Coining it in
14 October 2015
Currencies are evolving as technology spurs ahead and borders cease to exist
Image: Shutterstock
If there’s one thing financial services professionals can agree on, it’s that the world is changing, and it’s been said more than once that firms have to either adapt to the new world or risk falling behind.
The industry has never stood still, with constantly shifting trends and changes to funding patterns. Even regulations, contrary to popular feeling, have been on the move for decades.
But when it comes to payments, the industry is arguably moving in to unchartered territory. Currencies are shape-shifting, moving in to the modern, digital era with not a bank-note in sight, while previously domestic monies are becoming global super-currencies seemingly overnight—it’s no surprise that market professionals are feeling a little flummoxed.
Over the course of the last year, the Hong Kong-Shanghai Stock Connect has opened up China to global investment, and allowed the renminbi (RMB) to start trickling out to the rest of the world.
According to SWIFT’s RMB Tracker, there has been a significant increase in use of the currency in cross-border payments between Asia Pacific countries and China and Hong Kong. In these types of trades, South Korea saw an increased use of RMB to the tune of 173 percent, while Taiwan increased use by 45 percent, and Singapore by 19 percent.
Overall use of RMB for payments in Asia has increased from 24 percent of all transactions in the summer of 2014 to 33 percent this year, but the recent turmoil in the Chinese markets, and the devaluing of RMB by the People’s Bank of China, means it’s hard to see where the RMB will go next, and if it’s expansion has gone as far as it’s going to.
Vina Cheung, who is global head of payments, cash management and RMB internationalisation at HSBC, says: “The growth in RMB payments in general, and between China and Hong Kong in particular, is encouraging.”
She adds: “The recent SWIFT RMB Tracker indicates that RMB is now the most actively used currency for payments within Asia to China, and we expect the growth in the use of RMB to continue.”
On the other side of the world, in the midst of another financial crisis, the Greek island of Angistri has adopted a digital currency ecosystem using block chain technology, in a bid to stabilise its own economy. This is one of the first big steps towards a payments world that is almost unrecognisable, and this experiment suggests that it’s more than a mere passing phase.
When it comes to digital currencies, Gene Neyer, senior vice president and product manager of Fundtech, which is now a part of D+H, doesn’t see them coming in to the mainstream payments landscape any time soon.
According to Neyer, the bitcoin is currently the only viable digital currency in terms of liquidity, the level of maturity, and trust from its clients.
“It has achieved good penetration with early adaptors, and in special situations, such as merchants in countries with capital controls,” he says.
However, Neyer maintains that until there is a real drive from the market away from traditional currencies, even the bitcoin won’t be booming any time soon.
He says: “Currently there is no compelling reason for the wider market to adopt bitcoins in preference to traditional currencies, therefore we expect slow growth in the near-term future.”
What might become more prevalent, however, is the use of the technology and the platform, rather than a switch in the use of the currency itself. According to Neyer, there has been an increased interest in rationalising and simplifying the current banking infrastructure.
He says: “The technology is being closely looked at by innovation labs in the banks. And some banks have moved to proof-of-concept to get a deeper look into the benefits and technology. Based on the results, we may see early adaptors making their bets, for example, Nasdaq has announced plans to use this technology in building a specialised exchange. I think that the next two years will be significant to watch.”
On the other hand, Douwe Lycklama, partner at payments technology company Innopay, is fairly confident about the adoption of digital currencies, pointing out the ease of cross-border payments in a world where business is more international than ever.
“We are seeing exciting companies that address high remittance costs using the bitcoin as an easily-transferable intermediary currency between the payer’s currency and payee’s currency. Many governments have also expressed an interest in the applicability of digital currencies to their faster- and instant-payments initiatives.”
Lycklama also praises the security of the system, something that could be questioned by cyber-cynics. He suggests that it could be this additional security that brings digital currency in to the mainstream payments world.
“On the block chain or distributed ledger front, this technology is representative of a more secure, robust and transparent ledger or database for value with less governance-related overhead. Due to the broad range of applicability it is safe to say that digital currencies, such as bitcoins, and blockchain will have a prominent role to play in payments.”
If they were destined for the mainstream, digital currencies are, as Neyer says, “in the early stage of development”, and it will be some time before they attain the same kinds of complexities seen in the ‘real’ world.
The culture of traditional currency is a long and established one, but some denominations have only recently found their feet in this old-school world, let alone the digital one. The RMB has only recently taken up its place on the trading floor through the Hong Kong-Shanghai Stock Connect, which is gradually opening the Chinese market through ‘Q’ schemes such as the qualified foreign institutional investor (QFII) and renminbi QFII (RQFII) programmes, which have seen investors entering the market from Luxembourg, Canada, Ireland, and elsewhere.
Florence Lee, head of China sales and business development in Europe, the Middle East and Africa (EMEA) at HSBC Securities Services, points out that the International Monetary Fund now recognises RMB as no longer an undervalued currency, and draws attention to the offshore RMB deposit, which, as of May 2015, stood at RMB 1.8 trillion ($282.2 billion).
She says: “Stock Connect does not only broaden the usage of the RMB offshore via investment, it also provides unprecedented direct two-way market access to the stock markets. Investors outside of China can access the China A-shares, and Chinese domestic investors have direct access to the Hong Kong securities market.”
She adds: “The programme has also provided invaluable experience to Chinese regulators for future pilot programmes that may include instruments such as derivatives, futures and fixed income, or even cooperation with other markets.”
On top of this, Lee suggests that this stock connect will pave the way for more, similar systems. With the Shenzhen-Hong Kong Stock Connect also on the cusp of launching, Lee cites reports that suggest 500 mainland stocks could be traded through this link. At the same time, the People’s Bank of China has announced intentions to open the China Interbank Bond Market (CIBM) to certain international investors.
“Given the Chinese regulators have a track record of gradually opening up the financial market to foreign players, investors can also expect further relaxation of the rules or perhaps a ‘Bond Connect’ programme. The CIBM is heavily dominated by domestic institutions, and foreign participation only started in 2010 with the CIBM pilot scheme that allows three types of offshore institutions to access,” says Lee.
She adds that additional products may soon become available to foreign investors, with the China Securities Regulatory Commission planning to allow foreigners to trade in the onshore commodities futures market.
“The State Administration of Foreign Exchange promulgated the relevant foreign exchange management regulations to pave the way for trading to become possible, and to open future doors for other domestic commodities if the initiative shows signs of success.”
Investment in China and further internationalising of the RMB have been a long time coming, and each move has clearly been carefully considered and scheduled. The People’s Bank of China and the regulatory bodies take no chances, and are seemingly in the process of increasing volumes slowly, bit by bit.
Arguably old-fashioned, it is also a tried and tested route to success, and while it bears an element of risk—Chinese stocks haven’t exactly been stable of late—market players are at least playing a game they’ve watched, and played, many times before.
For those embarking on a digital investment journey, however, there is very little experience, and certainly minimal expertise, from which to take direction.
A paper recently issued by the SWIFT Institute questioned the stability of the bitcoin model, and the sustainability of its ‘mining’ system. The bitcoin works using open distribution, where ‘miners’ are rewarded with bitcoins for payments processing work. Participants form pools where they can share and trade rewards, and these pools form an essential part of the system.
While those participating in small pools can operate with reasonably low business risk, large pools can attack each other, with one ‘miner’ pretending to work on another’s behalf then taking a cut of the proceeds without ever actually contributing.
According to the paper, these kinds of attacks are not currently very prevalent, with pools agreeing not to operate in this way. But the balance is unstable.
As soon as one attack happens, it’s inevitable that parties will retaliate. This means profitability of public pools will drop and participants could move towards smaller, closed pools. Or, if pools grow too large, they could pose a problem for the entire system.
As digital currency is in such early stages, Neyer believes that issues like this will filter themselves out, and that those providers with the strongest models will survive.
However, given its significant head start, he doesn’t believe the bitcoin will be one that falls by the wayside.
He says: “Just like the car industry, which had many hundreds of manufacturers before the winners emerged, there will be a consolidation phase once the best models appear.”
“I don’t expect new currencies to seriously challenge bitcoins, since they don’t offer a compelling alternative to overcome the lead that the bitcoin has built since coming into existence in 2009.”
Lycklama takes a different approach, dismissing the idea that any instability in the bitcoin ecosystem would have a real effect on the asset servicing side of the payments process.
He points out that this kind of critique of the mining system is “based on game-theoretical scenarios that have not played out yet”.
He says: “This critique is only applicable to non-permissioned networks—public networks between parties who don’t trust each other—that use proof-of-work algorithms to enable consensus between the nodes, leading to relatively high energy costs for processing, but lower compliance and security costs.”
“Asset servicing is most likely to take place on permissioned networks—private networks set up between trusted parties—that use a wholly different consensus algorithm and lower energy consumption, but higher compliance and security costs.”
Lycklama suggests that, instead, the focus should be on the connectivity of the network itself—he believes that the real threat to digital currency is “not working together to realise the inter-organisational promise of the technology”.
In order for the digital currencies to be adopted in to the payments sector on a global scale, those working on it should embrace collaboration. According to Lycklama, the most important priority now is for the industry to work together to create a harmonised system, rather than creating competing, non-complementary platforms. By combining forces, the result will inevitably be optimal functionality for everyone involved.
Lycklama says: “The collaborative space in this new world will look quite different, and it is this challenge the industry should take up. We should avoid competing standards due to uncoordinated research efforts, or the network effect being impeded by intellectual property claims or irrelevant pricing models.”
“Seeing that the technology is so new and not all that easy to understand, open and honest dialogue between the institutions and regulators is also essential. Forming rigid opinions on these technologies, by authorities and incumbent institutions too early, in the process is the biggest mistake we can make, there is still much to be uncovered.”
Neyer also hones in on the issue of over-regulation, pointing out that too much monitoring can tend to stifle the growth of new innovation.
He says: “It is possible that as the bitcoin becomes more widely used, the regulatory requirements will grow proportionately and choke off the development. Also, the negative publicity around high profile breaches, thefts, or technology glitches continue to delay adoption.”
He also expressed concern that digital currencies—even bitcoins—have not yet created a mass-market strategy, casting doubt over the entire business model. He says: “The biggest threat is that the business model and business value for the mass market continues to remain elusive.”
If currencies such as the bitcoin start to slow, investors could become disinterested, moving their focus to newer and more exciting prospects. Neyer admits this is merely a “distant possibility”, given that funding levels remain steady, but it may be a concern for the currency’s future.
It appears that we can expect the world of payments to change; whether it’s a move towards the cyber sphere where traditional denominations are obsolete and funds can cross borders as easily as emails, or simply a space where RMB is a widely recognised and used currency throughout Asia, and beyond.
Predictions are vague and tentative, and the over-riding feeling is that we just don’t know. Technology is moving so quickly that it’s difficult, even for tech firms, to keep up, and volatility in the Chinese market makes developments on the RMB hard to predict, too. Neyer says: “I expect that there will be a lot of activity in crypto-vendors pivoting the technology as relevant business opportunities are identified for the crypto-infrastructure.”
Lee on the other hand thinks that the internationalisation of RMB will continue and that the Chinese economy is on its way up, saying: “The internationalisation of RMB is an integration of it as trade currency, investment currency and as reserve currency.”
She adds: “Each step complements the other and can deliver benefits to the Chinese economy. Reduced foreign exchange risk will encourage further trade and investment developments between China and the international community; increased foreign participation in the Chinese securities market will increase standards; and cross-border business will increase.”
“Ultimately, it will mean that China continues to rise as a world super power and further increases its influence on the global economy.”
The industry has never stood still, with constantly shifting trends and changes to funding patterns. Even regulations, contrary to popular feeling, have been on the move for decades.
But when it comes to payments, the industry is arguably moving in to unchartered territory. Currencies are shape-shifting, moving in to the modern, digital era with not a bank-note in sight, while previously domestic monies are becoming global super-currencies seemingly overnight—it’s no surprise that market professionals are feeling a little flummoxed.
Over the course of the last year, the Hong Kong-Shanghai Stock Connect has opened up China to global investment, and allowed the renminbi (RMB) to start trickling out to the rest of the world.
According to SWIFT’s RMB Tracker, there has been a significant increase in use of the currency in cross-border payments between Asia Pacific countries and China and Hong Kong. In these types of trades, South Korea saw an increased use of RMB to the tune of 173 percent, while Taiwan increased use by 45 percent, and Singapore by 19 percent.
Overall use of RMB for payments in Asia has increased from 24 percent of all transactions in the summer of 2014 to 33 percent this year, but the recent turmoil in the Chinese markets, and the devaluing of RMB by the People’s Bank of China, means it’s hard to see where the RMB will go next, and if it’s expansion has gone as far as it’s going to.
Vina Cheung, who is global head of payments, cash management and RMB internationalisation at HSBC, says: “The growth in RMB payments in general, and between China and Hong Kong in particular, is encouraging.”
She adds: “The recent SWIFT RMB Tracker indicates that RMB is now the most actively used currency for payments within Asia to China, and we expect the growth in the use of RMB to continue.”
On the other side of the world, in the midst of another financial crisis, the Greek island of Angistri has adopted a digital currency ecosystem using block chain technology, in a bid to stabilise its own economy. This is one of the first big steps towards a payments world that is almost unrecognisable, and this experiment suggests that it’s more than a mere passing phase.
When it comes to digital currencies, Gene Neyer, senior vice president and product manager of Fundtech, which is now a part of D+H, doesn’t see them coming in to the mainstream payments landscape any time soon.
According to Neyer, the bitcoin is currently the only viable digital currency in terms of liquidity, the level of maturity, and trust from its clients.
“It has achieved good penetration with early adaptors, and in special situations, such as merchants in countries with capital controls,” he says.
However, Neyer maintains that until there is a real drive from the market away from traditional currencies, even the bitcoin won’t be booming any time soon.
He says: “Currently there is no compelling reason for the wider market to adopt bitcoins in preference to traditional currencies, therefore we expect slow growth in the near-term future.”
What might become more prevalent, however, is the use of the technology and the platform, rather than a switch in the use of the currency itself. According to Neyer, there has been an increased interest in rationalising and simplifying the current banking infrastructure.
He says: “The technology is being closely looked at by innovation labs in the banks. And some banks have moved to proof-of-concept to get a deeper look into the benefits and technology. Based on the results, we may see early adaptors making their bets, for example, Nasdaq has announced plans to use this technology in building a specialised exchange. I think that the next two years will be significant to watch.”
On the other hand, Douwe Lycklama, partner at payments technology company Innopay, is fairly confident about the adoption of digital currencies, pointing out the ease of cross-border payments in a world where business is more international than ever.
“We are seeing exciting companies that address high remittance costs using the bitcoin as an easily-transferable intermediary currency between the payer’s currency and payee’s currency. Many governments have also expressed an interest in the applicability of digital currencies to their faster- and instant-payments initiatives.”
Lycklama also praises the security of the system, something that could be questioned by cyber-cynics. He suggests that it could be this additional security that brings digital currency in to the mainstream payments world.
“On the block chain or distributed ledger front, this technology is representative of a more secure, robust and transparent ledger or database for value with less governance-related overhead. Due to the broad range of applicability it is safe to say that digital currencies, such as bitcoins, and blockchain will have a prominent role to play in payments.”
If they were destined for the mainstream, digital currencies are, as Neyer says, “in the early stage of development”, and it will be some time before they attain the same kinds of complexities seen in the ‘real’ world.
The culture of traditional currency is a long and established one, but some denominations have only recently found their feet in this old-school world, let alone the digital one. The RMB has only recently taken up its place on the trading floor through the Hong Kong-Shanghai Stock Connect, which is gradually opening the Chinese market through ‘Q’ schemes such as the qualified foreign institutional investor (QFII) and renminbi QFII (RQFII) programmes, which have seen investors entering the market from Luxembourg, Canada, Ireland, and elsewhere.
Florence Lee, head of China sales and business development in Europe, the Middle East and Africa (EMEA) at HSBC Securities Services, points out that the International Monetary Fund now recognises RMB as no longer an undervalued currency, and draws attention to the offshore RMB deposit, which, as of May 2015, stood at RMB 1.8 trillion ($282.2 billion).
She says: “Stock Connect does not only broaden the usage of the RMB offshore via investment, it also provides unprecedented direct two-way market access to the stock markets. Investors outside of China can access the China A-shares, and Chinese domestic investors have direct access to the Hong Kong securities market.”
She adds: “The programme has also provided invaluable experience to Chinese regulators for future pilot programmes that may include instruments such as derivatives, futures and fixed income, or even cooperation with other markets.”
On top of this, Lee suggests that this stock connect will pave the way for more, similar systems. With the Shenzhen-Hong Kong Stock Connect also on the cusp of launching, Lee cites reports that suggest 500 mainland stocks could be traded through this link. At the same time, the People’s Bank of China has announced intentions to open the China Interbank Bond Market (CIBM) to certain international investors.
“Given the Chinese regulators have a track record of gradually opening up the financial market to foreign players, investors can also expect further relaxation of the rules or perhaps a ‘Bond Connect’ programme. The CIBM is heavily dominated by domestic institutions, and foreign participation only started in 2010 with the CIBM pilot scheme that allows three types of offshore institutions to access,” says Lee.
She adds that additional products may soon become available to foreign investors, with the China Securities Regulatory Commission planning to allow foreigners to trade in the onshore commodities futures market.
“The State Administration of Foreign Exchange promulgated the relevant foreign exchange management regulations to pave the way for trading to become possible, and to open future doors for other domestic commodities if the initiative shows signs of success.”
Investment in China and further internationalising of the RMB have been a long time coming, and each move has clearly been carefully considered and scheduled. The People’s Bank of China and the regulatory bodies take no chances, and are seemingly in the process of increasing volumes slowly, bit by bit.
Arguably old-fashioned, it is also a tried and tested route to success, and while it bears an element of risk—Chinese stocks haven’t exactly been stable of late—market players are at least playing a game they’ve watched, and played, many times before.
For those embarking on a digital investment journey, however, there is very little experience, and certainly minimal expertise, from which to take direction.
A paper recently issued by the SWIFT Institute questioned the stability of the bitcoin model, and the sustainability of its ‘mining’ system. The bitcoin works using open distribution, where ‘miners’ are rewarded with bitcoins for payments processing work. Participants form pools where they can share and trade rewards, and these pools form an essential part of the system.
While those participating in small pools can operate with reasonably low business risk, large pools can attack each other, with one ‘miner’ pretending to work on another’s behalf then taking a cut of the proceeds without ever actually contributing.
According to the paper, these kinds of attacks are not currently very prevalent, with pools agreeing not to operate in this way. But the balance is unstable.
As soon as one attack happens, it’s inevitable that parties will retaliate. This means profitability of public pools will drop and participants could move towards smaller, closed pools. Or, if pools grow too large, they could pose a problem for the entire system.
As digital currency is in such early stages, Neyer believes that issues like this will filter themselves out, and that those providers with the strongest models will survive.
However, given its significant head start, he doesn’t believe the bitcoin will be one that falls by the wayside.
He says: “Just like the car industry, which had many hundreds of manufacturers before the winners emerged, there will be a consolidation phase once the best models appear.”
“I don’t expect new currencies to seriously challenge bitcoins, since they don’t offer a compelling alternative to overcome the lead that the bitcoin has built since coming into existence in 2009.”
Lycklama takes a different approach, dismissing the idea that any instability in the bitcoin ecosystem would have a real effect on the asset servicing side of the payments process.
He points out that this kind of critique of the mining system is “based on game-theoretical scenarios that have not played out yet”.
He says: “This critique is only applicable to non-permissioned networks—public networks between parties who don’t trust each other—that use proof-of-work algorithms to enable consensus between the nodes, leading to relatively high energy costs for processing, but lower compliance and security costs.”
“Asset servicing is most likely to take place on permissioned networks—private networks set up between trusted parties—that use a wholly different consensus algorithm and lower energy consumption, but higher compliance and security costs.”
Lycklama suggests that, instead, the focus should be on the connectivity of the network itself—he believes that the real threat to digital currency is “not working together to realise the inter-organisational promise of the technology”.
In order for the digital currencies to be adopted in to the payments sector on a global scale, those working on it should embrace collaboration. According to Lycklama, the most important priority now is for the industry to work together to create a harmonised system, rather than creating competing, non-complementary platforms. By combining forces, the result will inevitably be optimal functionality for everyone involved.
Lycklama says: “The collaborative space in this new world will look quite different, and it is this challenge the industry should take up. We should avoid competing standards due to uncoordinated research efforts, or the network effect being impeded by intellectual property claims or irrelevant pricing models.”
“Seeing that the technology is so new and not all that easy to understand, open and honest dialogue between the institutions and regulators is also essential. Forming rigid opinions on these technologies, by authorities and incumbent institutions too early, in the process is the biggest mistake we can make, there is still much to be uncovered.”
Neyer also hones in on the issue of over-regulation, pointing out that too much monitoring can tend to stifle the growth of new innovation.
He says: “It is possible that as the bitcoin becomes more widely used, the regulatory requirements will grow proportionately and choke off the development. Also, the negative publicity around high profile breaches, thefts, or technology glitches continue to delay adoption.”
He also expressed concern that digital currencies—even bitcoins—have not yet created a mass-market strategy, casting doubt over the entire business model. He says: “The biggest threat is that the business model and business value for the mass market continues to remain elusive.”
If currencies such as the bitcoin start to slow, investors could become disinterested, moving their focus to newer and more exciting prospects. Neyer admits this is merely a “distant possibility”, given that funding levels remain steady, but it may be a concern for the currency’s future.
It appears that we can expect the world of payments to change; whether it’s a move towards the cyber sphere where traditional denominations are obsolete and funds can cross borders as easily as emails, or simply a space where RMB is a widely recognised and used currency throughout Asia, and beyond.
Predictions are vague and tentative, and the over-riding feeling is that we just don’t know. Technology is moving so quickly that it’s difficult, even for tech firms, to keep up, and volatility in the Chinese market makes developments on the RMB hard to predict, too. Neyer says: “I expect that there will be a lot of activity in crypto-vendors pivoting the technology as relevant business opportunities are identified for the crypto-infrastructure.”
Lee on the other hand thinks that the internationalisation of RMB will continue and that the Chinese economy is on its way up, saying: “The internationalisation of RMB is an integration of it as trade currency, investment currency and as reserve currency.”
She adds: “Each step complements the other and can deliver benefits to the Chinese economy. Reduced foreign exchange risk will encourage further trade and investment developments between China and the international community; increased foreign participation in the Chinese securities market will increase standards; and cross-border business will increase.”
“Ultimately, it will mean that China continues to rise as a world super power and further increases its influence on the global economy.”
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