“Digital Currencies and Revolution in the Payment Space” with Professor Darrel Duffie

TL;DR

The payment space needs a revolution because current bank rails can take one to three days, impose substantial fees, and generate payment revenues equal to about 2.3% of US GDP. Professor Darrel Duffie examines stablecoins, Central Bank digital currencies, and China's Central Bank digital currency while explaining how ordinary payments move through banks. Read on to understand the costs and delays hidden behind a simple transaction.

Transcript

So much undergrads, really nice to be here for the full reunion. And welcome everyone, at least virtually. I hope I get to see you in person at the next one. I'm delighted to be able to talk to you today about what's happening in the FinTech payment space. There's kind of a revolution going on as most of you probably know. And I want to get your fe... Read More

Key Insights

• "I've been doing some work on stable coins, on Central Bank digital currencies, and on China's Central Bank digital currency." (1:07)
• "Alice, in this situation, wants to pay Bob, the baker, $8 for a loaf of bread." (1:54)
• "But Bob instantly gets a message saying the money is coming, so you can give Alice the loaf of bread." (3:35)
• "As I said, this tends to take a long time, and along these payment rails there are various fees being extracted." (4:46)
• "Europe regulates interchange fees for cards, and it's much smaller." (5:59)

Questions & Answers

Q: Why does the current payment system need an upgrade?

Payments moving through bank rails can take a day or two, and possibly three, to reach the recipient's bank. Various fees are extracted along those rails, while credit card interchange fees in the United States are described as severe.

Q: How does a typical credit card payment move between a buyer and a merchant?

Alice sends a payment message using a credit card, mobile phone app, tap, or similar method. Her bank removes $8 from her account and sends it through the bank payment rails to Bob's bank.

Q: Why can a payment appear instant even when settlement takes days?

Bob immediately receives a message saying that the money is coming, so he can give Alice the loaf of bread. The underlying transfer to Bob's bank can still take one, two, or possibly three days.

Q: What role does Fedwire play in a United States payment?

Alice's bank can credit Bob's bank through the central bank payment system, which Professor Darrel Duffie identifies as Fedwire in the United States. A payment can also pass through a private payment system, be merged, and then flow through Fedwire.

Q: Who bears the hidden costs of a credit card payment?

The transaction experience works well for Alice, but she does not see what happens inside the bank payment rails. Bob bears substantial costs for accepting the payment, including credit card interchange fees.

Q: How does the North American payment system compare with other regions?

The North American payments stack is heavily weighted toward the consumer side, particularly credit cards. Card interchange fees account for about 10% of the payment stack in Europe and an average of 15% for the rest of the world, while the United States has larger consumer-side profit margins.

Q: How large are payment revenues in the United States?

US payment revenues constitute about 2.3% of US GDP. Professor Darrel Duffie describes these revenues as profits before overhead and other expenses, and notes that paper cash costs are not included in the cited diagram.

Q: Which digital currency topics does Professor Darrel Duffie study?

He says he has worked on stablecoins, Central Bank digital currencies, and China's Central Bank digital currency. His work in the area covers both research and policy.

Summary

In this video, the speaker discusses the revolution happening in the FinTech payment space and the need for an upgrade to the current payment system. They explore the issues with the current system, such as high fees and delays, and the potential solutions, including stablecoins, central bank digital currencies (CBDCs), and improvements to the existing bank payment rails. The speaker also discusses the implications of these changes on financial inclusion, cross-border payments, and the role of regulators in overseeing these developments.

Questions & Answers

Q: What are the current issues with the current payment system?

The current payment system has high fees and delays, particularly in the United States. The interchange fees for credit card payments are severe, and the US payment system costs about 2.3% of US GDP. Additionally, there are financial inclusion issues, with millions of households lacking access to banking or having limited and costly access.

Q: How are payments made in the current system?

In most cases, payments are made through credit cards or mobile phone apps, which eventually flow through bank payment rails. Alice, the payer, initiates a payment through her bank, which deducts the amount from her account and sends it through the payment rails to Bob's bank. However, this process takes time and incurs various fees.

Q: What are fast payment systems?

Fast payment systems are designed to provide 24/7 availability and near real-time access to funds. There are different approaches to fast payment systems, including deferred net settlement and real-time gross settlement. Countries like Korea, Mexico, Sweden, the United Kingdom, Singapore, and the US are implementing or developing their own fast payment systems.

Q: What are stablecoins?

Stablecoins are a type of cryptocurrency, with the price of each token intended to remain stable relative to a fiat currency, such as the US dollar. They are often used for medium of exchange purposes and have the potential to offer new opportunities for payments, such as programmable payments and smart contracts. However, concerns exist regarding the backing of stablecoins, operational stability, and regulation.

Q: What are central bank digital currencies (CBDCs)?

CBDCs are digital forms of fiat currency issued by central banks. They can be used for payments, with funds being transferred directly between the payer's and the payee's accounts at the central bank. CBDCs offer potential benefits such as more efficient, inclusive, and cross-border payments. However, design choices need to be carefully weighed, including privacy, operational stability, and the balance between the central bank and private sector involvement.

Q: How are CBDCs being developed in different countries?

Different countries are at various stages of CBDC development, with some still in the research or proof-of-concept phase, while others are focused on development. China has already introduced its CBDC, known as eCNY, which operates on a centralized database management system rather than using blockchain. Many other countries, including Sweden, Korea, Nigeria, and Canada, are also exploring or developing CBDCs.

Q: What are the policy options for the United States?

The United States has several policy options to consider. One approach is to improve the existing bank payment rails, making them more efficient and accessible, potentially through regulation and competition. Another option is to allow and regulate compliant private stablecoins or other FinTech payment service providers to compete with banks. A third option is to introduce a general-purpose CBDC. Each option has its own design choices and implications for the banking and payment landscape.

Q: What are the potential implications for money laundering and privacy?

Cryptocurrencies, including stablecoins and CBDCs, have raised concerns about money laundering and privacy. While blockchain transactions are public, privacy can be maintained through pseudonyms or ISP information. However, authorities are becoming more skilled at tracking cryptocurrency transactions, and there are challenges in ensuring compliance with anti-money laundering regulations while protecting privacy.

Q: How can regulators ensure an effective and non-politicized oversight of these developments?

Regulators play a crucial role in designing and regulating the payment system. It is important for regulators to be non-political, aligned, and guided by a clear plan. Government agencies, such as the Federal Reserve in the United States, should work in collaboration with Congress and the administration to establish regulations and develop a plan that balances innovation, competition, financial inclusion, privacy, and security. The involvement of private sector experts and international collaborations can also contribute to effective and coordinated regulation.

Q: What are the potential implications for commercial banks?

The introduction of CBDCs as a direct form of digital fiat currency could disrupt the commercial banking system. If individuals and businesses can transact directly with the central bank, commercial banks may be disintermediated. This could impact their profit models, balance sheets, and their role in conducting monetary policy. The potential radical reordering of the financial system requires careful consideration of the implications for existing commercial banks.

Q: What are the potential cost reductions from improving the payment system?

The cost reduction from the current payment system, which constitutes about 2.3% of US GDP, would depend on the specific improvements and reforms implemented. However, by making payments more efficient, cheaper, and accessible, it is expected that significant cost reductions would be achieved. The exact estimated cost reduction is not provided in the video.

Takeaways

The video highlights the need for an upgrade in the FinTech payment space and discusses potential solutions such as stablecoins, CBDCs, and improvements to the existing payment system. The current payment system faces issues of high fees, delays, and limited financial inclusion. Fast payment systems, stablecoins, and CBDCs offer the potential for more efficient, accessible, and inclusive payment systems. However, careful consideration is needed to address concerns regarding compliance, privacy, regulation, and the potential impact on commercial banks. Regulators have a key role in overseeing these developments and ensuring an effective and non-politicized regulatory framework.

Summary & Key Takeaways

• The current payment system is plagued by inefficiencies, high costs, and delays. However, the emergence of CBDCs and stablecoins offers the opportunity to address these issues and improve financial inclusion.

• CBDCs, such as China's eCNY, allow for instant and secure peer-to-peer payments, making transactions more efficient and accessible. Stablecoins, on the other hand, provide price stability and can be used for various payment purposes.

• The introduction of CBDCs and stablecoins raises concerns about privacy, regulatory frameworks, and the impact on existing financial institutions. Finding the right balance between innovation and regulation is crucial.