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Granularity and Organizational Restructuring in Financial Markets

In financial markets, the functions of financial intermediation have been unbundled, which effectively increases granularity in the markets, reducing the agency problem. These functions can be classified as:

  • • Providing a medium of exchange (payments function),
  • • Store of value (investment function),
  • • Facilitating the transfer of resources across time and space (savings function),
  • • Risk management (hedging function) and
  • • Price discovery (liquidity function) in financial markets.

The Payments Function

The world of payments is changing as people are buying more goods online and increasingly with their phones. For example, security is considered tightest and convenience enormous in the NFC tap-and-pay technology (or near-field-communication technology). Used by Google Wallet and Apple Pay, payments are processed wirelessly by tapping the NFC-embedded device to an NFC terminal. In the case of Pay, the transaction is finished after a biometric fingerprint is provided. Credit card information is stored as an encrypted Device Account (DA) number on a secure chip inside the device. (It is stored in the Cloud with Google Wallet.) Even Apple does not have knowledge of this DA number or the individual transactions. Other apps, not based on the tap-and-pay technology, such as Bank of America’s Mobile Pay app, allows the smartphone to be used as a point-of-sale device, which processes credit card transactions. PayPal uses the punch-in-identifiers technology which requires both hands to enter information into the app. Venmo, owned by PayPal, is a free app that allows users to transfer money to other users; merchants have only recently been added to this network. Both Square and Stripe, digital payment firms, have agreed to work with Apple to enable small businesses to accept Apple Pay. The transactional part of the payment is commoditized so their customer relation aspect, such as ease of use, differentiates the payments mechanisms.

These payments innovations have not eliminated bank deposits. They still require users to make the final payment using a bank account so banks as financial intermediaries will not be replaced. What may be eliminated is cash as a form of payment and while check use is on the decline, all new payment technologies ultimately link back to the bank deposit.2 Significantly, by making processing easier, most new payments services are eliminating banks from the lucrative part of the payment supply chain - connections with customers are weakened. Banks are left to simply balance the ledger, a process that is likely to be automated by adapting blockchain, the technology behind the Bitcoin platform. As a result, banks will be receiving less information from transactions processed by them and therefore, less revenue generated by reselling this information to advertisers. For example, blockchain is used by R3, a company that is developing a blockchain network for use by the financial services industry. Bank of America, Goldman, HSBC and JPMorgan are now backing the company as they look to blockchain as a means of upgrading manual back office machinery in order to speed up asset transfers, lower operational and counterparty risk, and hence lower capital requirements [91].

With the advent of privately issued digital currencies, such as bitcoin, we have an unbundling of the services of a currency. For example, Coinbase, a San Francisco startup, which raised $75 million from investors such as Andreessen Horowitz in 2015, is at the vanguard of companies building businesses around bitcoin [91]. This firm has created an online wallet that allows people to store, send and accept bitcoin payments and also launched an exchange that allows individuals to change real-world money into the cryptocurrency.

The payments function in bitcoin is detached from the savings, investment, risk management and price discovery or liquidity function. Bitcoin serves as a payments mechanism so long as there is a party who will be willing to accept it as payment for goods or services. It is also a means of transferring resources across space: for example, a person in China can use bitcoins as payment for goods purchased in Estonia without transacting via a bank or financial intermediary. Bitcoin is a platform with strong network effects: as more people accept it, more people will become part of the network of users. Coordination, and common knowledge, among users suggests that the digital currency market could coalesce around a single currency, such as bitcoin.3

However, the volatility in the dollar-bitcoin exchange rate makes its role as a savings and investment vehicle, hedging vehicle and liquidity provider much less compelling. The absence of a global supervisory authority that would determine total bitcoin volume and maintain a stable exchange rate with respect to the dollar and other currencies remains a major entry barrier for bitcoin as a currency. As Rainer Bohme et al write, “Thus, bitcoin today resembles more of a payment platform than what economists consider a currency” [93]. But, they go on to conclude, “most users (by volume) treat their bitcoin investments as speculative assets rather than as means of payment. ”

Mobile payments in developing countries are providing an alternative to credit and debit cards. Mobile payments transfer money using wireless or newer technologies, but they require four features: mobile phone ownership; awareness of mobile payments; mobile infrastructure and a forward looking regulatory environment. There is limited mobile payment awareness in developing nations, but M-Pesa, a mobile phone app in Kenya, functions both as a temporary store of value and as a payments mechanism. Nearly 90 % of Kenyan households reported using mobile money services as of August 2014 and 56 % make or receive payments using cell phone. Mobile wallets have become a means of providing a stored value account through which payment can be received on a mobile device, and then turned into cash through an agent. Mobile accounts are more prevalent than bank accounts in more than fifteen countries, and, with more features and more interactivity, it becomes mobile banking [94].

In the US, the rollout of mobile payment technology was awkwardly implemented. Merchants were brought onto the platform before courting customers, hampering the driving force of network effects and thereby slowed the development of a large user base. Each side is waiting for the other to attain critical mass. Consumers are waiting for the ubiquity of a single payment method while merchants are waiting for sufficient network size. It may be efficient for other stakeholders in the mobile payment ecosystem to convince both consumer and merchants to use either the same technology or the technologies to become seamlessly compatible, as in the case of the hugely successful MobilePay in Denmark [94].

 
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