Payment services will be the foundations of retail CBDCs

Thomas Hobbes' Leviathan (published in 1651) was probably the first text to record an analogy between William Harvey’s theory about the circulation of blood (1628) and the economic theory of the circulation of money. However, in the late 19th century, the German physician and Nobel Prize winner Paul Ehrlich and his student Edwin Goldmann discovered the blood–brain barrier, a membrane protecting the brain and the spinal cord from unexpected substances (like viruses) that may be transported in the human blood.

Scientists were able to understand the blood-brain barrier only in the 1960s: using an electron-scanning microscope, they discovered the endothelial cells forming those blood vessels are wedged so closely that they act as a micropore filter. This article will attempt to show how CBDCs are going to refine the classical theory of money circulation in the same way Ehrlich and Goldmann did.

The circulation of money: from pervasive to contained

Central Bankers dislike the idea of a stream of money running around the globe searching for better remuneration, like the old eurodollars of the 1970s. They know this could lead to one of their worst nightmares: double-digit inflation. Still, present-day money circulation is pervasive, meaning that Central Bank-issued money ends up in the most unintended places. As a result of these unintended spillages, the real-world monetary policies implemented by Central Banks are never as efficient as they are described by the theory.

A first example is about gross settling. It's a fact that any liquidity crisis in the TARGET2 RTGS system could bring the Eurozone economy to a halt. Accordingly, one of the tasks of the European Central Bank is to provide enough Euro-denominated liquidity to keep all TARGET2 participants solvable. However, this means that also non-Eurozone partners linked to TARGET2 can make use of this facility. With the help of a Fed-supplied swap line, non-Eurozone States can convert these Euros to Dollars and use them to pay for their imports.

Another example is related to consumer spending. In April 2014, in order to encourage consumption, the Italian government increased all low-end wages by 80 Euros. Those Italian families with a marked propensity to save put those Euros in the bank, where most probably they ended up in financing production. Other families directed those expenses to consumer electronics, financing imports and production in other Countries. No wonder that in July 2020, the economic arrangement was silently abolished, as it did not attain the intended effects on Italian economy.

On the contrary, CBDCs come in specific forms whose circulation can easily be contained. Safeguards could be programmed on a wholesale CBDC, ensuring it to be contained inside the RTGS it was designed for. In a retail CBDC, similar mechanisms could prevent liquidity thesaurization. In this way, Central Bank monetary policy could target (at least in the short run) very localized regions of the national economy.

Digital Payment Companies

A Digital Payment Company manages a technical platform connecting all sorts of customers (banks, merchants, businesses, companies and consumers) allowing them to execute and receive digital payments. Typical lines of business are:

• Merchant acquisition services: provide retailers with payment acceptance solutions across channels (in-store, online and mobile) and across payment methods(Visa, MasterCard, Union Pay, etc.) Acquisition services may also be classified by their offerings as

AISP, Account Information Service Providers (data integrators, aggregating consumer expenses on different channels and payment methods)

PISP, Payment Initiation Service Providers (payment facilitators, providing an easier payment experience to consumers)

• Clearing services: Automated Clearing House (ACH) for domestic and international payments. A value-added variation of this are ACH Instant Payment services.
• Issuer and security services: provide issuers with lifecycle management for payment cards. This extends to Customer Management Services and supplying relevant consumer data to Credit Bureaus and National Risk Management Facilities.
• Digital Corporate Banking: providing corporate banking services with full lifecycle management for corporate accounts, from onboarding, management and maintenance to transactions management, all through online digital channels.

The Payment industry: a natural follow-up for the European single-currency

One of the strange legacies of the last century is the different sentimental value of national assets. While most Eurozone citizens had readily accepted the single currency, many of them are still resolutely against the idea of a European Defence Force. In this regard, at least nobody is seriously questioning the idea of consolidating payments services across the Eurozone. Beno?t C?uré (previously a member of the Board of European Central Bank, now with the Bank of International Settlements) has been a constant critic of the dispersion in the European personal payments industry. The lack of a European player comparable to Visa and Mastercard is evident to everyone and this makes the payment industry a natural follow-up for the European unification process.

Last year, Nexi raised $2.3 billion in its initial public offering (IPO), which was among the biggest IPOs in Europe in 2019. Last October, Nexi and its domestic rival SIA reached a merge agreement with. The $5.4 billion stock deal created one of Europe’s biggest payment platforms. Last November, Nexi signed a binding framework with Northern Europe platform Nets. The deal (worth about $10 billion) includes long-term lock-up commitments by Nets’ current shareholders. According to a Reuters report, Nexi had to bargain against U.S. firm Global Payments to carry out the deal.

The speed and the neatness of the execution (Nets business-to-business payments branch has been sold to Mastercard, in order to get EU approval for the merge) make it apparent there is some strategy behind all this. We could just wish technical innovation will be the next step after consolidating the payment systems operational landscape.

The Chinese experience

The massive Chinese mobile payments market has been dominated by an all-out war between Tencent's WeChat Pay and Ant Financial's Alipay. In March 2018, People's Bank of China (Chinese National Central Bank) released the "Work Plan for WeChat and Alipay Barcode Payment Services Connecting to UnionPay Platform", forcing all the transactions acquired by WeChat and Alipay to be channelled to UnionPay which got the exclusive in bank forwarding and clearing services. After this manoeuvre (called in current jargon 'disconnecting the connected') WeChat and Alipay were left with their merchant acquisition services as their most solid assets.

Last Tue Dec 8th, People's Bank of China and UnionPay signed a deal about the DC/EP project. As UnionPay has already payment corridors with most Chinese regional banks, it will act as a payment hub for all these banks reducing the workload on Central Bank systems. By allowing UnionPay to convert bank money into digital currency (and the reverse) the bulk of the retail CBDC circulation will be confined between the consumers and UnionPay. Through this deal, Union Pay will be in the position of supervising the entire payment history of a consumer, consolidating payments both in the new digital currency and in traditional money.

A payment in CBDC received by WeChat Pay or Alipay 'merchant acquisition services' would be channelled to UnionPay (providing both 'clearing services' and 'issuer and security services') which would convert it into commercial bank money before crediting it to a regional bank account. This way regional banks would continue to receive and process commercial bank money with very little disruption to the present-day system.

TIPS, The TARGET Instant Payment Settlement system.

On Nov 27th Fabio Panetta (Member of ECB Executive Board) outlined four topics for digital euro ? trials. The first of them was "the compatibility between a digital euro and existing central bank settlement services (such as TIPS)".

TIPS is a realtime payment solution operated by the Eurosystem since November 2018, offering instant settlement services in Euro. In May 2022, it will also start settling payments in Swedish krona. TIPS messages are compatible with those defined in SCT Inst, the SEPA Instant Credit Transfer scheme for payments in Euro, expected to be used by a large number of payment service providers across Europe. 

All entities participating in TARGET2 are allowed a TIPS membership. However, access to TIPS may be granted to any organization which has signed adherence to SCT Inst and can provide funding via a TARGET2 account owned by a correspondent.

At present, participants to TIPS are allowed two levels of delegation:

• they can allow Instructing Parties to initiate payments on their behalf
• they can allow Reachable Parties to use their TIPS accounts for settlement

When a TIPS account is shared by many Instructing Parties, it is possible to set a Credit Memorandum Balance on every one of them, in order to define an upper limit for the usage of liquidity in payments. One ongoing investigation is about the performance of TIPS in handling big populations of Instructing Parties.

TIPS processes payments in a strict FIFO order, according to a two-steps workflow: in the first step, the full amount is reserved on the funds of the originator (or its delegate), and the beneficiary is notified about the payment. During the second phase, the reserved amount is settled immediately after the beneficiary (or its delegate) accepts the payment.

TIPS allows exchanging liquidity with more than one RTGS'es. These transfers must be always initiated by the RTGS; also, unlike instant payments, they do not require the reservation step and are settled immediately.

In order to make TIPS work overnight, snapshots of the TARGET2 balances are prepared every day at end-of-business. While TARGET2 stays closed, TIPS is responsible for updating the balances, that will be fed to TARGET2 before starting the next business day. The same procedure will be followed for the Swedish RIX RTGS system when it will be connected to TIPS.

From Oil deposits to Personal data

Until the dawn of the 20th century, world economy was based on coal, and oil as a commodity carried a pretty low value, if any. In need of a date for marking the change, we may assume 1859, Colonel Drake’s discovery of the first Pennsylvania oil deposit. Even before World War II, oil deposits were already considered a strategic asset. After the war, almost every Country established a state-owned company for the management of oil resources, incorporated under local Commercial Law.

Not surprisingly, States are realizing that the data originating from our day-by-day expenses are the oil of 21st century. Many politicians have come to realize that the management of our personal data is a strategic issue. The concept of Data Sovereignty (somehow less intimidating that the one of Digital Sovereignty) is now firmly established in our system of values. However, specific governance solutions for this problem are still in development. 

On Nov 5th, the US Department of Justice filed a civil antitrust lawsuit to stop Visa's takeover of Plaid. While the debate centered on antitrust issues, observers recognized it might have been the first Federal case involving the managing of consumer expense data.