The impact of digital money on how payments are made

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Payment services have made significant progress. Since 2008, when the Faster Payments service was introduced in the United Kingdom, instant payment around-the-clock has become a global norm. It is delivered not by blockchain technology but through domestic payments market infrastructures. In fact, payments infrastructures now process higher volumes of low value transactions and inter-bank payments more securely than ever before. 

Other innovations are having an impact. Open Banking, also pioneered in the United Kingdom, has (despite its shortcomings) intensified competition in payments. One consequence is that embedded finance - or integrated Buy Now Pay Later credit services - are readily available at retailers. The United Kingdom has also led the world in giving non-bank Payment Service Providers (PSPs) access to settlement in central bank money. 

The keys to cash payments on blockchains - namely, Stablecoins and E-money, which must be 100 per cent covered by cash on deposit at an independent bank - are either available now or awaiting regulatory approval. Digital wallets are readily available (indeed, the problem may be not a lack but a surfeit of them). A steady movement away from card intermediated payments to peer-to-peer and account-to-account payments out of digital wallets, saving retailers card fees, is gathering momentum. 

In corporate payments, payment versus payment (PvP) in cash and FX or delivery versus payment (DvP) in securities is replacing reconciliation and balance sheet updating between correspondent banks. Instant settlement is replacing the three-day settlement cycles of the past. Early payment is reducing the cost of liquidity, including the cost of cash and collateral. Payment transaction costs, which range up to 2 per cent for domestic payments and average 6.4 per cent in cross-border payments, are falling. 

An important question is what digital money could do to improve on these gains. Clearly, payments entrepreneurs believe there is still room for improvement. Consultants BCG have counted 5,000 FinTechs active in payments around the world. They predict that by 2030 FinTechs will own a quarter of a global payments market they say will be worth US$2.2 trillion in 2027. Which probably means not that a digital money revolution is imminent but that banks have struggled and are continuing to struggle to compete.

However, much of the improvement is more apparent than real. Instant payments are not instant, batch processing is more common than real-time processing of payments, and the most popular digital wallets continue to rely on banks and existing payment infrastructures. There are no genuine peer-to-peer, wallet-to-wallet, app-to-app payments going on. Banks have also resisted changes that might reduce their profits, notably in Open Banking, where they have made it hard for apps to succeed. 

The biggest potential benefit of digital money – namely, programmability – remains a pipedream. Expectations that money could be programmed to limit the use of funds to avoid expenditure on alcohol or tobacco or gambling, restrict the use of welfare payments to energy or food or rent, defer payments of suppliers until milestones are reached, self-execute payments by smart contracts once data oracles trip switches, make payments only if supplies are actually received and reduce chargeback and refund costs when goods are returned, remain mired in the realm of theory only. 

The forms that future money could take – Stablecoins, tokenised deposits, Central Bank Digital Currencies (CBDCs) and e-money – have proliferated, but without escaping niches (including criminal niches) or attaining scale or developing an inter-operable infrastructure that would drive network effects. Experiments with Bitcoin (in El Salvador) and CBDCs (in the Bahamas, Eastern Caribbean, Jamaica and Nigeria) as payment instruments have not enjoyed conspicuous success. Tokenised deposits remain intra-bank only. So far, the impact of digital money on payments is unimpressive. 

Benefits

• Cryptocurrency payments infrastructures are merging with conventional payments infrastructures, through fiat currencies issued on to blockchain platforms in the form of Stablecoins and e-money within regulatory frameworks such as the Markets in Crypto Assets Regulation (MiCAR). 

• The Internet of Things (IoT), in which domestic devices are connected to the Internet and initiate transactions, demands programmable money, real-time settlement and micro-payments, and this will drive further convergence of blockchain-based and conventional payments systems. 

• The traditional method of settling payments by reconciliation and netting and the debiting and crediting of bank balance sheets will be replaced by a payments system in which value is transferred in tokenised form across the Internet in the same way as other forms of data. 

• Cross-border, cross-currency payments will become faster and cheaper, with fewer intermediaries levying transaction costs, and more rapid crediting of accounts reducing the capital and collateral costs to corporates of maintaining liquidity in multiple locations around the world. 

• Embedding finance in the business of non-financial companies is transforming the payment experience by replacing cards and bank-to-bank payments with regular payments into an account coupled with approvals to debit the account made via an officially regulated and authorised (by Open Banking) app. 

• Bank issuance of Stablecoins is expected to increase significantly, because of the attractions of net interest margin, and as the rules prepared by international regulators for systemically important Stablecoins bed down and national regulators start to approve applications to issue a Stablecoin. 

Issues

• Suggestions that “gas fees” payable on cryptocurrency transactions are high by comparison with conventional payments are misplaced because, although “gas fees” spike occasionally they are stable and low enough most of the time and can be managed via layer two applications anyway. 

• The separation of the payment process from the underlying transactions should be further narrowed by embedding invoices and receipts into the payments process, eliminating the need for subsequent reconciliation by integrating the transaction, the payment and the documentation. 

• Technology has not solved the cost and friction associated with management of the risk that money is being laundered or defrauded by pausing payments until they are validated, though UK payments service providers (PSPs) must from 7 October 2024 make customers whole for push payment scams. 

• Innovation in the payments industry is not keeping up with the demand for better payment services created by faltering economic growth and rising inflation, which has increased the interest cash-strapped consumers take in achieving value for money in financial services. 

Regulation

• An obvious solution to payments fraud, implemented in Australia already, is digital identities, which can be attached to every transaction and so mitigate the need for delays to validate payers and payees, but the United Kingdom government has resisted adoption on grounds of voluntarism and privacy. 

• There is a risk that central banks that launch retail central bank digital currencies (CBDCs) will crowd out private sector investment in payments innovation, especially if they elect to supply services (such as wallets) rather than focus on protecting consumers and regulating private service providers. 

• The infrastructure that central banks provide and operate to support digital payments must be built on a recognition that Stablecoins, tokenised deposits, CBDCs and e-money will continue to exist and must be inter-operable as different parts of a common payments system. 

• There is a risk that the transformation of payments will be inhibited by a failure of inter-operability, isolating the most progressive payments innovations within silos where the benefits of a higher quality of service will be enjoyed by relatively small and closed business and retail networks only.