A recent press release from Mastercard announced that they had created a platform for testing central bank digital currencies (CBDC). CBDC is central bank money, a digital version of cash. Like cash, CBDC is aimed at peer to peer payments. Like many conversations involving public financial utilities like a central bank the private sector not only wants to build the solution, but also control access to it. This is far from the ethos of cash; which many people have described as printed liberty. The private sector distributes cash, but once they have done so, cash is free to be used between natural persons, retail businesses and others, anonymously.
Mastercard has invited central banks, commercial banks and tech and advisory firms to partner with them to evaluate the suitability of CBDC in their region. The sandbox will feature a “proprietary testing platform”. The platform may incorporate blockchain technology similar to many CBDC proof of concepts. The choice of underlying technology is not clear from the press release. The platform can do basic issuance and distribution and exchange of CBDCs between central banks, commercial banks and consumers. Tellingly, it also features interaction with existing payment rails.
Mastercard hopes that this offer will fall on fertile ground as recent surveys from the central bank of central banks (Bank of International Settlements in Basel) has indicated that 80% of central banks are at least contemplating issuing a CBDC. The press release does not state what the various participants will have to give or give up to join the testing platform. The press release does not talk about the already enrolled participants, or about the composition of this cohort.
The pitch is that the platform will give even the most unsophisticated central bank a turn key technical sandbox, which will allow experimentation. Most certainly, it will give Mastercard insight into the models, use cases and the thinking of central banks and other players, giving them valuable market intelligence. Additionally, they may be able to influence the direction of the CBDC solution. The CBDC sandbox will be backed at the edge by mastercard terminals for customer interaction.
Mastercard like all credit card associations, makes its money from providing payment rails for transactions. In Mastercard’s case, the Banknet service runs between acquiring (or the merchant bank) to the issuing banks that issue the card, during the authorization phase of the card transaction. During the settlement phase, the Banknet service gets involved in moving funds from the issuing bank to the acquiring bank. In addition to the card association (Mastercard), the issuing bank and the acquiring bank a credit card processor is often in the mix. All of these intermediaries extract fees. The total fees are composed of interchange fees, assessment fees and markup.
The interchange fees go to the issuing bank, the assessment goes to the card association and the markup goes to the processors. This imposes up to a 4% transaction fee for every transaction. These fees are often directly charged to the merchant. This happens even when credit is not involved, as in debit cards. None of these fees are relevant for a cash transaction.
One important aspect distinguishes CBDC from a card or mobile transaction, no settlement is needed. No need to phone home to an issuing bank, just a connection to the CBDC ledger for instant settlement. From the payer to the payee, instantly. No interchange fees, no markup and lower interchange fees, if any. These savings can be shared between the payer and the payee.
The prospect of this disruption must be worrying to many banking executives, card association CEOs and others who make money from the byzantine linkages in the payment system.
These fees are extracted from the bottom line of businesses that use payment services and in turn affect the prices that consumers pay for goods and services. These fees are not transparent nor directly affect the choices that consumers make. It is a 4% tax on every transaction. There is no cash discount available, in other words when you pay with cash you pay the same as a card or mobile-pay customer. There are still pockets where a cash transaction gets you a discount, like gas stations in New York state.
In an increasingly online world, cash is moot. With the pandemic this trend has accelerated. Cash is seen as tainted and difficult to handle and sanitize. What is the fate of a CBDC transaction? Will there be lower fees charged to the merchant? More importantly, will this saving trickle down to the customer?
Due to network effects, the moats around payment systems are large. There are jut a few card associations. Visa, Mastercard and American Express being the prominent ones. American Express is also an issuer bank. Closed systems like Alipay and Wechatpay have enormous scale in countries like China. The government is rightly concerned about their sway. As part of the creation and planned roll-out of the Chinese central bank currency, the government requires that Alipay and Wechatpay wallets support digital yuan/renminbi.
Central banks who are planning to issue CBDCs should regulate control of the payment rails for CBDC and at least mitigate the fees charged to make it most like cash. Most of the infrastructure of CBDCs, at least for large economies, will be be created, controlled or regulated by the central bank. For the foreseeable future, CBDCs will co-exist with payment rails like Visa and Mastercard. However, to be competitive with credit products and debit cards, will there be different prices for goods bought with CBDCs? How easy will this be to administer for merchants and processors? The answers to these questions will determine the degree of CBDC adoption by the public.