It’s broadly agreed that the rails that exist for payments – both domestically and globally – are antiquated. While there has been any number of advances and shifts toward digital wrappers and new ways for consumers to move money around, on the backend the payment rails themselves are roughly the same as they were 50 years ago.
Those rails have built the backbone for a financial system that, ultimately, just doesn’t work for everyone. Fees can be shifted and moved around – with harsh overdraft fees built in for the poorest and many ways to game the system for the wealthiest seemingly built in as features.
It’s a topic we’ve covered the basics of before, but the work being done to create better digital alternatives for the future has only gotten deeper over the years, and was the subject of a roundtable discussion at the Chicago Payment Symposium last week.
Imagining a Better Financial System
“This (current payments) system has a load of issues,” said Shamir Karkal, Co-Founder and CEO at Sila, a FinTech firm dedicated to rethinking ACH. “Banks operate by creating credit, so they lend more in good times and less in bad. This creates huge amounts of debt because banks have a strong incentive to do so; that’s how they make their money.
“But this isn’t the only possible financial system. We can imagine a better one. Think of a central bank that creates most of the money in the system and lets end users directly bank through it – at the Federal Reserve or even a global central bank. Maybe it’s hard to imagine a central bank being able to directly manage all of those services in-house, but unlike in the past, we have API platforms now. It’s not too hard to build provisional services hosted by intermediaries even with the central bank handling the funds themselves.”
Such a system, of course, couldn’t run over the traditional payments rails. It would need new ones, custom-built for a more agile digital environment.
“We have digital bank deposits, but we’re thinking beyond that because bank deposits have very little functionality attached to them,” said Neha Narula, Director of the Digital Currency Initiative at the MIT Media Lab, who moderated the panel. “So we’re seeing a lot of demand for stable coins, which run on a blockchain and try to maintain par with a fiat currency counterpart, usually fully backed by bank deposits – or another type, which doesn’t require an intermediary institution using an algorithmized smart contract.”
The reason these new forms of currency are at the core of discussions for a different kind of banking system is that there is, to date, no digital cash equivalent anywhere in the world. Without it, there’s no good way to move currency around; paper and hard asset equivalents are still tied down to the old rails.
Beyond the Theoretical
What industry insiders call a Central Bank Digital Currency (CBDC) is the goal, and blockchain technology may be the best-suited method to provide this digital cash. And getting there requires taking a hard look at the goal: digital money not just as a monetary instrument, but as a payments instrument.
“The monetary instrument portion is just as a startup value; who issues or backs the currency,” said Wee Kee Toh, Deputy Director of the FinTech and Innovation Group of the Monetary Authority of Singapore. “But money is really a payment instrument, a medium of exchange. The focus is on how people transact with it. This is about defining the relationships between the issuer and the users of the tokens, and the money these tokens represent. The different models take a similar view from the perspective of payments innovation. This is actually a common theme you’ll see across various different platforms.”
The other question about CBDC model is, broadly, about wholesale and retail. Wholesale CBDCs are helped by banks, with systems in which banks transact on central bank money. Technologies tend to focus on wholesale. Businesses, conversely, tend to focus a lot more on retail, which is more concerning the monetary economic implications of a digital shift.
Programming Money
For blockchain-based solutions, the consensus is increasingly focused on an open-source, programmable blockchain called Ethereum.
“Ethereum can be both permissioned and public,” said Lex Sokolin, CMO and Global Fintech Co-Head at fintech ConsenSys. “And that’s important for a variety of use cases. A permissioned enterprise blockchain offers a single layer with mutualized data that anchors the data around particular asset classes/business activities.”
That notion of mutualized data can mean a lot of things: ledgers of money movement, authenticated lending documents, real estate assets, etc. are all simply data for the purposes of a digital system, and the ability to easily combine them is core to the technology.
“Once you have that anchoring, you can create workflows and things applied as software,” Sokolin said. “Once you have the software, you start talking about the assets you might want to apply the workflows to. So rather than just anchoring real-world activities – agreements to settle, etc.- not only are you moving around these assets, but you’re also building your financial processes into the programming environment.”
One way to think about it, he said, is to consider companies like Fiserv or Envestnet or the larger card networks as performing their function within a blockchain-based network all on the same rail. They are using all the same standard protocols and systems. “So all your assets are essentially all mediated in the same software and technology. That’s the path we believe programmable blockchains can take us along,” Sokolin said.
The core idea is to build a modular approach to money, rather than the current purpose-built individual solutions: creating systems that can be used for multiple assets or purposes.
The Evolution of Payments
Realistically, these kinds of systems may seem like they’re a long way off, but the trend is towards evolution, not an overnight replacement: and it’s already happening. Tether, the largest of the stablecoins linked in value one-to-one with the U.S. dollar, currently holds $15 billion in total supply.
“I don’t think it’s going to be an either-or for these things; it’s going to have to be and,” Karkal said. “The vast majority of value on the planet is locked up in the traditional system. We can’t replace that wholesale. All the new systems will get built as layers on top of the old, and interoperability will be hugely important.
“Payments systems never actually die – settlement via gold still happens! They just recede into the backend. I think globally interoperable systems will evolve, and they will be integrated on top of existing systems in different geographies, unlocking huge waves of applications that transform everything.”