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The e-money mandate

The e-money mandate


Electronic money is back in the news again with the UK becoming the first European member country to enact legislation covering e-money issuers. The event is a milestone in the brief history of the digital cash movement, says David Birch, a director of specialist e-commerce consultancy Consult Hyperion.

On the 27th April 2002, the Financial Services Authority (FSA) acquired supervisory powers over e–money issuers and e–money regulation began in the UK. This event has its roots in a European Commission Directive of October 2000 which introduced the concept of an 'Electronic Money Institution', or ELMI. The idea behind the ELMI was that it would provide a way to stimulate experimentation and innovation in the e–money world by providing a means for organisations to issue e–money without a banking licence.
The UK is the first EU member country to actually pass the relevant legislation and seems to have opted for a fairly liberal implementation. Under the rules, anyone who wants to issue e– money will be able to provided that they meet the captial requirements of a million euros or 2% of the e–money outstanding. Thus, Vodafone could easily set up a subsidiary to issue e–money to be stored in mobile phone accounts, for example, without needing a bank in the loop. There is even a special waiver for small scale implementations so that if a school, for example, wanted to go cashless and give electronic purses (smart cards carrying e–money) to pupils it would be excluded from the more rigorous elements of the regulation.
There are a few limits: the maximum purse value is limited to £1,000 (although that can be increased subject to certain conditions), the e–money must be valid for at least one year and it must be redeemed to lawful holders within five days. In general, however, most potential issuers will be quite satisfied with the regime (which will, in any case, be reviewed in 2005).
To summarise, then: anyone who wants to can issue electronic money. But who wants to? It may be that there are many different kinds of people who want to, and for many different reasons.
Taking Positions
I’ve thought for some time that there are a variety of quite separate constituencies for whom e–money is a hot topic. It’s interesting to look at each of their perspectives in turn and evaluate them in terms of the trends that are already visible in the money world to see if any stand out from the crowd.
The Crusaders want to take control of money away from governments on a point of principal. Their modern champion is the Nobel prize–winning economist F. A. Hayek who, in the 1980s, argued persuasively against government monopoly on the issue of money and in favour of private institutions competing to provide currencies. The core of his thesis was that governments have systematically defrauded their subjects by forcing them to accept depreciating money and caused economic instability through using monetary policy in misguided attempts to 'manage' the economy. He thought that commercial organisations competing for profit would be more successful in providing money that retains its value, but noted some practical difficulties.
Firstly, Hayek saw that people are used to dealing with one currency and would find the concept of choice strange. However, he also noted that traders in border areas are usually happy to accept payment in the currency of a neighbouring country, providing its currency is reasonably stable at the time. Today, notions of locality and borders are being redefined. On the Net, we all inhabit a 'border zone' and are already confronted with dealing in multiple currencies. Paypal seems to have plenty of traction in Europe despite the fact that it is only presented in English and only denominated in US dollars.
The second difficulty noted by Hayek was a technical problem to do with the use of 'cash registers' or 'vending machines', where issuers might mint coins of differing denominations, size or weight, and where in any case their relative values would fluctuate. Hayek foresaw that within a well–defined region (the Net?) perhaps one currency would predominate, or (with amazing prescience) that smart cards might be invented to solve the problem.
There’s less debate about Hayek’s ideas today, primarily because inflation seems to be under control, but the central concept of leaving currency to the market and freeing it from potential government interference and mismanagement has its supporters (consider Argentina, for example).
The Idealists can be categorised as those from the right (let’s go back to commodity money) and the left (let’s go forward to community money) who dislike fiat currency and fractional reserve banking and therefore regard the current monetary system with suspicion.
Commodity money tends to mean gold. While in theory any basket of commodities could be used to denominate transactions, there is a historical reconnection (one might even say nostalgia) for precious metals in this context and organizations such as e–gold and Goldmoney are already up and running in this space. I think that there is likely to be significant growth in this area, especially in the Islamic world where an online gold–backed non–interest bearing currency is sought for cultural reasons.
Community money means Local Exchange Trading Systems (LETS), Time Dollars and the like. LETS are widespread but limited and all operate on a small scale, yet some see them as the vanguard of a money revolution. It’s a reasonable observation that the limited scale and poor liquidity associated schemes such these are at least partly to blame on the hassle associated with managing community ledgers and 'cheque books'. Therefore, the technology of digital money should make these alternative currencies more efficient and more successful. It’s fair to observe that most proponents of these currencies are driven by moral (rather than financial) imperatives that lead them to reject aspects (eg, interest) of the existing monetary system and search for alternatives. This, as in the case of commodity money, means they might succeed for cultural reasons.
The Determinists perspective can only gain ground in the face of constant technological advance and win more adherents in the government and central banking communities. This perspective recognises that since the introduction of fiat money and the demise of the gold standard, global monetary regimes have changed around once per generation . The next change may be to render monetary policy and central banks obsolete. The determinists would say that this is an inevitability for a number of reasons:
* The Net drives commerce online, making geography less important and therefore making currencies defined by geography less important.
* The combination of pervasive computing and the Net makes conversion between units of account (eg, £/€) and means of exchange (eg, Mondex to traveller’s cheque) simple. It can be automated and executed with transaction costs below the friction level.
* Increasing competition, because of online commerce, will support monetary stability. Thus because of the online commerce and efficient conversion, buyers and sellers alike will instantly desert weak currencies or inefficient systems.
* Virtual communities can define idiosyncratic currencies, and the lowered entry level costs mean that they will have an opportunity to build and launch those currencies.
The determinists expect the establishment response to technological change to be to embrace and extend (to use a stock phrase). If banks (and governments) help effect the transition to e–money then they have some possibility of control. In many ways, this might be seen as being the current position of retail banks in Europe. E–money doesn’t look like being a vastly profitable enterprise for them but they nevertheless have to be involved.
The Non–Bankers are sympathetic to the deterministic perspective but set it in a wider context of evolution in the financial world. In financial terms, they see a cusp coming where people will be happy to accept balances with non–banks, rather than only with banks, in final settlement. If this happens, because advances in communications and encryption further erode the banks special position, then digital money won’t need new units of accounts. E–money will still be sterling, euros, dollars and yen but it won’t be bank money. Organisations with the communications and encryption technologies in place (telecommunications operators, for example) could then net out transfers between third parties and cut banks out of the loop.
The non–bankers would also point out that banks have been slow to support new ways of doing business. The backwardness of payment systems has implications, and one of these is increased transaction costs for business (ie, non–banks). In Norway, payment systems cost the economy around 0.5% of GDP, whereas they cost around 3% of the US economy because of the reliance on antiquated paper implementations. In my opinion, the absence of a simple electronic payment mechanism for small transactions has significantly hampered growth and innovation in online commerce.
If, as the non–bankers suspect, the public are happy to deal in money that comes from somewhere other than banks then it begins to behave more like other goods and services. In particular, the power of brand cannot be overlooked. If the branding is correct, the public seem to be very happy with e–money. The US Starbuck’s pre–paid card provides an interesting case study. In its first two months of existence, 2.3 million cards had been activated (with a float of $32 million) and 2.2 million purchases had generated net sales of $9 million.
The Businessperson looks to e–money not just to provide another means of exchange but also to support other business strategies. In 1994, lateral thinker Edward de Bono put forward the idea of private currency as a claim on future products or services produced by the issuer. In his example, IBM might issue 'IBM Dollars' which consumers would use to obtain IBM products or services in the future. This gives a practical segmentation of the 'currency market'.
He wrote: "Companies like British Airways or Sainsburys could issue their own currencies, and could benefit from the float until these currencies were used."
There is a clear resonance between these comments and what’s happening with frequent flyer miles and supermarket points. These kinds of loyalty schemes are offering ever more cash–like tokens and it may be that in time these tokens might become attractive as a store of value as well as means of exchange to the average consumer. The Net has introduced more new elements into this equation. The low entry–level costs associated with bringing money lite to the Net, in the first instance, are a definite stimulus to innovation. It seems, therefore, that as the market for loyalty points of every type continues to grow and collides with the evolution of e–cash and the Net, this new conception of currency is developing.
Where Next?
It is difficult to predict how the rapid and unpredictable evolution of technology, with its apparent law of unintended consequences, will interact with radical economic and financial thinking to produce a new monetary system. If it is at all possible to make a single prediction, it is that the role of brand will become central stage in the medium term evolution of e–money.
As brand becomes a crucial component of e–money so international brand–based organisations will be in the best position to exploit the technological change. Just such organisations have, in fact, begun to experiment in this field. A current example is Coca–Cola’s trial with NTT DoCoMo in Japan. In addition to allowing consumers to buy Coke without coins (using their mobile phones), this system also delivers data to the machine operators (on stock levels and so on). The combination has increased profits per machine by as much as 70% . Right now they pay with yen, but who knows how long it will be before they pay with 'Cokes' instead?

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