Table 1 Top five stablecoins by market capitalisation as of 2023.
Since 2019, stablecoins have attracted lots of media attention, when Facebook (Meta) attempted to launch Libra (later on it was renamed as Diem) as the social media giant’s own cryptocurrency and payment system. The Diem has nonetheless later come under harsh criticism and opposition from central banks, academia, and the general public over issues related to monetary sovereignty, financial stability, data privacy, and anti-competitive issues. As of April 2023, the total market capitalisation of stablecoins amounted to $132.62 billion, representing 12.8 percent of the overall value of all cryptocurrencies. Because the majority of stablecoins are backed by U.S. dollars in a 1:1 ratio, they have often been traded at a price of near $1 USD per coin. From Table 1, we can see that the most popular stablecoins are Tether (USDT) and USD Coin (USDC) as they have a market capitalisation of $80.43 billion and $32.38 billion respectively. Other leading dollar-backed stablecoins are Binance USD (BUSD), Dai (DAI), and TrueUSD (TUSD), which all have a collective value of over $1 billion Clearly, stablecoins are viewed as one of the most feasible options for future digital money, given their price stability mechanism and close link with mainstream currencies, commodities, and other real assets.
In practice, stablecoins are reliant on a collection of technologies akin to those powering more well-known cryptocurrencies like Bitcoin and Ethereum. Therefore, the users of stablecoins could enjoy the same benefits offered by any cryptocurrencies like transparency, transaction security, anonymity, and privacy, as we have discussed in the previous section. Stablecoins, on the other hand, are less susceptible to price fluctuations, which are thought to be the biggest problem for most digital coins and prevent them from being widely used as a major currency. To reduce their price volatility, the majority of stablecoins have their value pegged to one or more mainstream world currencies or to other tangible assets like gold and silver. Stablecoins are therefore a special category of cryptocurrency whose price is supported by the value of their underlying assets. To maintain public confidence and price stability, the company or other entities that produce and operate stablecoins would need to maintain a reserve of underlying assets equivalent to the total quantity of stablecoins in circulation. Stablecoin owners have the option to redeem their coins for the underlying assets.
The popularity of stablecoins is partly attributed to the growing trend of decentralised finance (DeFi), which refers to the provision of financial services and products by using smart contracts and blockchain-based protocols. DeFi allows consumers to access basic financial services like saving, lending, borrowing, and investments without the involvement of banks and other financial institutions. Stablecoins are the application of DeFi in the money and payment systems, which forms the foundation and key infrastructure of a decentralised financial world. Investors, by purchasing stablecoins and depositing them into decentralised lending protocols, could achieve a better return than traditional fixed-income investments like savings, bonds, and money market funds. For instance, TerraUSD holders have been provided with a twenty percent annual return on investment which is the primary reason for stablecoins’ rising popularity. The higher return and potentially safer design make stablecoins appeal to many risk-taking investors of cryptocurrencies or traditional investors holding financial assets such as shares and bonds.
B. The Main Categories of Stablecoins
Based on how they function, particularly the type of the underlying assets, there are four distinct types of stablecoins. Firstly, fiat-backed stablecoins, which are the most common stablecoins, as their value is backed by U.S. dollar, Euro, Chinese yuan, or other major fiat currencies at a fixed ratio like 1:1. The examples of fiat-backed stablecoins are TrueUSD (TUSD), Tether (USDT), USD Coin, and Facebook (Meta)’s Diem. Most of them have been created by issuers who hold off-chain (i.e., not on the blockchain) collateral through regulated banks that serve as the depositary of fiat currencies to support the value of such stablecoins. The creation of fiat-based stablecoins is intended to promote wider use of cryptocurrencies. As a result, cryptocurrency users can utilise fiat-pegged stablecoins to make online purchases just like they would with any other kind of virtual money. Fiat-pegged stablecoins have another noteworthy feature in that their value is correlated to that of the fiat currency that serves as their underlying asset. Accordingly, they don’t fully base their value on the short-term effects of supply and demand, so fiat-backed stablecoins are typically seen as a more trustworthy type of cryptocurrency.
Secondly, commodity-backed stablecoins, which are pegged to the price of commodities and physical assets including precious metals, oil, and real estate. Gold has been the most common commodity to be used as collateral for such stablecoins. Traditional commodity investors are particularly drawn to commodity-backed stablecoins. It is because the stablecoins enable them to invest in gold without having to source and store real gold, which could be expensive and time-consuming. Examples of commodity-backed stablecoins are Tether Gold (XAUT) and Paxos Gold (PAXG). The stablecoins can typically be redeemed by their holders at a conversion rate to obtain the real assets. However, the cost of holding and safeguarding the commodity backing is part of the stablecoins’ operation.
Thirdly, crypto-backed stablecoins have their price being collateralised by one or a portfolio of cryptocurrencies, and the peg is executed on-chain (i.e., on the blockchain) via smart contracts. Stablecoins backed by crypto function essentially the same as stablecoins backed by fiat; they maintain the value of a pegged asset. But the cryptocurrency-backed stablecoin uses reserved cryptocurrency instead of money as collateral, and in most cases, Ethereum is used. One of the most well-known stablecoins with a cryptocurrency backing is MakerDAO. It pools enough ether (ETH) on the Ethereum blockchain in a self-executing smart contract to serve as collateral for its stablecoin. Users can then mint DAI, the MakerDAO stablecoin, once the amount of collateral in the smart contract hits a specific threshold.
Fourthly, algorithmic stablecoins, such as TerraUSD, which are not backed by any currencies, commodities, or virtual assets. Instead, they rely on computer algorithms to adjust the supply of stablecoins in an intelligent manner. At any time, the algorithms will automatically mint (create) new coins or burn (remove) existing coins from circulation, according to the real time data regarding the fluctuating demand for such digital tokens. A typical algorithmic stablecoin structure, known as a two-coin system, uses one coin to buffer market volatility while the other tries to maintain the peg. The former token is widely traded on secondary decentralised markets and is also identified as a balancer or sharing token. Algorithmic stablecoins rely on independent investors to engage in price stabilising arbitrage in order to get market incentives to sustain a supposedly stable ecosystem. But it is as dangerous to rely on independent, market-driven people to carry out discretionary arbitrage without being bound by the laws or any financial regulations.
C. The Advantages and Limitations of Stablecoins
Since the first wave of cryptocurrencies, including Bitcoin and Ethereum, are entirely virtual, there is no reliable process for setting their prices because they have no intrinsic value. Thus, the value of Bitcoin and most cryptocurrencies is basically determined by the overall market supply and demand of relevant digital tokens, which has rendered their price incredibly instable. Also, as cryptocurrencies have been issued by private entities, they do not have the endorsement from governments. Therefore, it is less likely for Bitcoin to become a common means of exchange due to the price fluctuation, the lack of underlying assets, and the lack of state credit. In contrast, stablecoins have been created to address these limitations associated with cryptocurrencies. They are considered a safer option for investors and consumers who could actually observe the value of assets underpinning stablecoins. In particular, fiat-based stablecoins, which are pegged to official currencies issued by central banks, have partially solved the issue of a lack of public trust.
There are various price stabilisation mechanisms for stablecoins, depending on whether they have adopted a centralised or decentralised design. Take Tether as an example for centralised stablecoins. They would need a central custodian to manage and hold the underlying assets. Tether, as it is backed by U.S. dollars, has a bank account to hold the currency reserves in an amount equivalent to the number of Tethers being circulated. Therefore, the price fluctuation of Tether could be minimised. On the other hand, there exists other decentralised stablecoins that could also achieve the function of price stability without resorting to a centralised authority. For instance, Dai, as a cryptocurrency-backed stablecoin, is operating on Ethereum blockchain. It employs smart contract to manage collaterals and maintain a value of $1.00 without actually holding any U.S. dollars in a bank account. This is done through the automatic adjustment of the number of digital coins in circulation to prevent price fluctuation.
It is debatable if stablecoins will actually be able to attain long-term price stability, which is a requirement for developing a widely used type of digital currency. Clearly, the price of stablecoins’ underlying assets could still undergo fierce price change. In recent years, we have experienced the Covid-19 pandemic, the war in Ukraine, and many other economic or geo-political incidents leading to enormous price fluctuation of major currencies and commodities like oil and wheat. A lot of ‘black swan’ events expose investors to highly unexpected financial risks, and it is unlikely to have fully safe or stable assets in the current macroeconomic environment. Therefore, if the underlying assets of stablecoins start to lose value or become illiquid during any economic turmoil, the price of stablecoins, correspondingly, will be likely to experience high volatility. In this sense, the price of stablecoins is not always stable, so its name might be a misleading label. It is simply that inventors and operators of stablecoins try to use their names to attract more risk-averse investors.
The U.S. Federal Reserve, in its ‘2022 Financial Stability Report,’ pointed out that stablecoins are susceptible to runs when investors rush to convert their holding of stablecoins to underlying assets. In May 2022, the price of TerraUSD fell below $1.00, which is the value figure that most dollar-backed stablecoins would like to maintain. It’s because Luna, a sister cryptocurrency to TerraUSD that uses the same operating system, underwent a price crash and dropped from over $100 to under a penny. Moreover, many investors of Tether, the world’s largest stablecoin, have often raised the concern of whether Tether has sufficient U.S. dollars or other dollar equivalents in its bank account to support their token value. In February 2021, Tether settled a legal dispute with the New York Attorney General’s Office, as the corporation and a crypto firm Bitfinex agreed to pay a total fine of $18.5 million for making false statements about the backing of Tether. According to Attorney General Letitia James, “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.” Besides, a senior regulator from the U.S. warned Tether investors about the lack of interoperability because stablecoins based on dollars cannot be exchanged for one another directly. Not all stablecoins operate in a same way across multiple blockchains. For stablecoins to be widely utilised in daily payment rather than investing, this could be a significant barrier.
V. Central Bank Digital Currencies (CBDCs)
There is no denying that the global economy has been embracing Fintech-enabled digital money. But it is less certain about which form of digital currencies will dominate tomorrow’s financial world. As discussed, cryptocurrencies are prone to significant price fluctuation, and their lack of public authority and ineffective regulation often cause regulatory challenges like money laundering and financial instability. Similarly, the value of stablecoins is not always stable as their operators have claimed, due to the insufficient reserve of underlying assets. So far, it doesn’t seem like traditional fiat currencies could be replaced by either the first-generation cryptocurrencies or the more current stablecoins. Therefore, as an official response to the crypto age, central banks and monetary authorities around the world have started investigating and testing central bank digital currencies (CBDCs). This section considers the incentives for central banks to introduce official digital currencies and the various design options of CBDCs.
A. CBDCs: Definition and Operating Mechanism
Aside from cryptocurrencies and stablecoins, the third type of digital money is state-backed CBDCs or sovereign digital currencies. They denote the official solution to the rise of digital money and Fintech payment networks. Central banks aim to exploit CBDCs to join the currency competition, having addressed certain limitations of privately issued digital tokens. CBDCs have certain advantages that are typically found in central bank-issued money (i.e., banknotes) such as settlement finality, liquidity, and integrity. Such features make them more widely acceptable for digital economy. CBDCs are the digital representation of sovereign currency made by one jurisdiction’s monetary authority that will appear on the liability side of their balance sheets. Contrary to decentralised money like Bitcoins or stablecoins, CBDCs are governed by a centralised system similar to that for conventional currencies, like U.S. dollars, Euro, British pounds, and Japanese yen. Since the government is pushing for digital payment and a cashless society, all transaction records and stored data of CBDCs will therefore be accessible to authorities. CBDCs also contribute to more effective monetary policy solutions, as they not only act as official money and payment systems but also work as an interest leverage tool. In practice, CBDCs could even be charged with extra regulatory functions like the anti-money laundering tool, fraud prevention procedure, as well as cross-border applications to accelerate currency internationalisation.
CBDCs have drawn a lot of interest recently as a potential digital substitute for conventional fiat currencies. CBDCs are issued and backed by central banks that are in charge of preserving the integrity and stability of the financial system. CBDCs are a new type of money being issued digitally by central banks as legal tender, which is genuine money in the legal and economic sense. This makes them distinct from privately issued cryptocurrencies like Bitcoin. CBDCs represent cash-like direct claims on the central bank. The Bank of England perceives CBDCs as a financial innovation in terms of both the form of money provided to the public and the financial infrastructure on which payments can be made. CBDCs have the potential to develop into a regulatory toolset if used widely. Initially, they are utilised as an official cash alternative to compete with other digital currencies. Different technological standards, such as distributed ledger technology or a more centralised strategy, can be used to build and deploy CBDCs. Regardless of their design features, CBDCs are expected to be subject to regulatory requirements that are comparable to those that apply to conventional fiat currencies as well as extra regulatory rules because of their digital character, such as cybersecurity and data privacy laws.
According to the Bank for International Settlements (BIS), eighty-six percent of sixty-five surveyed central banks have been engaging in some form of CBDC work, with sixty percent of them having progressed from conceptual research to experiences or proofs-of concepts and fourteen percent moving forward to development and pilot arrangements. Since 2014, the People’s Bank of China (PBOC) has carried out several trial runs of its prototype cryptocurrency, as it could be the first major central bank to issue virtual money endorsed by the state. In 2018, the Bank of England has further explored the design mode of freely trading bank deposits against CBDCs by elaborating several core principles of CBDC issuance. In January 2022, the U.S. Federal Reserve expressed potential interest of developing its digital currencies as digital dollar and issued a discussion paper examining pros and cons of the adoption of CBDCs. At present, CBDCs seem to be the most viable non-physical currency option for digital economy thanks to their advanced regulatory functions, the stable value, and most importantly, the official endorsement and wide acceptability. But it is argued that CBDCs may increase the risk of bank runs because a significant quantity of savings will likely be moved away from commercial banks. In addition, CBDCs could result in the rise of surveillance state when governments are able to collect more transaction data from citizens and restrict their financial freedom.
B. Market vs State: The Currency Competition
The decentralisation and lack of interference from governments are two distinguishing characteristics of cryptocurrencies. This is set to change, though, as a large number of countries have been experimenting state-backed digital currency. Up until the recent invention of peer-to-peer virtual currencies, the issuance of notes and the creation of new money had been the exclusive preserve of central banks for centuries. As a result, it is not surprising that monetary authorities are reluctant to transfer this great power to individuals or organisations since anyone with access to the Internet can now easily create a new virtual currency. An official cryptocurrency appears to be a compromise between governmental control and financial innovation. As of 2023, a hundred nations were studying CBDCs in some capacity, with some testing and possibly giving them to the general population. Evidently, one possible turning point in the history of money is the introduction of CBDCs. With CBDCs, central banks and financial regulators will find it simpler to monitor the money flow and identify underlying risks associated with state-backed virtual currencies. Other benefits of CBDCs include settlement finality, liquidity, and integrity, which are often present in central bank-issued money. These advantages make CBDCs a more commonly accepted form of payment for digital trade.
So far, the digitisation of money has raised the mounting issue of currency competition, as both private and public sectors compete to create new forms of digital tokens, making their own monetary standards for the future economy. CBDCs seem to be an effective solution in the eyes of monetary authorities because they help to restrict the use of privately produced digital currencies, which could endanger monetary sovereignty and financial stability. It is also challenging to monitor and regulate privately issued digital money operating outside the realm of a country’s financial regulatory architecture. In contrast, CBDCs are a sort of centrally controlled cryptocurrency that central banks can use to counteract the market dominance of private payment systems. Central banks are able to monitor almost all transactions made by CBDCs. The regulatory powers against criminal and illegal activities may be expanded for CBDCs. In the event that a large amount of data is gathered through their use, CBDCs could also serve as a future regulatory toolkit for financial authorities. Evidently, CBDCs compete more favourably than other digital currencies thanks to the strong backing of the national credit and the requirement of compulsory circulation. CBDCs could assist central banks in increasing the efficiency of monetary policy. Due to their digital nature, CBDCs can be used as a payment method as well as an interest-leverage instrument to improve the way monetary policies are transmitted. It is clear that CBDCs make it more straightforward for central banks to develop, implement, and adjust monetary policies in most jurisdictions. Since CBDCs are the fiat currency issued by a central bank, they benefit from the attribute of having unlimited legal credit. They are subject to the same legal indemnity framework as banknotes and coins due to the fact they are considered as legal tender. If the requirements for acceptance are met, neither individuals nor businesses may refuse to accept CBDCs when they are being used to pay any public or private debts. Being legal tender is the ultimate goal for any digital currency if it is going to be used on an expansive basis, so this is a significant competitive advantage for any CBDCs.
C. CBDCs’ Design Options and Characteristics
Next, it will examine five essential design elements for CBDCs. First, CBDCs are likely to substitute cash in circulation, which is known as M0 in economics. In practical terms, CBDCs often function as M0 to replace cash as the fundamental unit of money. M0 is the term used to describe the currency used by people in daily transactions, as opposed to the reserve currency kept in banks. It is classified as money in the strictest sense since banknotes are “monopolistically issued by the central bank of a sovereign state” and because there are alternative commonly used payment methods like checks and credit cards. Currency is divided into layers according to its liquidity: “M0 is the direct claim on the central bank with the highest liquidity; M1 contains both currency in circulation and tradable deposits, which represents the direct purchasing power of society as a whole; M2 typically consists of M1 and other non-tradable deposits such as the time deposit; and finally, M3 is made up of M2 and other current assets like government bonds, bank acceptances, and commercial paper.” When calculating the inflation rate and making monetary policies, central banks should classify CBDCs as cash (rather than deposits or other current assets) if they are to be considered M0, which would give them immediate purchasing power on the commodity market. On the other hand, the fundamental idea behind issuing CBDCs is the digitisation of currency whose inherent value is just as secure as legal tender.
Second, CBDCs can be used in three different application contexts: retail, wholesale, and cross-border. Retail CBDCs, often referred to as general purpose CBDCs, are virtual currencies designed for use by individuals and small businesses. They can be applied to a range of transactions, including in-person, online, and peer-to-peer payments. Retail CBDCs are easier to use and marketed towards the general public. Most existing CBDC projects, such as China’s digital yuan and Sweden’s E-krona, targeted retail transactions. “At retail level, the simplest and most common model for completing transactions is the direct cash payment without any settlement activities through banks or other financial institutions.” The benefits of cash payments in this situation are evident, including their adaptability, rapidity, and widespread acceptance. Cash becomes the best payment mechanism for retail purchases, which is also what CBDCs want to do. Furthermore, CBDCs can lower clients’ storage expenses and dangers associated with carrying cash. It lessens the time lag and lowers the cost of transfers among commercial banks. They can also reduce a nation’s maintenance costs for its currency. Wholesale CBDCs, on the contrary, are digital currencies made for use in high-value interbank settlements and other financial transactions conducted by banks and other major financial organisations. They are designed for usage within the financial sector and are not often available to the general public. The design aspects of CBDC applications vary in real-world use. While Dinero Electronico in Ecuador and Petro in Venezuela are primarily focused on retail CBDCs, Project Jasper in Canada adopts a hybrid approach with an emphasis on wholesale CBDCs. Apart from the retail and wholesale applications, by enhancing CBDCs’ cross-border applicability, central banks can encourage the further development and widespread adoption of sovereign digital money. For example, “according to the Financial Stability Board (FSB), there is a consensus among major economies, such as the G20, to enhance cross-border payments.” It is evident that national economies would benefit if CBDCs offered cross-border payment services that were less expensive, faster, more transparent, and inclusive.
Third, CBDCs could be offered in either token-based or account-based formats. Despite being a purely technical issue, the division of CBDCs has significant effects on their design, expense, identity verification, and access management. Account-based CBDCs are digital currencies that may be accessed using a digital wallet or other electronic devices and are kept in a central bank account. They can be used for a number of transactions, including peer-to-peer payments, online purchases, and in-person payments. They can be held by individuals, companies, and financial institutions. A trusted third party is often used in an account-based method to confirm a user’s identification as the account holder. It is also used to check user’s account balance before allowing them to make a payment. The accounts are then appropriately debited and credited. Account-based CBDCs could result in unnecessary expenses, and the requirement for additional verification stages could incur similar costs and deficiencies in current financial systems. For wholesale CBDC and interbank payments, where the compromise between accessibility and identity proof seems to be more clear-cut, an account-based solution might be more appropriate. In contrast, token-based CBDCs are digital money represented by a digital token or other tokenised assets. They are transferable between users and can be kept in a digital wallet or other technological device. CBDCs built on tokens may offer further features or capabilities, like the compatibility with smart contracts or other programmable forms of currency. In practice, the verification of token-based CBDCs employing blockchain technology removes the requirement to check a customer’s balance before approving a transaction. A transaction will be automatically executed, as long as users can prove their identity as the token holder, such as providing a private key and signing the transaction and meet the necessary level of identity criteria. Although there is a danger involved when a private key is lost, there are ways to maintain the control of ownership in such situations. Without the requirement for an account, token-based systems can offer a more direct, cash-like approach. The multi-factor authentication is used to stop double-spending, which is the practise of simultaneously spending or spending the same cash more than once.
Fourth, CBDCs’ operating models can be categorised as centralised, decentralised, or hybrid. A central authority, such as a central bank, which has the authority to control the flow of currency and keep an eye on transactions involving it, issues and regulates centralised CBDCs. This is the most common design option for global central banks. But CBDCs, that function in a decentralised manner, are supported by distributed ledger technology, such as blockchain. Transactions with decentralised CBDCs are documented on a public, decentralised network and are often protected by cryptographic methods. The additional design option could a hybrid CBDC, where decentralised and centralised components of CBDCs are combined. They operate similarly to a centralised CBDC in a way that they are issued and managed by a central bank. But they are also supported by a decentralised ledger system, making them comparable to a decentralised CBDC or other first-generation cryptocurrencies like Bitcoin and Ethereum. Compounding the advantages of both centralised and decentralised digital currencies is the ultimate aim of creating any hybrid CBDC. For instance, a hybrid CBDC can provide transaction efficiency and transparency that typically belong to a decentralised digital currency, whilst possessing the beneficial features of a centralised digital currency, such as state credit, security, and stability. As a result, this might make hybrid CBDC a more appealing choice to governments and a broader range of users, such as individuals, corporations, and financial institutions.
Fifth, the anonymity design is likely to be another crucial feature of CBDCs. When creating CBDCs, central banks must strike a fine balance between the requirements for anti-money laundering (AML) compliance and the protection of personal data privacy, so the anonymity feature should be carefully considered. In the European Union (EU), the proportionality test is a requirement for member states to ensure that the regulatory power given to any governments under a particular law does not improperly restrict other fundamental rights. The Court of Justice of the European Union (CJEU) may review the AML transaction monitoring procedure to determine whether a case requiring banks to implement the detection and reporting of suspicious customer activity complies with the General Data Protection Regulation (GDPR). Future outcomes of AML legislation enforcement may be subject to extrajudicial assessments because the protection of data privacy as a fundamental human right must first be respected. Thus, the EU member states are most likely to adopt the anonymity mechanism when designing their CBDCs. They will then gradually improve the design features for containing AML risks in order to balance the fundamental rights of individuals with the protection of public interest and reduce compliance costs. This viewpoint has been strengthened by the latest study conducted by the European Central Bank (ECB) on the anonymity of CBDCs. However, when personal data is used to identify and prevent crimes, Chinese authorities tend to believe that it is exempt from data protection laws. In mainland China, there are no special provisions that address the issue of AML compliance with respect to the collection of personal data, but the country’s Personal Information Protection Law (PIPL) does mandate that administrative officials and regulators should only collect personal data to the extent necessary to meet legal requirements. As a result, creating a token-based CBDC system with complete anonymity is seen as a risky endeavour and is unlikely to be approved by Chinese regulators in the future. China’s digital currency is probably going to follow the controlled anonymity approach. The authentication of digital yuan users’ identities relies on a controlled anonymity system that fully utilises the particular features of the digital currency: ‘front-end voluntary’ and ‘back-end real-name’ in order to preserve privacy and personal data protection. When users transact with one another, it is anonymous; however, the central bank will keep all transaction data under the real names of the users.
It is clear that individual countries have distinctive political, economic, and legal systems; thus, they might adopt different strategies to make their current financial and legal frameworks more compatible with the CBDC experiments. The importance of carefully weighing the benefits and limitations of various CBDC solutions is paramount, as central banks and financial regulators need to adjust their policy initiatives to meet their unique local circumstances. The practical requirements and policy goals of a country will ultimately dictate how a CBDC project is designed and implemented within its borders.
VI. Mobile Payment Systems
A. The Historical Development of Payment Methods
The payment industry has witnessed significant changes over the past two decades. People can now make payments using a variety of methods, including cash, checks, credit cards, debit cards, mobile banking, direct debit, and standing orders. A total of 39.3 billion payments were made in the UK in 2018, with approximately ninety percent of those coming from consumers and the rest coming from businesses, the government, and not-for-profit organisations. There exist traditional methods of making payments such as paying by cash (banknotes or coins) and paying by cheques. Cash payments once dominated all payment methods, but they have been in steady decline. A decade ago, cash accounted for sixty percent of all payments made in the UK, but now it fell to only twenty-eight percent. In the US, as people use cash less frequently, the number of ATMs has decreased annually over the previous few years to 451,500. It is because smartphone payments and card payments, particularly those with the contactless payment function, have grown quickly. Following the COVID-19 outbreak, a growing percentage of consumers who never used cash at all are now using cards and other payment options to manage their expenditures. Digital payments have become more common as a result of the fact that ninety-five percent of internet users now access the internet through a mobile device.
Although paying by cheques seems old-fashioned, it is still a standard payment method, especially among the older generation. Due to the growth of card payments and internet payments since the early 1990s, the use of checks has drastically reduced. In the UK, there were 1.32 billion cheque payments issued in 2008, but ten years later, that number had significantly decreased to 342 million. But when payers are unaware of the recipient’s bank account information, check payments are still a preferred payment option that are practical and secure. People who receive checks must take them to a bank branch and ask the staff members to deposit the funds into their own accounts. But, there are several drawbacks to using checks for payment. Given that checks do not always clear immediately, it could take longer than other methods of payment. Cheque recipients may need to wait a specific amount of time before the funds appear in their accounts. Furthermore, using checks requires caution because they are vulnerable to fraud. There are three basic types of check fraud: counterfeit, forgery, and fraudulently altered checks. A check is counterfeit if it was made on a non-bank paper in order to look real. Although it refers to an actual account, it was actually authored by a fraudster with the intent to commit fraud. A valid check that has a different account holder’s signature on it is referred to as a forgery. The check was signed by the fraudster to create a fake signature. A fraudulently altered check has been made out by a legitimate customer but has had some part of it changed before it has been cashed, such as changing the amount or the recipient’s name. The check is no longer valid because it has been modified.
Card payments are likely among the most used forms of payment, especially for routine supermarket and retail purchasing, aside from cash and checks. Debit and credit cards are the two primary categories of plastic payment cards. Instead of using cash, debit card users make purchases since the funds are immediately debited from their bank accounts. The money will then be instantly transferred from the payor to the payee. In many countries, debit cards have surpassed cash as the preferred mode of payment. With credit cards, users can make purchases using a line of credit provided by the institutions that issue the cards. In fact, cardholders borrow money to make payments with a pledge to reimburse the issuers later, along with interest and other fees. The evolution of bankcards has been seen over time. Magnetic stripe or swipe cards are the traditional types of bankcards. On the reverse of the cards, there is a real stripe that stores data using modified iron-based magnetic particles. When making a purchase, the cardholder must first swipe the card against the terminal device and then authorise the transaction with their personal identification number (PIN) or signature. Magnetic stripe cards are not very secure since fraudsters can easily copy the information on the strip to create a new card and use it to make purchases to steal money from bank accounts. Due to this, card issuers have been switching over to EMV chip cards during the past ten years, replacing magnetic stripe cards.
So far, the majority of bankcards have undergone an update to chip and PIN cards, which increases the level of complexity and security of financial transactions. On the top side of chip cards, there is a real computer chip implanted. The cardholder must first insert their card into the terminal before entering their PIN or signing their name. To validate and authorise the transaction, the terminal will get in touch with the issuer using the data from the chip and PIN. Compared to magnetic trip cards, chip cards offer far better security against fraud. The complicated technical standard makes it more difficult to counterfeit chips than stripes. Chips have the ability to generate a constantly changing, one-of-a-kind code each time a payment needs to be made, unlike magnetic trips that can only store static information about cardholders. It is impossible for thieves to read the information on the card because of the dynamic number. In the US, eighty-eight percent of Mastercard credit cards use chip technology presently. Additionally, more bank cards now include a contactless payment feature. It enables cardholders to conduct payment transactions by just tapping their cards over the device without entering additional information. The contactless cards’ integrated circuits store the data that the terminal will wirelessly read using the Near-Field Communication (NFC) technology. In the UK, Australia, and Canada, over sixty percent of bankcards now have the contactless capability, however the technology is still not commonly used in the US and Japan.
In addition, direct debits and standing orders are favoured when it comes to regular bill payment. Most consumers choose for standing orders or direct debits when paying regular bills to local authorities like utility companies or tax authorities. The distinction between these two payment methods is a source of much confusion. Both of these are requests for your banking institution to regularly pay a third party. When consumers create a standing order, they instruct the banks to make a payment to a certain recipient on a regular basis—for example, the utility company or the broadband service provider. Only the consumers are authorised to modify the standing order’s specifics, including the recipient and amount. It takes up to three days before the money is transferred. With a direct debit, consumers grant a third-party permission to take a specific sum of money out of their account. The funds will then be instantly sent to the account of the third party, such as the credit card provider. Standing orders are slower and more expensive than direct debits, hence direct debits have taken over as the preferred mode of payment for many businesses.
B. NFC vs QR Code: The Technical Battle for Mobile Payment
Nowadays there have been two competing sets of technologies frequently used in the mobile payment industry across the world: Near-Field Communication (NFC) and Quick Response code (QR code). Both technologies have attracted a large number of IT companies and smartphone makers, as they serve as the technological foundations for smart phone networks. NFC has been employed by notable mobile payment systems like Apple Pay, Samsung Pay, and Android Pay. In contrast, QR code has been mainly used by Chinese mobile payment providers, such as Alipay and WeChat Pay.
NFC is a simple but versatile low-power interface between two devices, supported by some international standards and an independent certification process. The NFC technology originated from radio frequency identification (RFID), and it was jointly developed by Philips and Sony as a new standard for digital devices to establish a peer-to-peer network to exchange information and data. An electronic device can gather and analyse data from another device or anything with an NFC tag, thanks to this short-range wireless technology. NFC tags are passive devices since they store information that active NFC devices can access and read. Without an internet connection, power and data will be delivered through linked inductive circuits in close proximity of a few centimetres. In practical terms, a number of major contactless payment systems employ NFC extensively. Additionally, it offers a condensed and adaptable method to convey information for advertisements and social media features like sharing contacts, images, videos, music, and files. With Android Beam, for instance, two Android phones may be held together to share webpages, pictures, contacts, and instructions.
So far, NFC has been adopted by smartphone operating systems devised by Alphabet (Google), Apple, and Microsoft. Although NFC chips have been built inside credit cards for the purpose of making contactless payments for a long time, the latest change is to incorporate such technology into smartphones and wearables like fitness trackers and smartwatches. When NFC is applied into any contactless payment system, smartphones need to be swiped at an NFC reader, which is normally installed near the cashier machines, so as to complete a contactless payment. NFC is said to digitalise people’s wallets as we only need to take a smartphone with NFC chips to buy groceries, take a taxi, or buy a cup of coffee. Users must hold their smartphones or smartwatches close to contactless payment terminals. Then, relevant payments will complete automatically within a few seconds, as the NFC devices transmit information regarding the smartphone users’ debit and credit cards. Because NFC occurs within very short distance, the payment transactions are considered secure and hard to tamper. NFC is also energy-efficient compared with other wireless communication methods. In the future, it is possible that we can store and use any plastic cards (e.g., loyalty cards, transportation cards, library cards, and business cards) into our smart devices via NFC. The potential of NFC should not be underestimated for it can be applied in various commercial scenarios. For instance, passive NFC tags can be built into printed advertisements, posters, and informational kiosks to transmit additional information that enable smartphone users to open a web address, get a discount voucher, or view a map.
QR code is a two-dimensional barcode with small black-and-white squares representing data in grid form which can be deciphered by a computer or mobile device. The barcode is a type of machine-readable optical label comprising information regarding the item where it is attached. In order to store data in a more efficient manner, QR code utilises four standardised encoding modes: numeric, alphanumeric, binary, and kanji. QR code can be scanned by electronic devices like the built-in cameras of any smartphone, and then the information will be processed by the devices using Reed-Solomon error correction until the image is finally interpreted. Finally, the data will be extracted from the visual patterns that are present in both the horizontal and vertical components of the QR code. QR codes often encompass information for a locator, identifier, or tracker pointing to a specific website or smartphone application. In 1994, QR code was first invented by Denso, a Japanese automotive manufacturer. It was originally used to track vehicle components during the manufacturing process as QR code allows workers and machines to scan a large number of components at an ultra-high speed. After QR code was invented, it became popular outside the car industry owing to its speediness of reading and great capacity of storing data. Nowadays, QR codes have been utilised in a much broader context ranging from commercial tracking applications to consumer smartphone applications. Its popularity has been growing rapidly with the arrival of the smartphone age, as over five billion people in the world now own at least one mobile device.
But QR codes have received a mixed reaction around the world. In China and some Asian countries, QR codes have become a common and everyday way of connecting offline life with smartphone apps and websites. Though, in the US and Europe, QR codes are less favourable due to the low penetration rate. Clearly, QR codes have multiple advantages over other information technologies. They are versatile and convenient in terms of marketing products and services as QR codes can be printed on product packaging, newspapers, magazines, posters, and billboards. They can be easily added to TV or online advertisements at no extra cost while adding great value to the products and services. As a result, viewers are able to interact with content creators as the QR code bridges the offline world with the online one seamlessly. Apart from that, QR codes can be created with images, logos, and other artworks to improve their visual attractiveness and enhance branding and marketing effects.
C. Case study: Alipay and WeChat Pay
With an estimated user penetration rate of 40.4% and an average annual transaction value of $3,940 per user, China has the largest mobile payment market in the world. As of 2023, the user penetration rates are 28% for South Korea, 22.7% for the UK, 22.8% for India, 19.6% for the US, and 20.2% for Germany. Alipay and WeChat Pay, two major providers of mobile payment who have been widely embraced by retailers, restaurateurs, and e-commerce platforms, control the burgeoning industry for payment apps in China. The development of mobile payment systems in China is unique in the sense that payment options used to be fairly limited just ten years ago. Cash had been the dominant form of payment for several decades prior to the rise of smartphone payment methods. Credit card use had never been broadly adopted in a nation with a large number of small businesses that serve consumers, leading to a leapfrog effect where businesses and consumers moved straight from cash to digital payment applications.
Furthermore, “alipay had a very humble beginning. It was first launched in 2003 as a simple built-in payment tool of Taobao.com.” Thanks to the rapid development of the online shopping industry over the past two decades, Taobao has become one of the most popular online shopping portals in China. In 2010, Taobao occupied eighty percent of China’s e-commerce market, with 170 million registered shoppers. It defeated eBay to become the market leader in the country. Accordingly, Alipay enjoyed an exponential growth as most transactions on Taobao were settled via Alipay. In May 2011, the People’s Bank of China (PBOC) granted third-party online payment licences to Alipay, along with another 26 internet finance companies. Thus, Alipay was among the first group of Fintech companies to obtain official authorisation to operate an online payment system. Until then, it had been largely regarded as an E-payment facility for online shopping.
2011 marked a new era for Alipay, as it expanded its payment service from online to offline. Alipay launched its smartphone APP on both Apple IOS and Google Android platforms, allowing smartphone users to pay for purchases and services in high street retailers, cafes, and restaurants. In contrast to mobile payment systems which adopt the Near Filed Communication (NFC) technology, such as Apple Pay and Samsung Pay, Alipay and most Chinese Fintech companies have chosen the Quick Response code (QR code) to carry out the mobile payment function. QR code is the trademark for a type of matrix barcode (or two-dimensional barcode) first designed for the automotive industry in Japan. Alipay uses QR code because it has a lower infrastructure threshold, making it cheaper and easier to popularise the country in a short time. When making mobile payments in-store, shoppers will use the Alipay APP on their smartphone to generate a one-off QR code, and then the retailers’ staff will hold a specially-designed barcode reading gun to scan the QR code, and complete the transaction. An alternative way of receiving payment is for some retailers to print out their Alipay accounts which are presented in QR code, and then stick the printed QR code near the counter. Consumers can use their smartphone cameras to scan the QR code and make immediate transfers. The latter method does not even require any investment in payment hardware, rendering the mobile payment facility available for everyone including small shops, street vendors, and street artists.
WeChat Pay is one of the leading third-party payment platforms, and it is affiliated to the Tencent Group. Established in 1998, Tencent is an internet-based technology and cultural enterprise headquartered in Shenzhen, which has the mission to ‘improve the quality of life through internet value-added services’. Through its user-oriented business philosophy, Tencent delivers various integrated internet solutions to billions of citizens across the world. The key products of Tencent include popular social networking software QQ and WeChat, Tencent Games, Tencent Literature, QQ Music, QQ Mail, Tencent News, and Tencent Video. By adopting ‘WeChat Pay is more than payment’ as its slogan, WeChat Pay is committed to provide safe, convenient, and professional online payment services for its users and enterprises. As of August 2018, the number of WeChat Pay’s active monthly users was around 1.058 billion. WeChat Pay has been accepted by millions of stores in over 30 industries. Users are able to use WeChat Pay when seeing doctors, shopping, dining, travelling, and paying utility bills, as the mobile payment network offers the smart life solutions. WeChat Pay is particularly well recognised for its red envelope feature, which is based on the Chinese custom of giving money to family and friends in red envelopes (“hongbao”) for special occasions.
WeChat Pay has been extensively used by Chinese residents when making payments, transferring money, and giving red envelops. As the increasing number of Chinese residents travelling overseas, WeChat Pay has also been accepted by thousands of stores across the world. WeChat Pay can be connected with a credit or debit card from over 300 banks as the payment network supports credit cards issued by JCB, VISA, and Mastercard. But the payment options might vary depending on whether the users have a bank card issued in China or not. If users have a China-issued bank card, they will be able to use the full functions of WeChat Pay without any restrictions. Users have to verify their accounts by providing identity documents such as mainland resident ID cards, Chinese passports, Mainland Travel Permits for Hong Kong and Macao Residents, or Mainland Travel Permits for Taiwan Residents. Then they can link WeChat Pay with savings cards and credit cards from over 70 Chinese banks. With the above documents verified and bank cards linked, users are able to use WeChat Pay for most online and in-store purchases. On the other hand, if users do not have a China-issued bank card, they will face certain restrictions when using WeChat Pay. It supports most Visa and Mastercard credit cards issued by any global banks. Users just need to link the cards to WeChat Wallet and can enjoy the payment services when accessing e-commerce websites or using mobile apps such as JD, Ctrip, Qunar, Didi, Air China, and China Railway Corporation. But the latter type of WeChat Pay (restricted account) can only be used to make payments but users are not allowed to transfer money or send red envelops. According to a survey, 64.4% of foreigners who live in China use WeChat Pay for multiple purposes including transportation, group buying, take-away, dining, convenience stores, supermarkets, and online supermarkets.
Alipay and WeChat Pay, as a cost-effective payment option, have brought great benefits and convenience for both retailers and consumers. It also has a profound impact on the operation of banks and traditional payment networks. The QR codes automatically generated by the smartphone apps are one-off, constantly changing to enhance the level of security. Users have to set up a passcode or use biometric information, such as the fingerprint censor and facial recognition function on their smartphones, to verify their identities before initiating payments. Alipay and WeChat Pay can be linked to debit and credit cards issued by most banks, so as to function as a mobile E-wallet.
In China, the swift shift from traditional payment (e.g., cash and cards) to mobile payment is due to the popularisation of smartphones in the last decade. Ninety-five percent of internet users in the country now go online through mobile equipment. At present, most brick-and-mortar stores like supermarkets, restaurants, and cloth shops, as well as online-to-offline (O2O) services such as taxi hailing, food delivering, and bike sharing, will accept mobile payment options including Alipay and its main rivals like WeChat Pay. Alibaba and Tencent have teamed up with millions of retailers across the country to build a cashless society. For instance, the US cafe chain Starbucks decided to accept WeChat Pay at its 2,600 shops in China, except for one located at Alibaba’s Hangzhou headquarter. Outside China, Alipay and WeChat Pay have been expanding fast to promote their innovative payment services to consumers in Asia, Europe, and the United States. In the UK, some department stores, including Harrods and Selfridges, already accept Alipay. Alipay now has 1.25 billion users all over the world, making it the largest mobile payment system contesting fiercely with its US competitors like PayPal and Apple Pay.
Making payment by smartphones has become a default option for many Chinese people. Even people asking for money on the street are presenting QR codes to receive donations instead of receiving physical banknotes and coins. The market scale of China’s mobile payment sector amounted to CNY38 trillion ($5.7 trillion), which was 50 times that of the US market ($112 billion). Alipay is extremely streamlined and convenient, allowing consumers to complete transactions in a few seconds without taking out their wallets. Recently, even the giving of red envelopes stuffed with lucky money, a millennium-old Chinese New Year tradition, has been fully digitalised. Nowadays people tend to hand out virtual red envelopes to their relatives and friends during the new year, which is a built-in function of Alipay and WeChat Pay. As a result of the proliferation of mobile payment facilities, many Chinese cities have become cashless and cardless. According to a survey, fourteen percent of Chinese no longer carry any cash when they go out, whilst twenty-six percent carry less than 100 yuan ($15), and seventy-four percent of participants said they can survive for over one month with only 100 yuan in their pockets. Clearly, smartphones installed with Alipay or WeChat Pay apps have become the only essential thing for people to carry when going out shopping, dining, and for entertainment.
As Fintech service providers rewrite the rules of the financial industry, the businesses of traditional banks and card payment systems have taken a beat. In the past, China UnionPay was the principal payment system in the country as most bank cards issued in China use UnionPay’s payment and clearing network. Even Visa and MasterCard found it difficult to compete with it. But, Alipay has surpassed UnionPay in terms of the daily number of processing payments, underscoring Alipay’s dominant position in the entire payment industry. As of 2015, Alipay earned CNY139 billion ($20.84 billion) from its payment services, which would otherwise have been channelled to UnionPay and major card issuers like the ICBC and Bank of China. Moreover, Alipay also poses a major threat to retail banking, as an increasing number of savers have moved their money from their bank accounts to Alipay E-wallets. Within the Alipay app, various financial services are provided such as wealth management, securities investment, insurance, and loan facilities. In practice, Alipay is serving as a de facto gateway to Ant Financial’s Fintech business empire. To many consumers, what makes Alipay’s E-wallet particularly attractive is an add-on service called Yu’E Bao (or left-over treasure) which invests consumers’ money into money-market funds but permits them to use and withdraw the money on demand like current accounts. Yu’E Bao offers an annualised return higher than the bank saving rates, and interest is paid on a daily base into consumers’ Alipay accounts. Attracted by the decent return and convenience, millions of savers have opted for Alipay as their default banking account, leading to a sharp drop in deposits for major Chinese banks. Yu’E Bao had around 260 million users across China, and in 2023, its users earned a total of RMB 54.5 billion ($7.63 billion) through their investment in the money-market funds. Apparently, the fast expansion of Alipay and WeChat Pay has eroded the deposit base, revenue, and profitability of China’s banking industry. It shows the competitive relationship between traditional financial institutions and Fintech platforms. Global Fintech businesses and their regulators could learn a lesson from the Chinese practices.
VII. Conclusion
Any financial system revolves around money. This paper has assessed the rapid development of digital money in its many forms since the turn of the twenty-first century. For the economy of the future, both the private and public sectors advocate creating their own digital currencies. Blockchain-based cryptocurrencies, stablecoins, and CBDCs are the three rounds of digital currency innovation that have so far occurred. They all have advantages and drawbacks. This paper suggests that, due to the state backing, constant value, and solid technological infrastructure, CBDCs have thus been viewed as the more viable form of money in the long term (i.e., by the middle of twenty-first century). In contrast, privately issued cryptoassets and stablecoins are more geared towards financial speculation and investments. But, in the near future, private cryptocurrencies and public CBDCs are expected to coexist for another decade or two. Despite the significant efforts of central banks in certain countries to roll out CBDCs on a large scale, traditional fiat currencies are likely to remain the mainstream form of money, while private coin issuers will strive to survive and compete with CBDCs.
Finally, thanks to the growing usage of digital currency and mobile payment methods, many nations and cities have declared their aim to create a cashless society within the next ten years. The widespread use of smartphones and the launch of high-speed mobile networks like 4G and 5G are largely accountable for the quick uptake of mobile payment over traditional payment methods including cash, cheques, and bank cards. As a result of growing Fintech, it is expected that cash will soon disappear in many parts of the world. A large percentage of consumers in China, Sweden, and the UK no longer carry cash when they go shopping and dining, thanks to the wide acceptance of Apple Pay, Alipay, and WeChat Pay by merchants. Therefore, international lawyers need to adapt to the cashless society, recognise the benefits and limitations of digital money, and better serve their clients while seizing commercial opportunities in the ongoing digital currency revolution.
