Digital Money

A quantum of dollars

[Dave Birch] The introduction of the word "quantum" into a paragraph not about physics usually signifies the start of something entirely bogus, like Californian new age healing or post-modern deconstructionist thinking. However, when it comes to digital transactions, heavy users of applied cryptography, there is a reason to take quantum speculation seriously because it will in time lead to entirely new developments in digital money and digital identity. Pop over to the e-prints library arXiv and have a look at a paper from MIT.

Breaking and making quantum money: toward a new quantum cryptographic protocol

[From [0912.3825] Breaking and making quantum money: toward a new quantum cryptographic protocol]

I was reminded of this paper by the article about quantum cash in last week's New Scientist. Having read the article two or three times to try and understand it (bear in mind that I actually have a degree in Physics) i decided that it probably wasn't ready for the short-term roadmaps of our customers.

To physicists, quantum cash is a toy problem, a sort of test case with which to study the strange properties of quantum mechanics.

[From Schrödinger's cash: Minting quantum money - physics-math - 20 April 2010 - New Scientist]

Well, it may be a toy problem, but it's a tough problem. In the original conception of quantum cash, where the authenticity of the banknote depends on the polarisation of a number of photons, you could only use the note once (because measuring the polarisation of the photons would change them) and only the issuing bank could tell you whether the polarisations were correct or not. This isn't much like a banknote, where you or a shopkeeper can self assay. The New Scientist article discusses a new idea, a hybrid between quantum and public key cryptography.

In Aaronson's scheme, so-called "public key quantum money" is always issued in two parts. The first is the quantum state. This might belong to a group of photons with a particular set of polarisations, which the issuing bank keeps secret. The second part is a circuit (or the plans for such a circuit) that verifies whether the secret set of polarisations is present in something purporting to be quantum cash. Such a circuit would be to quantum transactions what an ultraviolet light is to today's banknotes.

[From Schrödinger's cash: Minting quantum money - physics-math - 20 April 2010 - New Scientist]

There's another problem, which is that even if you can make money that can be verified by anyone and not counterfeited, how do you stop the bank from creating clones and putting them into circulation? This is entirely hypothetical, of course, and I'm not for one moment suggesting that banks would create financial instruments with a face value that exceeded the value of the assets behind them many times over. But just hypothetically? The authors have come up with a solution, which is to use a state for the quantum money that is constructed in a way that is known but not replicable.

This state is a superposition of an exponentially large number of unrelated terms each of which is created by the measurement of an equally exponential superposition. Incorporating this quantum measurement into the process of creating the quantum money ensures that a bank cannot reproduce this state, even though it knows how the initial superposition was created. At least, the bank cannot do this in any reasonable amount of time.

[From Technology Review: Blogs: arXiv blog: Unexpected Problems For Quantum Money]

Got that?

Counter-feat

[Dave Birch] I saw a story in Metro about a chap who was arrested in Tesco for trying to pay with a Northern Ireland twenty pound note. The staff though the note might be a forgery and refused to accept it, whereupon the narked consumer complained and the police were called. He got arrested and spent the afternoon in Bournemouth nick before being released without charge. Tesco said that they have the right to refuse any note (neither Scottish nor Northern Irish banknotes are legal tender in England, also they are generally accepted as a courtesy for historical reasons). I have to say that I'm sympathetic to the Tesco staff: after all, how are they supposed to know that the note they are presented with is real, even if they do know whether it is legal tender or not? I'm not sure whether I could tell a forged British twenty from a real one and I certainly wouldn't know whether a Scottish note is real or not. For that matter, nor would most Scots since the design seems to change constantly and they are issued by three different banks with three different designs.

I think the situation is even more confusing when you have old and new notes circulating together outside the country where they are legal tender, as will be the case with the US $100 bill. How is your typical South American drug dealer or Somali pirate supposed to know which bills are real and which are fake? Try and pay with one of the new bills with extra anti-counterfeiting features and you might get your head blown off let alone an afternoon with Bournemouth plod.

Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke unveiled a new $100 bill equipped with two new security features. The bill will go into circulation Feb. 10, 2011.

[From U.S. Unveils New $100 Bill - WSJ.com]

There is currently around $890 billion in $100 bills in circulation, two-thirds of which are outside the U.S. This represents an interest-free loan to Uncle Sam that is heading towards $1 trillion. At 5% per annum, that's $50 billion per annum to the Federal Government for doing nothing. These notes are not, of course, actually "in circulation" but stuffed under mattresses in various parts of the world. In fact, even in the US already you can't actually use them for some retail transactions. In that great TV comedy "30 Rock", comedienne Tina Fey (as her character Liz Lemon) was at one point complaining that "the ATM gave me a $100 bill... it's like Confederate money, no-one's going to take that".

This is something we're seeing quite a bit of already, as the majority of stores don't accept $100 or $50 bills, even in some cases $20 bills, because of an increase in counterfeit money. The biggest growth area for cards in the coming years will be in transactions of $20 and under.

[From The future of e-payments - The Globe and Mail]

As the noted futurologist and savant Andy Warhol wrote way back in 1975...

"if you give anybody a hundred–dollar bill in the SUPERMARKET, they call the manager”.

Malcolm Cooper

[Dave Birch] Malcolm Cooper is the author of "In Search of the Eternal Coin" and the Official Historian for the Long Finance project. He holds a First Class Bachelor of Arts in History from Dalhousie University, a Master of Arts in History from the University of Western Ontario, and a Doctorate of Philosophy in Modern History from Oxford University. His career has included a Research Fellowship at Downing College, Cambridge, management of the research programme of the Institute of Chartered Accountants in England and Wales, equity research management with three different investment banks and a five year spell as Head of Research for the City of London Corporation. His most recent post was as Head of research for the independent public policy think tank Centre for Cities.

Malcolm commissioned and worked with Z/Yen on the Global Financial Centres Index, and has since written several pieces on the impact of the recession on financial services employment in the UK. He is involved in both the London Accord and Long Finance initiatives.

Long Finance aims to improve society’s understanding and use of finance over the long-term, in contrast to the short-termism that defines today’s financial and economic views. Our goal is to develop a Long Finance movement that submits challenging ideas and options to rigorous analysis and vigorous debate. Along the way we hope to have some intellectual fun. The Eternal Coin in the iconic project for Long Finance and in this podcast Malcolm discusses the Eternal Coin and the long history of value.

Listen here in either [Podcast MPEG4] or [Sound-only MP3] format.

Genghis did have some good ideas

[Dave Birch] China continues to fascinate, especially given the news that one of the companies that we look at from time and time again, Tencent, is now taking a stake in DST, the Russian holding company that owns part of Facebook. Tencent are famous (to me) for their QQ Coins, a very popular virtual currency in China that we have looked at again and again because the sheer scale of their use makes them a case study for the impact of virtual currency. You may remember that the Chinese government have not been entirely happy with the astonishing success of QQ's currency.

The Chinese government had a bit of a crackdown on QQ coins with the predictable (to economists) result: the price of the money went up (in fact it went up by 70% against the Yuan) which clearly indicates that there is a significant unfulfilled consumer demand for the new currency.

[From Digital Money: What kinds of competitors?]

Tencent runs social network and instant messaging services, but its business models makes use of virtual goods rather than being advertising-based.

Unlike its U.S. counterparts Tencent makes money by relying on users to spend money within its networks, not on brands to advertise on it. For example, online advertising is a small part of Tencent’s overall revenue, or only 10 percent, while e-commerce represents about 70 percent of the company’s overall revenue (mobile makes up the rest). In all, it sells about $750 million in virtual goods a year.

[From How One Social Net In China Is Making A Lot Of Money | paidContent.org]

Interesting, to say the least! It's not just Tencent's QQ Coins that are causing concern to the authorities. Last year, a senior official with the People's Bank of China said that the rapid development of e-money and online payment systems "affects the central bank's monetary policies". Is this right? What are the figures?

The amount of cash in circulation reached 3.4 trillion yuan ($500 billion) last year, and the gross payment, the total amount of money exchanged in transactions nationwide, was 1.13 quadrillion yuan ($166 trillion) as of last December, according to Ouyang Weimin, director-general of the Payment System Department of the PBC... "The gross payment has risen rapidly, but the cash in circulation has kept steady at around 3 trillion yuan ($441 billion) these past few years. This indicates a rapid increase in the use of electronic money and online payment."... Of the more than 10 trillion yuan ($1.5 trillion) in gross retail sales last year, electronic payment through bank cards reached 3 trillion yuan ($441 billion).

"More than 1 trillion yuan ($147 billion) cash went into circulation in 2005. From this we can see the increasing liquidity, which may cause inflation, partly due to the frequent use of electronic payment," said PBC's Ouyang.

[From Global Times - E-money poses problems for central bank]

This is an understandable concern, but if the cash is not being used for transactions then it is less of a worry. The figures show that in China, just as in Europe and in America, the amount of cash in circulation continues to increase significantly, but the fraction of retail payments in cash is falling. So what is the cash being used for? Who can say: some of it is probably being hoarded, but there must be a suspicion that some of it is being used to fuel less-regulated parts of economy. Presumably the authorities will at some time become concerned, but will they want to start a Chinese war on cash? I think they may, and given the administrative arrangements in China compared to Europe, say, then one might predict a greater likelihood of success. Back in the day, Genghis Khan created a paper money system through the simple expedient of capital punishment, instituting the death penalty for anyone who tried to use gold or silver instead of his accept paper money.

As Marco Polo noted in his "Travels"... "Furthermore all merchants arriving from India or other countries, and bringing with them gold or silver or gems and pearls, are prohibited from selling to any one but the emperor. He has twelve experts chosen for this business, men of shrewdness and experience in such affairs; these appraise the articles, and the emperor then pays a liberal price for them in those pieces of paper. The merchants accept his price readily, for in the first place they would not get so good an one from anybody else, and secondly they are paid without any delay. And with this paper money they can buy what they like anywhere over the empire"   

The Chinese fiat currency system eventually collapsed in hyperinflation (as I suppose they all do in the end) in the 14th century, but I digress. So far as a potential war on cash goes, the Chinese central bank says that

Compared with cash, electronic money has advantages such as lower cost and higher efficiency... "The cost of electronic money is just 35 percent of that of a cash payment"... However, it brings problems such as payment safety and supervision difficulties, Guo Tianyong, director of the Research Center of the Chinese Banking Industry at the Central University of Finance and Economics, told the Global Times.

In April, the PBC launched its first investigation into the payment business of non-financial companies, including online payment services like Alipay.com, China's PayPal, virtual money providers like qq.com, and shopping malls and supermarkets issuing shopping cards.

[From Global Times - E-money poses problems for central bank]

Incidentally, Alipay (which is China's leading e-payment system with more than 200m users)has just announced another five billion Yuan investment in its infrastructure, which must reflect confidence in the continuing growth of the online payments sector there. There's still a long way to go though.

In many parts of the world it is a difficult to buy things online with traditional currency and traditional payment vehicles such as credit cards. The phenomenal growth of virtual worlds, virtual items and virtual currency in China is directly related to the lack of good ways to buy and trade things online in a traditional manner.

[From Kevin's Corner: Virtual Currency Meets Main Street]

The market needs payments, but it works the other way round as well. New payment systems (that work) create new markets on top of them. The Chinese have so far focussed on introducing "Western" payments to their domestic market (although under a local monopoly) but I wonder if it might develop further by creating new payment systems more suited to the local market? There are a staggering 1.5 billion payment cards in the Chinese market already but

Of the huge sum, active cards, which were used at least once every month, were only about 80 million, less than 10 percent of the total... The large number of dormant cards is partly due to payment habits of some domestic consumers, who prefer cash transactions instead of the "virtual numbers" on the cards, analysts said. Besides, to lift market shares, domestic banks issued a massive number of cards to take in as many clients as possible. Many cards were scarcely used after issuance.

[From Bank cards pose challenge yet opportunity]

This all looks puzzling from a pure market perspective: QQ Coins are successful, so crack down on them and issue everyone with cards that they don't use instead.

Bernard Lieater

[Dave Birch] Bernard Lietaer is an economist and former central banker who is well-known as a leading thinker in the field of alternative currencies. He spoke on the Future of Digital Money at the Digital Money Forum back in 2002 when we gave copies of his book "The Future of Money: Beyond Greed and Scarcity" to the delegates. He knows what he's talking about: while at the Belgian Central Bank he implemented the convergence mechanism (ECU) to the single European currency system, he co-founded one of the largest and most successful currency management firms, GaiaCorp. Business Week named him “the world’s top currency trader” in 1992. In this podcast, he talks about alternative currencies and how they might evolve over the coming years.

Listen here in either [Podcast MPEG4] or [Sound-only MP3] format.

Ad valorem, add value

[Dave Birch] Thanks to our friends at Payments News, I found myself reading a fascinating piece in the Federal Reserve Bank of Kansas Economic Review called "Regulating Debit Cards: The Case for Ad Valorem Fees". It says, in essence, that in the US most debit card transactions have a percentage fee (unlike, say, the UK where merchants pay a fixed fee of a few pennies per debit transaction) which, the economic analysis shows, reduces merchant profits but leads to an increased consumer surplus and overall social welfare. Were regulators to set fixed transaction fees for debit card transactions, merchants would benefit (which is why they are lobbying for it) at the expense of payment cards networks, but also at the expense of consumers and the overall social welfare. It concludes

Therefore, caution should be taken when policymakers consider intervening in the debit card market

[From Payments News for Payments Professionals from Glenbrook Partners]

I agree. And this isn't just about debit cards. Suppose, as we were discussing recently, that there are surcharges for card use. What would happen? To be honest, it's hard to tell. In Australia, the merchants applied surcharges much greater than payment costs and pocketed in the difference, but closer to home in the Netherlands, where merchants are free to surcharge for debit card use (over cash use), very few actually do and then typically only for very small transactions (under €10) -- see S. Schuh and J. Stavins. "Frontier policy issues in consumer payment behaviour" in the Journal of Payment Strategy and Systems 3(4), p.333 (2009) -- so there are clearly market-specific factors at work here. I suspect that they are something to do with the relative power of the different sectors (Australia has a concentrated retail sector) rather than the underlying economic dynamics. The point I'm trying to make is that the issue of overall social welfare is different from the welfare of banks or retailers. It's not as simple as often presented.

...those who use cash-cards or cash for their purchases will no longer be forced to subsidise credit card users. The surcharge is expected to lead to a drop in the use of credit cards and Retailers Association chief executive John Albertson has pointed out the obvious: financial institutions and credit card companies do not like it... However, as we contemplate a possible return to carrying cash in our wallets and purses to avoid paying the credit card surcharge, there are those who make a very valid point about what is now an old-fashioned means of payment.

[From Card surcharges | Otago Daily Times Online News]

Which, if it were me making the point, would be that cash is expensive and unfair: it raises transaction costs for society as whole but also distributes those costs toward the less well off. Back to the point about debit cards though. What should the public policy be? In the US, there is a specific and interesting sort of case study within debit, which is the competition between PIN and signature debit.

Safeway, 7-Eleven and CVS drugstores automatically prompt consumers to do a less costly PIN debit transaction. The banks, however, still steer consumers toward the more expensive form of signature debit. Wells Fargo and Chase are among those that offer bonus points only on debit purchases completed with a signature.

[From The Card Game - How Visa, Using Fees Behind Its Debit Card, Dominates a Market - Series - NYTimes.com]

I can't see what's wrong with this situation. This is competition working, isn't it? Surely the retailers should just compete in the same manner by offering double loyalty points on PIN debit transactions, or whatever. If there was a law in place preventing retailers from launching their own payment scheme, or pricing their own products, or forcing them to accept Visa or MasterCard, then they'd have a point. But there isn't, so they don't. Walmart and Safeway could have bought Revolution card, but they didn't, so that's that.

costs and interchange, debit cards, payment cards, retail