You Lost Your Electronic Cash? Tough Luck
If electronic cash is going to be like real cash, then it is going to get lost. And that's a good thing.
Dateline: San Francisco, 9th May 2022.
If you want to have digital currency that is a form of electronic cash, that is digital value that can be transferred from person to person (or, more accurately, from device-to-device) without online access to some central database or blockchain or whatever else, then you have the obvious problem that if the device containing the electronic cash is lost or destroyed then the value is lost or destroyed with it.
But is this actually a problem?
One of the issues that central banks struggle with when they are looking at the problem of digital currency, and considering the various characteristics of a practical currency as applied to their circumstances, is the “flight to quality”.
What this means is that there is a reasonable concern that were public confidence in commercial banks to be damaged for whatever reason (financial crisis, a massive fraud, rumours on social media and that sort of thing) then rational consumers would withdraw their bank deposits and hold them in the form of central bank digital currency.
We don't need to go over all of the economic fundamental and behavioural economics here, other than to note that the central banks’ concern is real, although it seems that the impact may not be as great as some of them fear.
The Bank of Israel, for example, has just released a detailed analysis of simulations in this area which concludes that even though a flight to quality may have a negative impact on the banking system’s profitability, under reasonable scenarios there is no concern for the system’s stability.
They do go on to note, however, that in exceptional circumstances the public holdings of digital currency may need to be limited in some way. One way to do this, as already set out by the European Central Bank (ECB), is to limit the amount of digital currency that an individual or a business might hold (which will, of course, mean that there will have to be a functional digital identity infrastructure in place, but that’s a discussion for another day).
Another way to limit holdings though might be to limit loss recovery and this is worth some reflection.
Let me explain why this is by first asking a related question: Why don't people draw all of their savings out of their zero interest (or in some places, negative interest) bank accounts and hold it all as cash anyway?
It is because, as we know from a variety of studies, that even when interest rates go significantly negative the costs and risks of holding cash remain significant (burly security guards, vaults and alarm systems are not without cost) and therefore the deposits remain within the commercial banking system.
Now, obviously, you could argue that the costs of holding and managing digital currency in the form of electronic cash would be less than the costs of holding and managing physical banknotes and you might well be right. But to hold significant amounts of electronic cash, as the cryptocurrency sector has discovered, you need significant expenditure on security, custody, governance and recovery strategies.
It's not enough just to do as I do and put your bitcoin on a USB stick, wrap it in tinfoil and bury it in the back yard. After all, what if I forget where I buried it? Or what if it is dug up by a badger and carried away by a magpie?
Charles Khan and his colleagues put forward an interesting proposal for limiting the downside by attaching expiry dates. In a paper called “Best before: Personal loss recovery for offline digital cash”, they suggest that when you withdraw money from the banking system and store it as electronic cash on your phone, it should come with an expiry date. If you have not spent the cash by the time this date rolls around, then the cash is auto-deleted from your device and auto-reappears in your bank account. Thus, if you drop your phone in the ocean you don't need to worry about recovering your cash: it will happen automagically.
In the event of a bank run I could therefore transfer my cash onto my USB stick confident in the knowledge that if the dog eats the USB stick, I won't lose out.
Is this what we really want though? After all if I lose my wallet while I'm out jogging today, even if I had taken the basic precaution of writing down the serial numbers of the £50 notes that are stuffed inside it, I couldn't go to the Bank of England and ask for replacements. It seems to me that treating electronic cash just as physical cash in such circumstances has a logical consistency to it that will resonate with consumers while simultaneously reducing the attraction of holding substantial amounts of cash outside of commercial banks.
(I assume the existence of a two tier digital currency scheme here, where it is down to the commercial banks and other regulated institutions to provide the interface to consumer wallets.)
If I know that losing my phone means losing the cash on it then I am unlikely to hold more on my phone that I need for transactional purposes. Of course, there are plenty of other reasons for not wanting to lose my phone, but these are to do with identity not money, as this unfortunate Chinese resident remarks with respect to the plan to put national ID cards on smartphones: "while it is a lot more convenient, the problem is also more serious if you lose your phone” after having spent a day re-registering services on a new phone.
While we are talking about China, by the way, my good friend Brett King commissioned some interviews with consumers for his excellent Breaking Banks radio show in order to find out what the “man in the street” in China thinks about e-CNY, the Chinese central bank digital currency.
I couldn’t help but notice that some of the Chinese digital currency users hit on precisely this point. As one of them said “the interface is relatively simple and the operation is very smooth, but the recharge process is too troublesome”. Why is the recharge process such a focus? Well, it’s because, as that Chinese consumer went on to say “e-CNY is cash, it has no interest, and the balance of its wallet will not be too large”.
Since these Chinese consumers clearly want to maintain a balance for transactional purposes only, it is annoying and inconvenient to move money between bank accounts and digital currency purses so they naturally want a smart wallet to do it for them. Given the miracle of open banking, it should be no problem for the wallet on my phone to take care of acquiring the funds that it needs to deliver the necessary liquidity with no manual intervention, since the wallet can simply go and get cash from my bank when it needs it.
(Richard Turrin, who wrote the book “Cashless: The Chinese Digital Currency Revolution”, told me that one of the banks has already launched an automatic "top-up" and "push-to account" feature so that if your balance is low it pushes money to e-CNY to a minimum amount and then if you receive e-CNY it will push it to your bank account if the balance exceeds a maximum amount.)
Incidentally, this is not a new observation. Early studies of M-Pesa in Kenya found that the opportunity costs associated with holding wallet balances were significant and so holdings generally did not exceed transactional needs. Take a look, for example, at the National Bureau of Economic Research working paper 17129 (from June 2014) which looks at the economic impact of the ground-breaking mobile money service. Researchers concluded that “we find little evidence that people use their M-Pesa accounts as a place to store wealth”.
Even a modicum of artificial intelligence goodness in the smart wallet means that it would be able to go further than reactive top-ups and automatic sweeps. It should be able to predict with some certainty how much cash it might need to hold so that I can buy a sandwich when I’m out and about. And, as the Bank of Israel analysis notes, there is no systemic risk to the banking system if the electronic cash that the public hold is for transactional purposes (although, of course, there is a risk to bank profits if interchange income evaporates) so it clearly makes sense to make this an integral part of the wallet functionality.
It seems to me then that as a normal consumer this is a more than adequate set of arrangements. I won't really be bothered about dealing with electronic cash at all. If I tell my phone to send twenty quid to my brother, it will be invisible to me that the phone goes to the bank and draws out the £20 in digital sterling, sends this digital sterling across the Internet to my brothers wallet and then my brothers wallet can go to the bank and deposit it.
(It will look to me as if the £20 has gone from my bank account to my brother’s account, which it has, but at no point will that £20 ever go near SWIFT or the Fed Now or any other banking system infrastructure.)
I can see the attraction of trying to think of ways to help people get their hard earned cash back from the phone that fell in the toilet or the laptop they dropped on the ground or the car that was stolen from the driveway. But I think this is misplaced and that it is better to focus on delivering secure efficient and convenient offline device-to-device value transfer. If people want to add insurance, escrow or other protection services on top of that basic infrastructure (especially if they do not have bank accounts), then it's up to them.
When it comes down to it, I am hard line: if you lose your wallet, you lose your cash and if you lose your phone, it should be the same.