Future of payments

Current payment structures may seem efficient, however new technologies such as virtual currencies and blockchain are here to teach us otherwise.

Current bank transactions need intermediaries in order to successfully transfer money from subject A to B, depending on multiple issuers of payment cards, schemes (e.g., MB or Visa) and processors (e.g., SIBS). At first, one could say that bank transactions are one of the most efficient and fast ways of transferring value in our day to day lives, however there is a need of repetition of information through different kinds of entities which could lead to a transaction time increase (especially if it is a global transaction), not mentioning the possible fees. Virtual currencies arrived to change such status quo of daily transactions.

In this post we will explain what virtual currencies/payment tokens are, as well as its different typologies and current legal understanding.

Virtual currencies (VCs), also referred to as crypto-currencies[1] or “payment/exchange” tokens,  were created in order to fulfil the economic end of money (mean of exchange, unit of account and storage of value). They are considered to have no tangible value, therefore their value comes from the expectation that they may serve as means of exchange or payment for goods and services outside the ecosystem which they are built.

The underlying technology of virtual currencies, the distributed ledger technology (blockchain being the most known), makes it possible to have no intermediary transfers – which leads to a timeliest and bureaucracy efficient way to transfer value across the world. These technologies enable the recording of transactions which are kept in nodes, and all the precedent transactions are connected with the present node (which creates a chain of nodes or a chain of blocks).

Another benefit we considered noteworthy is the prospect of financial inclusion; it is believed that could reach parts of the world population that do not have access to banks, but have access to mobile phones.

Virtual currencies can be stablecoins or decentralised issuerless systems (like Bitcoin). Stablecoins are typically asset-backed and can be categorized into: e-money tokens (ex: EU stablecoin), asset-referenced tokens (ex: former Libra, now Diem), and algorithmic stablecoins (which uses algorithms to stable the value of the token by altering the supply and by taking into account demand[2]). There is also a type of stablecoin called Central Bank Digital Currencies (CBDC)[3], however, it can be considered that those have legal tender since they are issued by a central bank – therefore they work as normal sovereign coin. MiCA foresees both asset-referenced tokens (ARTs) and e-money tokens (EMTs).

E-money tokens are defined on Article 3 (1) 4 MiCA as a type of crypto-asset which main purpose is “to be used as a means of exchange” by maintaining a “stable value by referring to the value of a fiat currency that is legal tender”. According to MiCA, it is conceivable the idea of regulating stablecoins under the Electronic Money Directive and Payment Services Directive when said stablecoin is backed by one fiat currency with legal tender (e-money tokens), since it is similar to the definition of e-money (Article 43 MiCA)  – which means tokens can be considered electronic money if they i) are electronically stored, ii) have monetary value,  iii) represent a claim to the issuer,  iv) are issued on receipt of funds, v) are issued for the purpose of making payment transaction and vi) are accepted by persons other than the issuer, [4] as previously explained.

What does it mean for e-money tokens to be considered as electronic money? According to Article 2(2) of the Electronic Money Directive , the holder of electronic money can always claim its value and redeem it for fiat currency (legal tender and par value with that currency) (Recital 10 MiCA) – therefore, in order to not undermine the confidence of users and respect Article 2(2), e-money tokens should grant their users a claim to redeem[5] their tokens at all times and par value against the currency of which the token is referenced to (Article 44 MiCA and Recital 10), otherwise they are prohibited.

Asset-referenced tokens are defined on Article 3 (1) 3 MiCA as a “type of crypto-asset that purports to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one or several crypto-assets, or a combination of such assets”. As observed, the definition of “electronic money” within MiCA states “type of crypto-asset (…) maintain a stable value by referring to the value of a fiat currency that is legal tender” – the Indefinite article “a”, in the singular form, suggests that we should only consider electronic money virtual currencies that are backed by one fiat currency with legal tender and there is no requirement for a direct claim or redemption of its value into fiat currency.

According to Article 17 (1) e) MiCA may provide a direct claim or redemption right, however they are not obliged to do so (Recital 40 MiCA) – anyhow such decision must be clearly and unambiguously informed to the users in the white paper of each virtual currency,[6] and the issuer must always ensure liquidity of ARTs (Article 17 (1) f)). It is proposed that, to ensure liquidity, the issuers should “maintain written agreements(Article 3 (1) point 12) with crypto-asset service providers authorised for the crypto-asset service”(Article 34 (4), “constitute and maintain a reserve of assets backing those crypto-assets at all times” (Articles 31, 32 and 33 and Recital 37) and the requirement of only investing in secure, low risk assets (Article 34).

Another two valuable user’s protection requirements are the fact that: i) users can request redemption of their ARTs if the value significantly varies from the value of the reserve assets and ii) have the right to withdrawal in relation to all virtual currencies (and crypto-assets), other than ARTs and EMTs, during 14 days after the purchase of such crypto-asset “without incurring any cost and without giving any reasons” (Article 35 (4) and Recital 40). However, this last right does not apply in case crypto-assets are admitted to trading.

Many argue that virtual currencies will never be stable enough – is fiat money stable enough? – however, even if that ends up being true, we still can positively conclude two things. First, even if virtual currencies (as a source of value) cease to exist, we will still have the chance to profit from Blockchain’s efficiency in other areas of our daily life. Secondly, we can adapt our current system of value into Blockchain’s reality. CBDC are an interesting look into the future because they seem to balance (almost) the best of both worlds: they benefit from the technological advancement of Blockchain ’s currencies by improving payment efficiency and reduce cost while maintain a “stable” value.

[1] Some authors differentiate between virtual currencies (issued and regulated by a central entities) and crypto-currencies (distributed and decentralised system only based on cryptographic protocol). We follow the in-text organization of concepts to better comply with the latest understanding of the European Union – however, such taxonomy is discussable. See (PDF) Libra and the Others: The Future of Digital Money | Istituto Affari Internazionali (IAI) e nicola bilotta – Academia.edu, 2.

[2] To better understand why algorithmic stablecoins are not considered ARTs, see Recital 26 MiCA.

[3] “a digital asset issued by a central bank for the purpose of payment and settlement, in either retail or wholesale transactions”

[4] Article 2 (3) Electronic Money Directive (Directive 2009/110/EC) and Article 5 (4) Payment Services Directive (Directive 2015/2366/EU).

[5] However, it is possible for issuers to apply a fee whenever holders ask for redemption of their tokens. MiCA Recital 45.

[6] Article 24, Article 25 (2) and Article 25 (1) MiCA. In Recital 31, it is also added that “they should disclose the amount of asset-referenced tokens in circulation and the value and the composition of the reserve assets, on at least a monthly basis, on their website. Issuers of asset-referenced tokens should also disclose any event that is likely to have a significant impact on the value of the asset-referenced tokens or on the reserve assets”, also in Article 26 (1).

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