Four powerful forces—cryptocurrencies, the decoupling of geographical and monetary boundaries, ad-based digital platforms’ foray into the world of payments, and the value of data—are threatening the familiar world of payment systems. The EU has to choose the proper route to follow, and it must do so sooner rather than later.
Editor’s note: The following is based on testimony given before the European Parliament’s Committee on Economic and Monetary Affairs on July 13.
Every aspect of banking and finance is undergoing a radical transformation throughout the world. National and international regulation is shaping this transformation. There is no more important area—both because it is at the very foundation of any financial system and because it has important regulatory and geopolitical considerations—than the payment system.
Since the middle of the 17th century, the world has progressively converged to one model of payments: inside the geographic boundaries of a state, payments are made in a domestic central-bank issued currency, via private deposit-taking institutions. Internationally, payments are made in US dollars via private deposit-taking institutions and a cumbersome system of communication, also known as SWIFT.
Four powerful forces threaten this familiar world. First, the rise of cryptocurrencies. Please do not think about bitcoin. While technically brilliant, bitcoin has no future as a payment system, because of its volatility and its very high (and polluting) operating cost. Yet, many of its subsequent imitators are well positioned to provide international payments almost at zero cost. Today, the $702 billion of international remittances are burdened by $46 billion in fees. Eliminating these fees would automatically transfer the same amount per year to some of the poorest people in the world, providing the largest international welfare program ever conceived.
Second, the decoupling of geographical and monetary boundaries, due to the digitalization of money. In the past, it was costly for local merchants to accept foreign currencies, because conversion often had to cover the cost of physically transporting the currency back to its country of origin. Today, with electronic money, that cost is trivial. As a result, it is more tempting for countries with unstable currencies to “dollarize,” i.e., to accept a foreign-issued currency as primary medium of exchange.
Third, the entry of ad-based digital platforms into the world of payments. By now, it is well known that platforms like Facebook and Google offer us many free services (search, email, communication, navigation) in exchange for our data. The obvious next step is for them to offer us free payment services in exchange for our data. In doing so, they will be able to undercut any competitor who cannot use data as efficiently as the digital platforms can.
Finally, the increasing value of data, not just from an economic point of view, but also from a political and geopolitical perspective as well. Payment data can be used to monitor and incapacitate terrorists, criminals, and rogue nations. The United States has used this power very effectively, particularly after 2001, to track terrorism financing and to enforce sanctions against Russia and Iran.
These powerful forces will shape which payment system will prevail in the future: one based on central bank digital currency (CBDC), on private companies currencies (like the initial version of Facebook Libra), or on stablecoins, like USD Coin or the second version of Facebook’s Libra, renamed Diem. The outcome will not be solely determined by the relative efficiency of these three solutions. In a market where every buyer wants to carry the same currency their potential trading partners are using (what we economists call network externalities), there are multiple equilibria, with different level of economic efficiency and very different distributional consequences. As the example of the international transfers shows, which systems prevail can reallocate $46 billion from a few banks to the pockets of millions of poor.
The rents at stake are enormous. Just the seignorage derived from the US dollar bills held abroad is estimated at $30 billion a year. The “exorbitant privilege” derived from the reserve status of the US dollar is worth at least $514 billion a year. These figures do not account for the political and strategic benefits derived from controlling the main hubs of the international payment system. Who will get these rents will depend in large part on the cooperation of the United States and Europe.
Governments around the world have adopted three different approaches. The United States has left all the choices to the private sector, confident that the technological advantage of its firms will protect the dominance of the US dollar and its strategic role throughout the world. China relies on the introduction of a central bank digital currency, which will become the center of a new payment system, certainly nationally, but in the Chinese perspective also internationally. One of the main reasons why the Chinese government has chosen this path is the fear that private companies might control more data about its population than the government itself. The third approach, pioneered by India, consists of a private public partnership. With an enormous effort, the Indian government has produced a universal anthropometric measure of digital identity (aadhaar). Thanks to a joint venture with the private sector, the Indian government has also produced a uniform payment interface, which any provider can use. By creating a common standard, the Indian government has insured a high degree of competition in the sector, with all the benefits that this entails.
At present, these choices are confined to the countries of origins, but it is easy to imagine how the digital renminbi could become an attractive currency for many countries in Africa, especially if they trade intensively with China, displacing the dollar as the main international currency for the area.
The EU has to choose the proper route to follow. This choice cannot ignore the military alliance with the United States that most EU countries have, but it should also not ignore the different sensitivity that Europeans have about data privacy, or the specific economic interests of EU members. By agreeing with the United States on new standards and regulations for payments, the EU can influence the final outcome. Yet, this effort must be done now: When a market with strong network externalities starts to tip in one direction, it is very difficult to reverse it. By that time, any intervention will be fruitless.