legal tender and deliver it directly to the banks in the central bank’s network.

Cash is a barrier to financial inclusion

Physical cash and coin just doesn’t fit with the model of complete and instant connectivity that the world has grown to know and love. With Monetas technology, your mobile phone or any web browser lets you send money to a friend, receive your paycheck directly, pay for groceries or lunch, or buy insurance. Any barriers to the global financial system that existed due to geography or social status have disappeared.

Cash is a constraint on monetary policy

If a central bank wants to experiment with negative interest rates or “helicopter money”, physical cash is a problem. Issuing digital notes provides more policy options and greater control. A central bank can react faster in a crisis and ensure the money is delivered to the parts of the economy that need it most.

Cash is corruption

If you want to eliminate or at least reduce corruption, you need a way to make sure that money flows in the way that you expect it to. With physical cash and coin this is impossible, but with digital cash this is simple. With Monetas technology, you can create digital vouchers that can only be spent in certain places or under certain conditions. In a natural disaster, digital vouchers might be distributed and redeemed for food, water, or shelter. Education vouchers can only be spent on school supplies or for tuition.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

Traditional Mobile Money Wallets Aren’t Wallets, They’re Accounts.

June 22nd, 2016 Posted by Cryptofinance technologies, Mobile money 0 comments on “Traditional Mobile Money Wallets Aren’t Wallets, They’re Accounts.”

Wallets and accounts are two very different things. The leather wallet in my pocket is exclusively accessed by myself, and holds bearer instruments (physical cash) directly. My bank account however, is where I have entrusted my money to a third party- my bank.  That trust, is expensive. Not only the insurance of my deposit, but the amount of capital expended to insure the correct state of the ledger raises the costs of financial services, which in turn raise the barriers to entry.

Today’s mobile financial services use antiquated technology providing a simple digital interface with a centrally managed account being held by a bank or mobile network operator. We have seen tremendous success of mobile money in Africa, where users are able to digitize a once risky task; domestic remittance.

Mobile money today is far from financial inclusion. Currently, mobile money allows a user to dip their toes into financial services for the first time through the ability to transact high values digitally within a country, to a friend or family member who is also using the same mobile network.

Mobile money can not yet allow for true financial inclusion because of the antiquated system of central account management it is built on top of. What today is referred to as a ‘Mobile Money Wallet,’ is nothing more than an interface to access a centrally managed account via a mobile phone.

Centrally managed accounts are what we have used exclusively for financial services because, until now, we have always needed a trusted third party to complete transactions not taking place in physical cash. Banks have taken on this role for hundreds of years, and recently mobile networks have entered the scene. These centrally managed accounts are expensive because of the necessary backend support required to insure the correct balance and security of the account. Not everyone today realizes what an account actually is, and they don’t understand the value they see represented in an account represents only a promise.

An account balance is a promise. It’s a promise that the financial institution will return the value that the depositor has lent it.  We have seen this promise broken countless times in history, from sovereign crisis in Cyprus and Greece, to the devastation of 50,000 depositors at Chase Bank of Kenya just a few months ago. Deposit insurance, greater controls, and continual audits help to build trust and insure the safety of consumer deposits, but all add cost for the end customer and further raise the barriers to access financial services.

What if you could hold cash in a digital wallet, just like you hold paper cash in your leather wallet today?

One of the greatest advantages users of bitcoin have found, is the sovereignty of control and ability to be the sole party able to hold and transact value. When somebody holds a bitcoin, they hold a financial instrument that is conceptually similar to physical cash. As a bearer instrument, whoever is in physical possession, is the rightful owner. There are no centrally managed accounts, and holders of the cryptocurrency are the only ones able to access it.

Cryptocurrencies aren’t exclusively bitcoin, and new technologies have made it possible for central banks to issue legal tender exactly how they do today, but in a digital medium. Digital legal tender is extremely advantageous for central banks, and dozens have created working groups to investigate digital issuance to help lower the cost of printing, distributing, and securing money. China, Russia, England, and dozens of other central banks have looked at accelerating financial inclusion with digital national currencies.

This digital legal tender, which is equivalent to physical cash in every way except the medium which it is printed on, is able to take on favourable properties of cash without having to occupy the physical world.

A user is able to hold and transact digital cash directly, without the need for a trusted third party. This ability has the potential to change financial services at its core, and change the role financial institutions play today. The financial services paradigm shift brought forth by bitcoin and the blockchain is still not fully known. The ability to hold any digital bearer instrument directly, however, will change finance. A user’s wallet will hold a variety of financial instruments; cash, equity in a company, commodities, or even non-monetary instruments such as identification documents, school records, and driver’s licenses.

Because institutional risk is removed when a user is responsible for their own bearer instruments (just as it is when a person holds paper cash in their leather wallet), cost drops dramatically and the need for physical infrastructure diminishes as digital services are accessible anywhere a data network exists (which is already over 97% of global population coverage).

Mobile based banking will not be revolutionized by Apple Pay, Google Wallet, or even MPesa. No, those services simply offer an increased convenience to access legacy technologies which at their core are prohibitively expensive, complex, and require reconciliation between financial service providers.

Financial services will be revolutionised by the disintermediation of trusted third parties and the ability for value to flow like information is communicated today – digitally.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

Digital Legal Tender: The Foundation of Future Digital Trading and Finance

June 21st, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “Digital Legal Tender: The Foundation of Future Digital Trading and Finance”

With the rapid increase of digital financial services, the urgent need for a central bank issued digital currency has become apparent in order to create inclusive, frictionless, and efficient national economies. A national digital currency will provide a  boost to economic growth allowing all financial service providers to participate and leverage their niche, while benefiting from unified global system.

Mobile money operators have made huge progress leapfrogging traditional brick-and-mortar banks providing digital financial services directly to users via mobile phones across underbanked regions such as Sub-Saharan Africa. Mobile money has done more to expand financial services in the past year than banking in the past decade.

With over 271 mobile money services now in operation, we are experiencing the same problem economies faced years ago before the existence of central banks. As the economy evolved from the exchange of fundamentally valuable assets such as gold, commercial banks began to issue their own private banknotes (based on deposits). Issues of interoperability arose – trust held in different institutions played a role in when and where your private bank note could be spent and interbank settlement was costly and problematic.

Central bank issuance of one national unit of account solved all these problems. Remove a five pound note from your wallet and you will read the fine writing – ‘I promise to pay the bearer on demand the sum of 5 pounds’, followed by the signature from the chief cashier of the Bank of England. This note is a bearer instrument – whoever physically holds it is assumed to be the owner of the property and the note is backed by our trust in the central bank.

Mobile money services are fragmenting national financial ecosystems through the issuance of private digital currencies – network specific tokens’ representing the national currency based on deposit accounts are issued onto their systems. These tokens are only tradable within the network they are issued into – in Kenya for example Safaricom M-Pesa customers can only transact with other customers of the same network. Any interoperable solutions that are arising are based on complicated technical bridging solutions between networks. Friction in the economy is occurring as the funds kept within these systems are not legal tender. They are not insured by the central bank and there is a systematic risk of loss. Certain methods of payment can only be used in certain places for certain things and a constant cycle of exchange between the digital world and physical legal tender exists.

There is a way to solve this problem – the same solution the central banks used years ago with the creation of physical legal tender. Central bank issued digital legal tender.

For conceptual purposes, the issuance, storage, and transacting of digital legal tender works in an identical manner to physical legal tender today (just safer and without the limitations of space and time). It provides one unit of account fully backed by the central bank, that can be utilized by digital financial service providers nationwide. Moving from multiple private issuers to a single issuer totally eradicates the need for privately issued ‘tokens’ and provides seamless interoperability between all systems.

Central Banks have been investigating this opportunity in the past year. On a macroeconomic level, the opportunity to take advantage of the digital economy whilst maintaining regulation and reducing costs is an undeniably attractive prospect.

The burden of managing an economy based on physical cash is heavy – a study by theFinance Ministry of Indiaestimated the cost of cash to the economy as 5-7% of the GDP in developing countries. The production, security, distribution, and eventual destruction of notes and metal coinage is expensive. Switching to a digital payment systems will reduce costs drastically whilst expanding the size of the formal economy through the provision of more accessible digital financial service offerings. The new found option for unbanked and underbanked individuals to forgo their reliance on physical cash (read here how cash based economies hits the poorest hardest) and enter the formal economy will reap large economic benefits for a country. A study by Tufts University estimates that in Mexico every 1% of the informal economy that is formalized represents US $560 million of new revenues with no change to tax rates.

In today’s fragmented digital systems, central banks are unable to keep track of the amount of privately issued digital currency in circulation. Digital legal tender will contribute to the ability of central banks to maintain security and stability within the national economy through execution of monetary policy in an efficient and targeted manner across all digital financial service providers. Furthermore, counterfeiting will be totally eliminated. The use of digital legal tender will create a more transparent system. Financial service providers can implement tiered AML/KYC regulations for domestic and international transactions offering far more reliable and complete identification than traditional paper-based systems.

It is clear that digital legal tender will not replace physical notes and coins completely in the near future. Central banks however must adapt and embrace the digital economy in order to fulfill important economic goals for growth and financial inclusion. Digital legal tender will move through the economy in a complementary manner to notes and coins. The emergence of cryptofinance technologies provides the ideal platform on which this new format of national currencies can be created and used in the most secure and efficient manner. I outline briefly the three key steps in the creation of a truly digitized financial system through the use of digital legal tender below:

1. Issuance: Central banks are the exclusive party to have the required software and hardware for the issuance of digital legal tender. The issuance process is identical to how physical money is issued today. Cryptographically secured, digital cash cannot be counterfeited. Digital legal tender enters the economy alongside, and in the same manner, as physical cash.

  1. 2. Storage: Digital legal tender is held by users in digital wallets exactly as cash is held in a physical wallet. Digital wallets hold bearer instruments (digital legal tender) directly on a mobile phone, can exclusively be accessed by the individual in physical possession, eliminate counterparty risk, and allow the user to be the sole party in complete control of their assets at all times.
  2. 3. Transacting: Legal tender is transacted between wallets in the same manner as physical cash today – directly from person to person with no involvement of financial intermediaries. Each transaction is a direct value transfer.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

An Invisible Burden on the Poor – The Cost of Cash

May 24th, 2016 Posted by Cryptofinance technologies, Mobile money 0 comments on “An Invisible Burden on the Poor – The Cost of Cash”

Due to the extortionate costs of today’s digital financial services (specifically for low value transactions), cash is widely perceived as free, and thus used as a payment tool by the poorest individuals. This misconception must be addressed, and digital services must provide for those at the bottom of the pyramid who are suffering most from the hidden losses and costs associated with a life reliant on physical notes and coinage.

Cash is still king in the developing world. Despite the success of M-Pesa in Kenya, the average transaction size over this service remains at $27. Carrying high minimum fees, the most frequently occurring merchant transactions (under 1 dollar) would carry a transaction fee of up to 10% when executed digitally across these services.

Why? Costly and complicated legacy financial infrastructure render low cost transactions expensive for the operator thus expensive for the end user. With the exception of occasional larger value remittance transactions, digital financial services remain out of reach for the billions of people across the world living on $1-2 per day.

Looking at the impact of cash on individuals and society we can identify a number of key issues.

The sole reliance on physical cash locks an individual out of the formal and global economy, and the opportunities it presents. Individuals are hard pressed to finance a small business or purchase a vehicle because of the lack of a “digital history” that allows lenders to create a risk profile for lending. Savings are stashed under mattresses, at huge risk from theft. Even small household cash flow spikes can be disastrous because of the inability to safely store value. Informal community savings groups exist, however demand high re-pay rates and leave households vulnerable to loss. Even the most intelligent, entrepreneurial minded individual will be unable to step out of poverty without access to basic financial services.

Transactions in physical cash do not carry an immediately identifiable transaction fee. This has led to the common misperception that cash is free. Despite understanding the security risks of  carrying cash and the lack of access to financial services, the principal and least recognized downfall associated with cash is the actual losses and costs associated with accessing it.

Tufts University has conducted extensive research into the cost of cash across developed and developing economies. The results are clear – those hardest hit by the hidden costs of cash are the poorest.  In Mexico alone, the costs of access to cash represents around MXN 2.3 billion (USD 125 million) and 48 million hours of time every year. And furthermore, this number excludes all other means of loss associated with holding cash;  petty crime, loss, corruption, and the opportunity cost of cash not held in an interest bearing account.

For the poorest individuals the cost of travel and the time lost in reaching the cash access point is highest. An average Mexican loses around USD 1 per month. In the US, people spend 28 minutes per month accessing cash, with the lowest income individuals spending on average 5-10 minutes longer. Specifically those with no bank account or unemployed. This time and money lost travelling to and queuing at a cash access point, as well as paying the access fee results in a huge loss of productivity.

If these costs were to be calculated into a “cost per transaction”, it would become obvious that cash is clearly not the cheap option we all perceive it as. And certainly not for those who rely on it most heavily.

Furthermore, it is important to recognise the costs to the government. On a macroeconomic level, producing, securing, and distributing physical notes and coinage costs around 1–2% of GDP in developed countries, and 5–7% of GDP in developing countries. These costs may seem invisible but are in reality a huge burden on the economy.

Today, cash may be the cheapest option but it certainly isn’t free. Looking to the future of a cash lite society, we can identify three key steps that must be taken: the first is the significant reduction in transaction fees and provision of a service that can process true micro transactions digitally –  even less than $0.01. The second is the creation of a fully interoperable digital ecosystem through the central bank issuance of a national digital currency. Thirdly,  we must consider the use of an extremely efficient and secure technology that is able to power the transactions of entire national economies.

It is unlikely in the near future will see total eradication of physical cash, however the benefits associated with the introduction of a widely used digital payments systems will be huge: lowering the barrier to access financial services, stimulating financial inclusion, and adding huge value to a country’s economy.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

Solutions Delivered by Cryptofinance and Blockchain Technologies

May 9th, 2016 Posted by Cryptofinance technologies 0 comments on “Solutions Delivered by Cryptofinance and Blockchain Technologies”

“It sounds like pretty soon we won’t need banks” is the fearful comment I hear from finance professionals when we talk about cryptofinance technologies. The nascent cryptofinance industry is off to a slightly confusing start, and I think these type of comments are a symptom of that. You probably arrived here thanks to the term “blockchain”, which is what most people think of when they hear about cryptofinance and fintech. Let’s address that first.

“Blockchain”, or the even more verbose and politically correct term “distributed ledger technology”, is Bitcoin. Bitcoin was created to be a transparent, scarce, fungible, censorship-resistant tool of exchange. I think a true story might help to clarify Bitcoin’s value proposition.

For about 70 years, a small family ran a leather shoe making and repair business. Their close attention to detail, friendly customer service, and reasonable prices kept their business growing. But over the years, economic conditions around them deteriorated, and their customers started shopping elsewhere. They knew they had to get up to speed with the rest of the world and start offering their products online.

This boring story ends “so they started selling their shoes online and lived happily ever after”, right? Sure, some people can just create an eBay store and call it a day. But this family business happens to be in Iran, and for a long time the banks in Iran couldn’t do business with the rest of the world. There was no PayPal, no eBay, no Western Union that could come to the rescue. There was simply no company that could help these entrepreneurs get paid for their products. So what could they do? Interestingly enough, they learned about Bitcoin and started accepting it as a payment method. They built a solid reputation for themselves online and started shipping their products worldwide. Today Bitcoin remains that business’s sole payment method.

Bitcoin’s success has brought a lot of interest to cryptofinance, and Bitcoin is certainly valuable in a number of ways. But it’s like gold, in that you don’t want to carry it around with you all the time and try to use it for all of your business needs. So what’s the right cryptofinance “thing” for your business application? The answer of course, is that it depends on your application. But realistically, the answer is probably digital contracting.

Digital Contracting

Digital contracting comes after Bitcoin, and borrows and improves upon some of its technology. It is not a “blockchain”, but you can certainly move between the two technologies with ease. Digital contracting provides the things that satisfy business needs:

  • Everyday currencies can be used
  • Easy to be in compliance or regulate
  • Unique units can be used based on need, like healthcare or education credits. Because it’s a digital contract, it can’t be spent in the wrong place
  • Contracts written in plain english, in case there’s a dispute
  • Distributed proof of ownership, in case there’s a dispute. Some might call this “distributed ledger technology”
  • Very low cost transfers, so everyone can use it in perpetuity
  • Instant “settlement”, meaning the transaction can’t be reversed in any way and there’s never any doubt as to who the owner of a thing is
  • Instant exchange for digital assets, currencies, physical cash, or anything else
  • Your activities are private; it would be nearly impossible for almost anyone except for yourself and law enforcement to see your financial history
  • 24/7/365 transfers, with no respect to timezones or geography

What’s the big catch with digital contracting? The catch is that it doesn’t do the things that Bitcoin sets out to do. It’s not designed to be censorship resistant, because it’s a business tool. It’s not designed to be completely trustless (read: slow); it’s designed to provide complete certainty in the event of a contractual dispute. It’s open just enough to be completely legal and accepted in all jurisdictions, but at the same time it’s private and protects you fully against your competitors seeing how much you pay your employees, or your siblings from seeing how much money your grandma sent you for your birthday.

Applications

There are a lot of industries that will benefit from digital contracting and there are already a lot of solutions being built. Here are a few notable applications for digital contracting:

  • Merchant processing, bill payment and remittance
  • Commercial payments, such as pensions and salaries
  • Trading and registration systems, such as stock and commodities exchanges
  • Coupons, tokens or other digitally scarce assets, that could be used for customer retention, offers of discounts or other promotions
  • Voting systems, where a limited number of voting tokens are created, distributed, and redeemed

There’s really only one unfortunate thing about digital contracting, and it’s that at the moment there’s only one company that is offering solutions in this space (Monetas). On the bright side, I think it’s a very good company! (Disclaimer: I work there!) But the way technology is moving and the amount of talent I see heading in this direction I expect many more to join in the next few years. So, getting back to that troubling question from the beginning: will banks still exist in the future?

I think yes, but I also think that they will start to look like very much like cryptofinance software companies.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.