There’s no substitute for real money

History is replete with schemes and approaches to create substitutes for real (that is, government-backed ) currency. And what they all have in common is that, eventually, they have all failed disastrously. Let’s review some of the more famous debacles that happened in the past and a couple that are playing themselves out presently.

In the 1600’s the Tulip Craze hit Holland. While the craze is usually cited as the stereotypical example of irrational exuberance leading to a market bubble that ultimately is unsustainable, it is also true that during that period the tulip actually acted as an informal currency. A large variety of real goods and services were exchanged for tulips.

Fast-forward now to the dot-com era, during which the online currencies Beenz and Flooz were introduced as alternatives to actual hard currencies. Both failed spectacularly in 2001, with Flooz even garnering the honor of being named one of the Top 10 Dot-Com Flops by CNet.

Even the most successful alternate currency systems, the myriad of loyalty points programs such as those run by the airlines, are fraught with problems. Frequent flier programs are seeing growing discontent from consumers, with industry analysts predicting a wholesale exodus from such programs in the near future.

Despite the failures of all these schemes in the past, new forms of alternate currencies continue to be introduced. For instance, in virtual worlds and massively multi-player games, the practice is common to create an in-world currency: Second Life has Linden Dollars, World of Warcraft has gold. So long as the virtual money remains confined to the systems with which they are associated and is used only to acquire virtual goods within those alternate worlds, these currencies are just “Monopoly Money” and little if any harm can be done. But, as we all know, these currencies are being exchanged for actual, real money.

Back in the real-world, the modern-day tulip is the mobile phone airtime minute, which has taken hold in places such as the Philippines and Africa as a form of cashless currency.

The problems with such informal currencies are many, which can be analyzed in terms of 3 overlapping categories: Trust, Fungibility, and Real-World Issues.

Ultimately the purpose of a currency is to protect the sanctity of a transaction. Back in the ages when bartering dominated commerce, the sanctity of the transaction was not an issue because there was no lag time between when you gave 3 chickens and received a bushel of apples. Introducing currency allowed you to drop off your chickens at the butcher shop and then go next door to the fruit stand to get your apples. But, if the currency can’t be trusted to retain its value for the short period of time between when you to conduct the two transactions, the currency is ultimately worthless. (I’m avoiding a discussion of the time value of money by keeping a focus on short time periods.)

Trust is broken when value is lost (note the currency crisis in Argentina a few years back). Real-world currencies protect trust through government backing, formal monetary and fiscal controls, and regulation. Governments ensure scarcity of the legal tender and act to control inflation, thereby ensuring a stable money supply and value preservation. Who is ensuring the trustworthiness of informal currencies? Do their incentives align with this goal?

Fungibility speaks to the usefulness of the currency. Real-world currencies are highly fungible because they are essentially universally accepted and also convertible into other currencies. Informal currencies are also convertible, to a point. But, the controls and the mechanisms for such conversion are akin to the black market exchanges in the former Communist states, much because informal currencies are not recognized as legal tender by any government. The effect is similar to what happened when the Soviet Union outlawed the possession of US Dollars: it drives the exchange market underground, which ultimately makes use of the currency inefficient.

Informal currencies lack fungibility because they are not universally accepted. The reason for this ties back to the Trust issue and the lack of formal backing. Concentrating on the currency of airtime minutes, obviously this currency lacks fungibility because it’s necessary to find someone willing to accept minutes as legal tender, which has a number of barriers: must be on the same network, must agree on the value of the minutes, must be on a prepaid airtime plan, must be able to further use the minutes as currency to make purchases, etc.

Real-world issues have a profound impact on informal currencies. How are transactions taxed? What are the property-rights implications? Who adjudicates and resolves disputes?

All these issues, and many more, have already been addressed for real currencies over a period of thousands of years. The banking industry and infrastructure that we see today is the culmination of these efforts. Until such time as informal currencies have the same amount of control, they will continue to be just a shadow of the real thing, and they will always eventually wilt, just like a tulip.

It’s expensive to be outside the financial mainstream

Millions of people have come to the United States, welcomed by the famous words inscribed on the Statue of Liberty:

Give me your tired, your poor,
Your huddled masses yearning to breathe free…

Well, breathing may still be free, but everything else has a cost associated with it. And, the dirty little secret is that the less money you have, the more expensive things are (and not just as a percentage of income or personal wealth). Take, for instance, financial services. If you have a million dollars, banks fall over themselves to give you free service and make sure all your needs are met. But, if you live paycheck-to-paycheck, many banks would prefer if you don’t even walk in the door.

This lack of welcomeness forces many people to the underbelly of the financial services world: to check cashers and payday loan shops. And the numbers of people in this predicament are staggering: “Nearly 10 million U.S. households do not have a bank account. This represents 9.5 percent of all U.S. households, 22 percent of low-income families, and 8.4 million families earning less than $25,000 per year who do not have either a checking or savings account. ” [source]

Check cashing and payday loan establishments are some of the most predatory businesses in the world. They charge exorbitant fees for the simplest of financial services: giving people access to their own money! Check cashing fees, at least, are regulated by each state. A typical maximum fee is 5% of the check value, although some states (NV, UT, MA, and the non-state Washington DC) have no limit on fees.

Would you stand for having to pay 5% just to cash your paycheck? Neither would I, but millions of people have no choice.

And heaven forbid is someone has an emergency and needs some additional cash before their next paycheck. As was highlighted recently on CNN Money, payday loans carry the “low, low interest rate of 396 percent,” although I’ve seen other reports placing the number over 500%. Granted, these are high-risk, short-term loans, so the interest rates should be higher than would a typical prime-targeted financial product, but still, the only other business that enjoys margins like this landed Al Capone on Alcatraz 75 years ago.

Yes, it’s expensive to be poor, but it doesn’t need to be that way. Everyone deserves access to high quality, appropriately priced financial services. The cure for this ill is a more robust ecosystem for the not-so-well-to-do demographic. But, more on that later. (Spoiler alert: it might just include a mobile component.)

A Tale of Two Markets

m-Via’s Chris Sorensen tells “A Tale of Two Markets” in the November 2007 issue of Intele-Card News.

“Like many early stage technology markets, the mobile payments market is starting to split into separate sub-markets. The first sub-market includes both m-Banking (checking bank account balances, transferring money between accounts, locating bank branches, etc), and m-commerce (using a bank account, credit or debit card associated with a mobile phone to make purchases from the phone, pay bills, and buy prepaid airtime).

The second sub-market could be termed ‘m-unbanking’ which focuses on using mobile phones to provide financial services to the roughly 70% of the world’s population who do not yet have a bank account, credit or debit card. …”

The full article is available here.

Showing value to overcome consumer doubts

The naysayers are out in droves. This time it’s “Mobile banking must overcome consumer doubts.” Yes, it’s natural for people to have fear and doubt about new things. Such is human nature. People like constancy.

But, mobile payments and mobile banking are no different than any other new technology that has every been introduced. And in that regard, the solution to driving adoption is already known: demonstrate undeniable value.

The value proposition is the key to driving adoption of mobile financial services. And that is precisely where mobile banking fails. Mobile banking, at this moment in time, does not offer enough value for people to look beyond their fears and apprehensions. Mobile banking is just another way for people to access their bank accounts. But, people can already access their accounts almost anytime they want. Therefore, we’re seeing that, in terms of mobile banking, the main benefit seen by consumers is the up-to-the-second balance inquiry ability. Yes, that is a very helpful feature in today’s always-on-the-go world. But, it’s not enough.

The greater value proposition is in mobile transactions, such as mobile remittances. Mobile transactions provide undeniable value to a systematically underserved market segment: the unbanked. There are over 40 million unbanked people in the US alone. And, roughly 70% over the world’s population is unbanked.

Mobile transactions bring the financial services infrastructure to this untapped consumer. Mobile transactions raise this consumer to a first-class financial citizen. Mobile transactions provide necessary tools that are currently unavailable.

So, when pundits debate the readiness of consumers for mobile banking, they are missing the whole point: Mobile banking is a vitamin, but mobile transactions are a pain pill.