Singapore Management University’s Professor of Quantitative Finance (Practice) speaks with FST Media about how digital currencies will shape the payments space in 2020.
FST Media: Where do you see the future of crypto-currencies like Bitcoin and how will this change the financial services sector over the next 5 years?
Lee: My research involves understanding the key issues faces by ASEAN and beyond. I feel that Singapore has been growing for many years and inclusion has always been the key policy that they are looking into. One key development that has arisen from the growth of bitcoin and cryptocurrency is actually its use as a new technology and the Monetary Authority of Singapore (MAS) is very interested in this. There is a lot of interest in doing further research in the area and there seems to be a consensus that new technologies like bitcoin can help the financial institutions to further their business especially in terms of lowering their business costs. As a consequence, there is the possibility of servicing new customers who possibly could not have been serviced before.
The key here is that the focus has been on the technology rather the currency itself. However, I think the currency bitcoin and cryptocurrency in general will see a lot more clarity going forward from a tokenisation point of view because there are a lot of possibilities to have your own cryptocurrency – either as a country, organisation or business enterprise. We are still in the early stages but the technology itself has proven to be groundbreaking and a very interesting creation.
FST Media: Does Bitcoin represent a threat to banks or an opportunity for innovation in financial services?
Lee: Bitcoin is one of the biggest experiments that we have seen so far in the financial world. We have had other innovations like eCash which the public has resisted. Many of them run into compliance problems and stop operating, but bitcoin is in some ways decentralised, so it is a lot harder for the regulators to examine it closely. Because there is no legal entity behind bitcoin, it is harder to regulate it. The only way we can regulate it is through the financial intermediaries, and a lot of countries have set out rules and regulations for intermediaries and for the technology authorities to look at whether it is a currency or asset for trading.
As far as the banks are concerned, what I am observing is that the banks have a lot of compliance procedures to abide by. When they are regulating the intermediaries, they have to ensure that the intermediaries would all have the same standard of compliance so that they could be responding to the authorities. In some cases, the cost of compliance is a lot higher than the profit that they can generate from these enterprise so it is not surprising to me that some banks are not so keen to engage with these bitcoin companies. However, this does not apply to all banks as there are a lot of other banks who are keen to work with bitcoin companies, it is just a matter of getting the right standard of compliance for the intermediaries. I think it is not an unsolvable problem, it is just a process that any enterprise has to go through especially where if you are deemed to be a financial intermediary, you need more time to convince the banks and financial institutions that you are running a genuine business.
FST Media: What will be the next big innovation in contactless payments?
Lee: The next big innovation will be cybersecurity-related. I think bitcoin has come out with this groundbreaking idea of blockchain technology, providing a decentralised ledger that can potentially save a lot of operational cost for financial services institutions as well as many other industries. The real contribution that bitcoin has made has been with this consensus ledger, and I think this will change the way that we look at accounting and the way we store data, as well as how we form consensus on register. If the technology can successfully penetrate the market and the industry comes to the consensus that this is the way to move forward, then we could see the technology being used in a way that not only saves costs but also, in terms of cybersecurity, may help mitigate the [problem] of hacking. From a cybersecurity perspective, the consensus ledger will be a very interesting innovation that many financial institutions and institutions in other industries will embrace for cost-effectiveness.
I am not undermining the tokenisation of the decentralised system [of bitcoin]. However, when the regulations catch on, bitcoin currency will be a major force. Though, it is still too early to see bitcoin as a world currency because we are not there yet but we should not undermine the tokenisation of digital currency as well.
FST Media: How will digital currencies shape the payments space in 2020?
Lee: The first thing that you notice is that cash is not cheap; it is inefficient. Most of the central banks eventually will come to the consensus that digital currency is the way to move forward for various reasons: taxation is much clearer, you have a greater knowledge of money flows through available data and analysis, and you have a real control of money supply. I think digital currency has a lot of potential to give us a lot more information than cash itself. Those benefits will eventually be used by most of the government and in the collection of taxation, it is also much more efficient as you can trace where the money is going. It makes perfect sense to have digital currency and I see that this is a natural progression going forward – it is just a matter of how long it takes for us to reach that conclusion.
FST Media: In your novel, Handbook of Digital Currency, you discuss how crypto-currency was traditionally thought to possess “the characteristics of a currency that can impose fiscal discipline on the government.” What are the key challenges that governments face with regulating crypto-currencies like Bitcoin?
Lee: One of the ideas of Satoshi is that by having constant growth rates of your money, you are able to have more discipline. It also makes a lot of sense in terms of looking at digital currency – it is the issue of debt. By having a constant growth rate, the ability to trim and pay off your debt is a lot more challenging because of the [nature of] the modern debt system. There are no restrictions on a government when it comes to printing currency, provided that there is enough confidence in that particular currency. I think that will reach a point where debt is so huge and when your consistent budget deficit will signal to the rest of the world that your debt cannot be repaid.
In this situation, the confidence in the currency will be shaken and that is where we will have a major issue. However, it does not mean that a new financial system will not be a form of innovation. One area that you can look at is the Chinese way of internationalising their currency through bilateral agreements. The establishment of the AIIB is another very interesting development in the sense that more money which is needed now for raising debt is no longer used for consumption but rather for infrastructure building. You now have a world organisation that focuses on infrastructure building for borrowing and consumptive use within a country. You will see the whole financial architecture changing over time and there will be fears surrounding the question of whether those countries who are in huge debt will increase their taxation for foreign investors, as well as whether they have the ability to redeem and return their debt as this will have ripples in the entire monetary system. Government discipline imposed on how much you bring and borrow is important because it affects the interests and confidence in that currency and can have an effect on the rest of the world.
The implications that this may have on cryptocurrency is very interesting, particularly when we look at how this unfolds in years to come. My own view is that cryptocurrency has an advantage over digital currency because it has no central storage, is more transparent and also provides you with the opportunity to be in control of the growth of this currency. With cryptocurrency, you may not be able to create as much debt as you wish to have.
FST Media: In your novel, you also discuss how the authenticity of Bitcoin transactions can be determined using digital signatures and public-key cryptography. How significant is the problem of cybercrime with bitcoin transactions and what are the key security issues that need to be addressed?
Lee: I think the problem we have here is one of perception. Bitcoin has been seen to be used for transactions surrounding activities like money laundering, drugs and online casino games. Our research has shown that there is a lot of speculation on the future of bitcoin and many believe that it will not be a world currency because generally people are wary that it is being used for the wrong purpose. In addition, it is designed in such a way that it is very difficult to regulate because there is no legal entity to make anyone responsible and this makes it hard. The only way it can be regulated is through the intermediaries such as enterprises all over the world. Compared to cash, you have a lot more transparency with bitcoin as it leaves a trace whereas cash does not leave any public record. Given the kind of technology we have for tracing where the money is located or where it is going, it is unwise to use bitcoin for the dark side of cybercrime.
FST Media: What are your thoughts on payment platforms like Google’s Android Pay and Alibaba’s Alipay and how can banks learn from them?
Lee: I think the disruption of banks is a very interesting area, particularly when we consider how banks can use some of these technologies (like a consensus ledger) to lower costs and enhance their operational ability. The major challenge for banks is not from bitcoin or cryptocurrency, but from the centralised non-financial institutions and e-commerce firms like Alibaba. There is no point in having e-wallet [capabilities] and then hoping the public will use this. However, introducing certain business activities can help to create customer retention.
For businesses to buy and sell their goods, e-commerce firms like Alibaba create retention by forging a sense of trust between buyer and seller through Alipay. Subsequently, it becomes a lending platform for people who want to buy more goods to sell online and you then create a retentive population who will use your platform. Even though your payment app is given as a freebie, you can actually increase your profit margins by providing fund management services, micro-insurance business, crowdfunding for movies and many other similar business ventures. This is what separates Alibaba as a business organisation backed by an e-commerce platform that has extended its services to lending platforms, big data credit analysis and other platforms because essentially data itself is being monetised. This is the greatest challenge for financial institutions: how do you create customer retention?
We are seeing challenges to banks, not only from e-commerce platforms like Alibaba or telecommunications platforms like M-Pesa, but also a lot of other alternative platforms that are creating consumer retentiveness. Disruptive companies like Uber and Airbnb could all be challengers to financial institutions in the future.
In this sense, the challenge does not revolve around bitcoin or cryptocurrency, but from the centralised businesses focusing on consumer retention. Going forward, I think cryptocurrency will play a significant role in financial services because you will need to tokenise your services and if regulation allows this, then it can create a lot of loyalty through these tokens. Once companies like Alibaba have your data, they can record your behaviour using this data and then use it for monetising solutions. As a result, the incumbents are increasingly being disrupted.
FST Media: What is the ‘holy grail’ that is yet to be delivered in financial services?
Lee: The next big thing in financial services is about ‘connectivity inclusion’. This is more than just financial inclusion, it is about being connected by smartphones, wearables and across all radio signals. They connect you to more than just economy – this is the amalgamation of social inclusion, financial inclusion and collectively I term this to be ‘connectivity inclusion’. Previously, it has been very expensive for banks to service people who are not in the system because of high compliance and operational costs. Now, with the latest technology this has become viable and this is where cryptocurrency comes into the picture. I think the consensus ledger is one of the cheapest and most secure ways to overcome this problem. For connectivity inclusion, banks need to look at these new technologies and cryptocurrencies to lower their costs. Inclusion is the key word here, if you want the economy to grow and businesses to continue to advance, then this is the opportunity to see sustainable growth. This is how I came up with my ‘LASIC model’: low barriers of entry for business, asset line, sociability, innovation, and then compliance-ready. All the new disruptive models will conform to these LAZIC principles.
The most advanced country in the world for digital banking and financial inclusion is China. We have seen some digital banks being set up in Kenya, the US and Europe but the sustainable model for growth rests with China because it has a social agenda behind digital banking.
FST Media: Every leader has a legacy they wish to be remembered for, what is yours?
Lee: I would not say that I am a leader. I study economics because my inclination is to do research to improve the welfare of people. To advance your knowledge is something that is very appealing to me but that was not my mission. I have been in the industry for a long time; I have been in the financial industry and an academic for close to 30 years now. I want to do research that has an impact on the welfare of people and I hope that the things I do will help address certain issues in the financial industry which to me are unreasonable. I want to take it a step further and discover solutions which are a win-win for enterprises and regulators, as well as the people who will benefit from this. At the end of the day, we need to make sure that whatever research we do, we are improving the welfare of people in the world at large. We have a very unbalanced economic system in place and it is unreasonable to have so many people not included in the financial, economic and social system globally.
I want to look at how an ecosystem can be initiated and studied so that we can solve the problem of ‘connectivity exclusion’. I hope that all of us can create an ecosystem to make the world a better place.
Professor David Lee Kuo Chuen will be speaking at FST Media’s 6th annual ASEAN Technology & Innovation – the Future of Banking & Financial Services conference in Singapore, in addition to a distinguished panel of executives across financial services from July 22-23. For more insights and information about the event, register for your complimentary pass here.