The New Digital-Payments Race
In the classic account of technological disruption, small, flexible upstarts topple large, plodding incumbents because the latter fail to grasp the radical implications of innovations. But in the case of payments systems, central banks are not typical incumbents, and are more likely to facilitate the revolution than be devoured by it.
LONDON – Steve Jobs is said to have had only one business book on his must-read list: The Innovator’s Dilemma, by the longtime Harvard Business School professor Clayton M. Christensen (who passed away earlier this year). Few books have left such a lasting impression on business leaders. And now that central bankers are confronting potentially disruptive innovations in payments, they would do well to absorb its lessons, too.
Christensen showed why incumbent firms often fail to harness the next wave of innovation within their own industries. The problem, he concluded, is not that incumbents are blind to the threats posed by startups, but that they do not recognize the radical potential of new technologies and processes. Focused on short-term profits, they tend to assess disruptive innovations with an incrementalistic mindset, and thus fail even to imagine how a new entrant could capsize an entire sector seemingly overnight.
Throughout the digital era, Christensen’s work has motived many tech startups to pursue disruption with the confidence that incumbents will be slow to respond. For central bankers, then, the key question is whether payments systems themselves are on the verge of being disrupted. After the 2008 financial crisis, it was generally assumed that onerous regulations and capital requirements would deter new entrants to the banking and financial sectors. But that presumption is being challenged, not least by Facebook, which caught most central bankers by surprise when it unveiled its Libra currency last year.
Libra, a digital “stablecoin” and payments system, has triggered some interesting conversations, and helped to raise awareness of the relatively high costs of some types of payments, particularly for remittances and small businesses operating across borders. It has also prompted central bankers to respond, with the Bank of England (BOE), the Bank of Japan, the Bank of Canada, the European Central Bank, Sweden’s Riksbank, and the Bank for International Settlements establishing a “blockchain working group” to assess the prospects of a central bank digital currency (CBDC).
How revolutionary are the latest developments in digital payments? Here, we should consult Christensen’s basic definition of a disruptive innovation:
“First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits. Second, disruptive technologies typically are first commercialized in emerging or insignificant markets. And third, leading firms’ most profitable customers generally don’t want, and indeed initially can’t use, products based on disruptive technologies.”
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Looking at the payments domain today, it is clear that many new services are both cheaper and substantially better than the older alternatives. Ant Financial, the Chinese payments giant (an affiliate of Alibaba), has almost one billion customers – five times more than the largest US bank. Together with WeChat Pay (an affiliate of Tencent), it handles almost 90% of all mobile payments globally; both have facilitated commerce at scale and significantly improved financial inclusion. The same goes for PayTM, an Indian payments platform with well over 300 million clients (many of them small businesses), and Stripe, a US platform that has become the world’s most valuable private fintech firm in just over a decade.
Given the rapid growth of these new entrants, I suspect we will see a three-horse race between new private tokens, CBDCs, and efforts to improve the current system by accommodating new payment platforms. A new global private currency tethered to anything other than a fiat currency seems highly unlikely. As the economist John Paul Koning has argued, Libra “has about as much chance of displacing the dollar as Esperanto has of replacing English.” Besides, a company whose founder established it with the motto “Move fast and break things” hardly inspires confidence that it is equipped to build a new payments system that could underpin the entire global economy.
Private currencies also don’t mesh well with the current political environment, which increasingly features demands for more national sovereignty. In any case, new regulations and barriers are already being erected, suggesting that closed networks that use tokens to transfer value securely at scale, rather than Libra-style “stablecoins,” are a better bet.
The idea of a CBDC is alluring, but presents major challenges of its own. For starters, there could be far-reaching unintended consequences if central banks were to compete directly with banks in this domain. Under current conditions, we don’t actually use much central-bank money on a day-to-day basis. In the United Kingdom, for example, only about 3% of the money in use was issued by the BOE; the remaining 97% represents claims on regulated private banks.
One key lesson from the financial crisis is that the financial system is far more complex than traditional macroeconomic models assume. We were reminded of this again late last year, when the repo market suddenly almost seized up, forcing the US Federal Reserve to provide around $400 billion in emergency liquidity.
Given these fragilities, any radical changes at the heart of the financial and monetary system should be considered with extreme caution. Indeed, China’s own foray into the CBDC domain will reportedly adhere to a classic two-tier structure. Chinese policymakers will be able to explore some of the narrower potential benefits of crypto-technologies without having to replace the entire system.
The limits on private currencies and the precautionary attitudes of central bankers suggest that the digital currency and payments domain will be spared from the broader techlash. Central banks will likely take a page from BOE Governor Mark Carney’s playbook and act as a “platform for innovation,” by bringing payment firms closer to their own inner sanctums. Such overtures are likely to involve extensive collaboration with payment firms to improve speed, reduce costs, and prevent fraud.
As for the longer-term future of payments, the policy agenda should focus on shaping better protocols and messaging standards, enhancing cybersecurity – including stress testing payment firms – and enabling better digital identification (an area where India, China, and several other countries are leagues ahead of everyone else). Next-generation payments regulation will need to recognize the value of data and open finance, and policymakers will need to prepare for cash-lite economies, to ensure that the new payments systems work for everyone.
For policymakers and financial market participants alike, fundamental changes are on the horizon. Given the far-reaching uncertainty this implies, central bankers should consider adding another book to their reading lists: Only the Paranoid Survive, by Intel co-founder Andy Grove, another committed student of Christensen.