Trump-proofing Canada means ditching MasterCard and Visa

We're all busy doing our best to boycott U.S. products. I can't buy Special K cereal anymore, because it's made in the U.S. by Kellogg's. But I'm still buying Shreddies, which is made in Niagara Falls, Ontario. Even that's a grey area, since Shreddies is owned by Post, a big American company. Should I be boycotting it? Probably. However, the disturbing thing is that I'm paying for my carefully-curated basket of Canadian groceries with my MasterCard.

If we really want to avoid U.S. products, we can't just vet the things we are buying. We also need to be careful about how we are doing our buying. Our Canadian credit cards are basically made-in-U.S. goods. They rely on the U.S-based Visa or MasterCard networks for processing. Each credit card transaction you make generates a few cents in revenue for these two American mega-corporations. It doesn't sound like much, but when multiplied by millions of Canadians using their cards every day, it adds up. Vigilant Canadians shouldn't be using them.

Canadians who want to boycott American card networks have two options. Go back to paying with cash, which is 100% Canadian. Or transact with your debit card. Debit card transactions are routed via the made-in-Canada Interac debit network.*

We're lucky to have a domestic debit card option. Our European friends are in a worse position, since many European countries (Poland, Sweden, the Netherlands, Finland, and Austria) are entirely reliant on MasterCard and Visa for both debit and credit card transactions. 

Unfortunately, going back to debit cards means doing without all of the consumer protection that credit cards offer in an online environment. Worse, you're giving up your credit card rewards or cash back. If you don't pay with your 2% cash back credit card, for instance, and use your debit card instead, which doesn't offer a reward, you're effectively losing out on $2 for every $100 you spend. This should illustrate to you, I hope, the golden shackles imposed on us by our U.S.-based credit cards. It's fairly easy to replace your American-grown tomatoes with Mexican ones or your U.S.-made car with a Japanese car. But networks, which tend towards monopolization, are not so easy to bypass.

Which gets us into the meatier issue of national sovereignty. The difficulty we all face boycotting the MasterCard and Visa networks reveals how Canada has let itself become over-reliant on these critical pieces of U.S financial infrastructure. My fear is that our neighbour's political leadership is only going to fall further into authoritarianism and belligerence, eventually making a play to slowly annex Canada—not by invasion, but by "Canshluss". If so, this will involve using our dependencies on U.S. systems, including the card networks, to extract concessions from us. "Canada, if you don't do x for me," says Trump in 2026, "we're TURNING OFF all your credit cards!" 

In anticipation, we need to remove this particular financial dependency, quick. We're already safe when it comes to debit cards; we've got Interac. But we need the same independence for our credit cards. More specifically, we need to pursue an end-goal in which all Canadian credit cards are "co-badged". That means our credit cards would be able to use both the Visa/Mastercard card networks and Interac (or, if Interac can't be repurposed for credit cards, some other yet-to-be-built domestic credit card network). With co-badging, if your credit card payment can't be executed by Visa because of a Trump freeze order, at least the Canadian network will still process it.

This is how the French card system works. While much of Europe suffers from a massive dependency on MasterCard and Visa, France is unique in having built a 100% French card solution. The local Carte Bancaire (CB) network can process both French debit card transactions, like Interac can, but goes one step further by also handling French credit card purchases. Before paying for their groceries with a card, French card holders get to choose which network to use, the local one or the international one.

THIS IS WHAT CANADA NEEDS: This French credit card, issued by Credite Agricole, is co-badged with the domestic Carte Bancaire (CB) network and the international MasterCard network. When incidents occur on one route (CB, for instance), traffic is automatically routed to the back-up route, MasterCard, and vice versa. I think that a Canadian solution to the Trump problem would look something like this French CB card.

The incoming Carney government should move to co-sponsor a CB-style domestic credit card network along with the big banks (perhaps a simple upgrade to Interac will do?). All Canadian financial institutions that issue credit cards would be required to co-badge them so that Canadians can connect to this new network as well as Visa or MasterCard. Even if annexation never actually occurs, at least we've got a more robust card system in place to deal with outages arising from hacking or natural disasters.

Along with France, we can take inspiration from India, which introduced their Visa/MasterCard alternative, Rupay, in 2012. Thirteen years later, RuPay is now a genuine competitor with the American card networks. I can't believe I'm saying this, but we can also use Russia as a model, which was entirely dependent on Visa and MasterCard for card payments until it deployed its Mir card network in 2016—in the nick of time before Visa and MasterCard cut ties in 2022.

Europe will have to push harder, too. The EU has been trying to rid itself of its Visa and MasterCard addiction for over a decade now, without much luck. Its first attempt, the Euro Alliance of Payment Schemes, was abandoned in 2013.  (In fact, one of the reasons the European Central Bank is exploring its own digital currency is to provide an alternative to the American card networks.) As Canada builds out its own domestic credit card workaround, we can learn from the European mistakes.

The U.S. is no longer a clear friend. Boycotting U.S. products is one thing. But if we truly want to reduce the external threat, we need to build our own card infrastructure—before it's too late.

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* In-person debit payments are processed by the Interac network. However, online debit card transactions default to the Visa or MasterCard networks. While Interac does allow for online purchases, many retailers don't offer the option, and when they do, the checkout process requires the user to log into their online banking, which is more of a hassle than using a card.

Embargoed by MasterCard/Visa, kratom vendors turn to crypto and eChecks

I spend a fair amount of time tracking real-world use cases for cryptocurrencies. I'm not talking about silly speculation, or millionaire crypto hobbyists using their bitcoins to buy Teslas, or illegal dark web markets that use Monero for payments. I'm talking about actual licit businesses that have turned to cryptocurrency payments -- not because they particularly care about crypto -- but because they need to.

To date, the retail kratom industry is one of the best examples I've been able to find of broad non-speculative licit cryptocurrency adoption. Kratom is a plant that grows in southeast Asia. The kratom leaf can be ground into a green powder that, when ingested, acts as a stimulant. In the U.S., online kratom stores are ubiquitous.

I'm not going to get into whether kratom is dangerous or has medicinal value, or whether it should be legal or not. (For that sort of discussion, I'd suggest visiting the FDA, WebMD, or the Mayo Clinic.) The main point I want to make in this post is that kratom is legal in the US (although several states have banned it).

Although kratom is legal, MasterCard and Visa have decided to prohibit kratom sales from their networks. This poses big problems for online kratom shops. Because the card networks dominate online payments, exile by these oligopolies causes serious financial damage to the unfortunate targets. To survive, the kratom industry has been forced to turn to backup payments systems.

MasterCard's Business Risk Assessment and Monitoring (BRAM) policy, for instance, lists a number of impermissible activities:

Source: Netpay

Most of the prohibited transactions listed by MasterCard are illegal, such as the sale of child pornography. But some are legal, including the sale of "certain types of drugs or chemicals." MasterCard specifically mentions salvia divinorum, a legal drug that has hallucinogenic properties. Although it isn't listed as an example, kratom is usually considered to fall into the same category as salvia.

Acquirers, the financial institutions that connect businesses to the card networks, face large penalties if Visa or MasterCard catch them facilitating prohibited card transactions. To reduce this risk, acquirers will often hire what are called Merchant Monitoring Service Providers, or MMSPs, to scan through retailer data and spot anything that looks dangerous. MMSPs such as LegitScripts are very aggressive about rooting out kratom sales.

Despite the card networks disallowing kratom sales, many of the 20 or so sites that I scanned through still offer card payments. According to my research, kratom sites have a number of ways of securing card availability, one of which is called transactions laundering. That is, a kratom site camouflages its prohibited product sales by routing them through a front store that sells legitimate goods. Eventually these prohibited transactions get caught by the card network or the acquirer, and the site's card network access is revoked. It then has to scramble to build another front.

One commenter on Reddit describes kratom transaction laundering thusly:

"...we can do manual credit cards (as I can) over the phone because we use standard processors that don’t know it’s kratom. We do this by creating Dba’s that have fake web presences selling other products and they don’t find out it’s kratom for a while. Usually we can get a processor to work for 3-12 months before it gets shut down."

(Note: Dba refers to "Doing Business As". A DBA is a business pseudonym or a “fictitious name filing.”)

Another route that kratom sites take to get access to the card networks is to use an overseas aggregator. Kratom Crazy, a website that has since closed for business, describes how and why:

"International is the only way to go because card schemes are less aggressive on banks in international communities. This doesn’t mean they can’t be fined or shut down – oh because they can and still do. No aggregate account we have ever seen has lasted over 6 months before being shut down. The major downside is these accounts are usually 9% fees and up plus 10% rolling reserve over 6 months. So the merchant takes 19%+ off the top immediately plus they have to wait for 2-3 weeks before seeing the first days processing payout. Its a bad deal all around and a massive risk for losing money. In addition, when these accounts get shut down, there is usually no payout to the merchants."

So the upshot is that the sort of card network access that many kratom sites have managed to secure is unreliable and spotty. Indeed, many sites don't accept cards at all, including (at the time of writing) OG Botanicals, Canada Kratom Express, Krypto Kratum, and Rhizohm. Rhizohm's payments page goes to some pains to explain how it would rather be honest than lie to get card access:

Source: rhizOhm

Which gets us to cryptocurrency. Almost all of the kratom sites, including those that haven't been able to sneak themselves into the card networks, accept cryptocurrencies including Bitcoin, Ethereum, Litecoin, XRP, Stellar Lumens, or some other one. Third-party crypto processors like CoinPayments or Coinbase Commerce are typically used for payments processing.

When they accept cards, kratom sites often offer discounts for cryptocurrency payments. For instance, Happy Hippo's checkout page offers a 20% discount:

It's easy to understand why kratom sites would offer such discounts. It's expensive to use overseas aggregators for card payments. By steering a customer to Bitcoin or Ethereum, a kratom vendor saves itself the pain of a 10-15% card processing fee.

But cryptocurrency isn't the only payments option that kratom sites fall back on. Even more popular than crypto is eChecks, a traditional "fiat" form of payment that gets processed via an automated clearing house, or ACH. A kratom buyer inputs their bank routing and account numbers into the payments page, the payment then gets routed to the ACH network and, once cleared & settled, the funds arrive in the kratom merchant's bank account.

In the same way that a business must work with a card acquirer to get access to Visa or MasterCard payments, they must work with an eCheck acquirer in order to accept eCheck payments. But onboarding standards seems to be much looser with eCheck acquirers than card acquirers. For instance, in the screen shot below an eCheck acquirer is actively soliciting all sorts of high-risk industries, including not only kratom but also CBD oil and MLM-based businesses.  

If there's an online retail payments option that's as badass as bitcoin, it's got to be eChecks.https://t.co/HJfEIeQER3 pic.twitter.com/sb4DnHW2X1

— John Paul Koning (@jp_koning) October 7, 2021

Many kratom sites also accept a bespoke payments method called GreenBean Pay. Users open an account with GreanBean Pay and submit their banking account information. The service then uses Plaid -- a piece of financial plumbing that allows apps to hook into banks -- to link to the buyer's bank account and process the kratom payment.

Lastly, a bunch of kratom sites accept person-to-person payments options such as Cash App, Venmo, Zelle, and Interac eTransfer. (This probably goes against these services' terms of service, which generally limit usage to person-to-person payments).

While these backup options have become vital for connecting kratom retailers to the public, they are not really a great substitute for a card network connection. Cryptocurrency is clunky, awkward, and risky. eCheck is slow. By not offering the convenience of card payments, kratom sites lose out on a steady stream of would-be buyers. And this is evident by how desperate they are to find hacks that get them back into the Visa and MasterCard walled gardens.

In closing, I want to touch on something I mentioned in my previous post on MasterCard and porn. A big reason that card networks refuse to process legal transactions for things like kratom (or, similarly, for salvia divinorum, which I wrote about here) is they don't want to damage their brand. These substances may be permitted by law but they are controversial, and so the networks refuse to touch them.

All businesses have the right to protect their brands. But the card networks are oligopolies, and thus necessary for online survival. And so in my view the card networks should be required to forfeit their right to protect their brands. That is, Visa and MasterCard (insofar as they retain their oligopolistic powers) should not be be allowed to police vendors for what they deem to be controversial but legal products.

Which is not to say that I'm a champion of kratom. I'm only suggesting that the appropriate way to control such a product is not by card network bans, but by the Drug Enforcement Agency declaring it to be a scheduled drug.

The good news is that these sorts of situations are very rare. The card companies allow almost every legal transaction under the sun on to their networks, save a few outliers like kratum. This means that the population of licit businesses that need to use a back-up system like cryptocurrency payments (or echecks) is not very big. But examples like this still warrant our attention. Even if we don't particularly care about kratom, one day a product that we regularly consume could get censored by Visa or MasterCard.

Those 70s ACH payments

Here is Facebook's David Marcus, who has been involved in rolling out Facebook's much-touted Libra/Novi/Diem payments system:

I often make the parallel between money and communication networks. Unfortunately money still moves at the pace of the early 70s (ACH), and for the most part at the same price. Unacceptable. https://t.co/beNCtCD3To

— David Marcus (@davidmarcus) July 9, 2021

By ACH, Marcus is referring to automated clearinghouse payments. If you want to pay your phone bill, the payment gets sent to a clearing house, which batches your payment together with many other payments and then settles it the next day. These systems were built in the 60s and 70s.

I don't want to pick on Marcus, since he isn't the only one with this view. But modern money no longer moves at the pace of early 70s ACH. His critique would have made sense maybe 6 or 7 years ago, and only in the US. But that's not the case in 2021.

The speeding up of modern payments is a great success story. Let me tell you a bit about it.

To begin with, central banks and other public clearinghouses have spent the last 15-or-so years blanketing the globe with real-time retail payments systems. Europe has TIPS, UK has Faster Payments, India has IMPS, Sweden has BiR, Singapore FAST. There must be at least thirty or forty of these real-time retail payments system by now. 

The speed of these new platforms get passed on to the public by banks and fintechs, which are themselves connected to these core systems. In the UK's case, for example, consumers can bypass the slower ACH system, BACS, which takes three days to settle, by choosing to make their bank payment proceed via the Faster Payments system.

The U.S. is lagging. The Federal Reserve's FedNow retail payment system, which will facilitate real-time retail payments, won't be in place till 2024, more than 15 years after UK's Faster Payments was introduced. So Marcus's tweet could just be a function of having a U.S.-centric viewpoint.

However, the Fed's private competitor, The Clearing House, has had a real-time settlement system in place since 2017, the Real-Time Payments (RTP) network. Roll-out has been slow, but as of July 2021 The Clearing House claims that RTP reaches 56% of U.S. checking accounts. 

The US is inching towards ubiquitous instant P2P payments. Here is the coverage map for the US's only real-time retail payments settlement system, The Clearing House's RTP network, introduced in 2017.

RTP now reaches ~56% of US demand deposit accounts. https://t.co/xvAKknwaE2 pic.twitter.com/GojH6oR885

— John Paul Koning (@jp_koning) July 9, 2021

RTP illustrates that it's not just central banks that are facilitating real-time payments. Private players are too. Visa and MasterCard, for instance, built their own proprietary real-time person-to-person payments platforms, Visa Direct and MasterCard Send, on the back of their debit card networks.

As Arturo Portilla points out, Visa Direct and MasterCard Send don't actually settle payments in real-time. They only clear them. From the perspective of the consumer, however, it makes little difference. Ned can send Jenny $100 using a Visa Direct enabled account, and Jenny can then spend that $100 within moments of receiving it. (Ned and Jenny's banks settle up the next day.)

In 2017 U.S. banks debuted Zelle, a now ubiquitous instant person-to-person bank payments option. Zelle was built using the Visa Direct and MasterCard Send networks. And now Zelle is being connected to The Clearing House's RTP network, too. Which means that settlement can be done in real-time.

Perhaps Marcus's ACH critique is limited to non-domestic transactions. But even cross-border payments are also going quicker.

Remittance companies like Western Union and MoneyGram are leveraging Visa Direct and MasterCard Send to do instant cross-border transfers. As of late 2020, Western Union was facilitating real-time payouts to 80 countries. MoneyGram recently announced that 575 corridors from 25 countries in Europe would go instant thanks to an integration with Visa Direct, complementing its existing instant payments options from the US.

Remember when everyone was poking fun at Western Union for its slow remittances? It now does real-time payouts in 80 countries, up from 50 earlier this spring, and is targeting 100 countries by the end of 2020: https://t.co/oSiihGCwvs pic.twitter.com/ovRKZMMH8y

— John Paul Koning (@jp_koning) October 28, 2020

Transferwise, another global remittance company, is dispatching up to 38% of its remittances instantly. Whereas Western Union and MoneyGram are building on top of Visa Direct and MasterCard Send, my understanding is that most of Transferwise's success in speeding up remittances comes from integrating with the new retail real-time payments systems I listed above, like Singapore's FAST and UK's Faster Payments.

Let's not forget SWIFT gpi, which is bringing a new speed standard to corporate cross-border payments.

Even the ACH network that Marcus criticizes is upping its game. ACH payments have typically not settled till a day or two after origination, which meant consumers have had to wait for salaries and bill payments to settle. But in 2017, same-day ACH was introduced. It's taken some time for this option to gain adoption. As of the first quarter of 2021, only 2% of all ACH transactions are done on a same-day basis.

But same-day ACH is getting better. In 2020, the limit for same-day payments was raised from $25,000 to $100,000. Just this year a third window for clearing and settling same-day ACH payments was introduced, 6:30 PM EST, making same-day ACH even more convenient for Californians and others in later time zones. Next year, limits will be raised from $100,000 to $1 million.

Lastly, Marcus maligns slow in his tweet. But remember, slow can be a good thing, too. Slowing down transactions allows us to batch them together and cancel out reciprocating payments, thus reducing the amount of work our payments systems must do. And this makes our payments systems cheaper. (I've written two articles on this topic, here and here.)

The ideal payments ecosystem isn't slow or fast. It provides a combination of slow, medium, and fast options. The Libra/Diem/Novi project project that David Marcus is working on will fit in somewhere on this spectrum. The more options, the better off are consumers. But 70s ACH is no longer a very realistic way to describe modern money.

The unbanked, the post office, and fintech in the 1880s

"A large population of people are excluded from the financial system because they don't have bank accounts. Fintechs compete to connect them and parallel plans emanate from the government to reach the unbanked, including postal banking."

What year am I describing in the above paragraph? 

It could be 2021. But it also describes 1870s. 

It's 2021 and the U.S. still has a large population of unbanked, those who have so little money that banks would rather not serve them. An astonishing 5.4% of Americans—that's 7.1 million households—do not have bank accounts.

Financial technology companies (aka fintechs) like PayPal and Facebook's Libra have well-meaning plans to connect the American unbanked population. Government-run proposals abound too. Postal banking is probably the most popular option, but more exotic solutions like central bank digital currency (CBDC) have also been floated. But many economists are wary that these government efforts will cripple the private sector.

None of this is new. Concerns over the unbanked, fintech, and a government participation in the payment system were all present back in England in the 1880s. Since I enjoy when the past resurfaces in the present, I'll tell the story.

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Britain in the 1870s had a very sophisticated chequing system. Because banks were the only way for people to access cheques, and banks preferred to limit accounts to rich people and wealthy merchants, the poor and middle class were often left out. 

Luckily, the 1870s version of fintech came to the rescue. The PayPal of the day was something called the Cheque Bank. Established in 1873, the Cheque Bank—like PayPal today—was a bank-on-top-of-a- bank. What do I mean by this?

PayPal is a customer of Wells Fargo, a large commercial bank. Wells Fargo provides PayPal with banking and payments services. PayPal in turn passes these services on to PayPal account holders, folks who might not otherwise qualify as customers of Wells Fargo or, if they could, prefer the way PayPal rebundles underlying Wells Fargo services.

Stock certificate for the Cheque Bank, Limited

The Cheque Bank operated on the same principles. It opened accounts at bank branches all across United Kingdom and overseas. Like PayPal, it passed through underlying banking services to its unbanked customers. The Cheque Bank's main product was cheques, which today might seem quaint. But back then they were cutting edge.

Anyone could buy a book of Cheque Bank cheques at a stationer or cigar store, the Cheque Bank redepositing the cash it received with its bankers. The customer could then spend those cheques at stores, send them to family via the mail, or hold them as a form of saving in lieu of cash (which was always at risk of being stolen). People who accepted a Cheque Bank cheque as payment could promptly take the document to any bank and cash it.

Much like PayPal does today, the Cheque Bank held 100% reserves. That is, for every $1 in cheques it issued, it kept $1 locked up with its bankers. And so its cheques were considered to be as safe as cash. Put differently, regular banks engage in both lending and payments. But fintechs like PayPal and the Cheque Bank don't lend at all. They deposit all of their assets at an underlying bank and focus on offering the payments side of the banking business to their customers.

The Cheque Bank attracted the attention of William Stanley Jevons, one of the most important economists of the day and still very much a household name among economists today. Jevons was one of three economists (along with Carl Menger and Leon Walras) to discover the principle of marginal utility, a key economic principal which had eluded even Adam Smith. 

In his 1875 book Money and the Mechanism of Exchange, Jevons devotes a full chapter to the Cheque Bank, describing it as a "very ingenious attempt" to "extend the area of banking to the masses." Here is what one of the Cheque Bank's cheques looks like:

1899 cheque issued by the Cheque Bank [source]

The cheques could only be filled to an amount printed on the document, writes Jevons. So the above cheque, which had been purchased for £5, could be written out for anything up to £5, although in this particular case the cheque writer (H.L. Stevens) chose the sum of 3 pounds 3 shillings. 

Jevons isn't the only notable economist to write about the Cheque Bank. It also pops up over a hundred years later in economist Edward S. Prescott's work, who describes it as a "highly interesting experiment in extending the use of checks to the lower and middle classes." Prescott suggests that the ability to write a specific amount on the face of one of these cheques would have greatly facilitated payments through the postal service since there was no need for change. Unlike a regular cheque, which also offered this flexibility, the recipient of one of the Cheque Bank's cheques needn't worry about it bouncing.

Jevons was excited by the Cheque Bank. But he was not a fan of a subsequent competing payments innovation, the postal order.

The British Post Office, owned by the government, had long been engaged in the business of transmitting money orders, unofficially since 1792 and officially since 1838. A customer would walk into any money order office, put down, say, £2 and 2 shillings, and get a £2 2s money order. The recipient's name was then written on the order. It could then be sent via post to a distant office, upon which the recipient could take the money order to the counter to be cashed. The officer would first confirm the payment by referring to a separate letter of advice. This letter, sent from post office to post office, served an an extra layer of security against fraud. Only then would the £2 and 2 shillings be paid out.

The problem, according to then Postmaster General Henry Fawcett, is that the money order wasn't very useful to people who only wanted to send small amounts. "If a boy wanted to send his mother the first shilling he had saved, he would have to pay twopence for the order and a penny for postage," wrote Fawcett. In other words, to send a 12 penny (i.e. one shilling) money order, three pennies—a massive 25%—had to be sacrificed in fees. (A shilling in 1880 was worth around US$8 today.) And so it would have been an expensive payments option for the poor.

Prior to his appointment as Postmaster General in 1880, Fawcett had been both parliamentarian and the first professor of political economy at Cambridge. And while he wasn't as illustrious an economist as Jevons (he hasn't left us any bits of economic theory), Fawcett did write what was one of the popular textbooks of the day.

But if Fawcett wasn't going to change the study of economics, he did intend to change the payments system. As Postmaster General, Fawcett proposed complementing the money order with a new product called a postal note, or postal order. (The postal order had been earlier conceived of by George Chetwynd, the Receiver and Accountant General of the Post office). Like the cheques issued by the Cheque Bank founded just seven years before, postal orders would have a fixed denomination printed on them. These increments were to start at 1 shilling and go up to 20 shillings (US$8 to US$160 in 2019 dollars).

By contrast the post office's traditional payment product, the money order, was open-faced and had no denomination. Because postal orders would be issued in smaller amounts, the Post Office needn't bother sending separate letters of advice as a security measure, which meant that they would be far cheaper to process. And so the fees could be lower for postal orders than money orders, broadening the pool of customers.

In an 1880 essay, William Stanley Jevons blasted the idea of postal orders, which hadn't yet received legislative assent. Singling out Fawcett, Jevons wrote:

"The fact of course is that not only from the time of Adam Smith, but from a much earlier date, it has always been recognized that a Government is not really a suitable body to enter upon the business of banking. It is with regret that we must see in this year 1880 the names of so great a financier as Mr. Gladstone, and so sound an economist as Professor Fawcett, given to schemes which are radically vicious and opposed to the teachings of economic science and economic experience."

So that lays out the cast of characters in 1880. It includes exclusionary banks, hoards of unbanked, a set of opposed economists in Jevons and Fawcett, fintechs like the Cheque Bank, and a post office on the verge of issuing a novel product; postal orders.

2020 seems very much like 1880. To help connect the large population of American unbanked to the financial system, a number of modern day Fawcetts (Morgan Ricks, Mehrsa Baradaran, Rohan Grey) have floated public payments solutions including a return of postal banking, central bank digital currency (CBDC), or central bank-accounts-for-all.

Our modern day equivalents to the Cheque Bank includes non-banks such as prepaid debit card issuers Walmart and Netspend, both of which are trying to reach unbanked Americans. Online wallet companies like PayPal and Chime are also in the mix. And stablecoin issuers such as Facebook's upcoming Libra project talk a big game when it comes to financial inclusion. To round things out you've got your modern day Jevonses; economists who don't buy the idea that the government should get into banking (Larry White, George Selgin, Diego Zuluaga).

So how did things end up in 1880? Despite opposition from Jevons and the Economist, Fawcett's postal order dream came to fruition. After receiving legislative approval, the world's first postal orders were issued in 1881:

The world's first postal order was issued in 1881 by the British Post Office. The fee of a halfpenny on a one shilling postal order (~4%) was less than two pennies for a regular money order, which meant the not-so-wealthy could finally afford to make small remote payments. pic.twitter.com/KpbyoY0uHj

— John Paul Koning (@jp_koning) December 30, 2020

Postal orders would go on to become very popular. They largely displaced money orders, except for large amounts. Other postal systems including that of New Zealand, Canada, Australia, and the U.S. would go on to copy the idea. The UK's modern day incarnation of the post, the Post Office, still offers a version of the product.

And what about the Cheque Bank? Digging through old documents, Edward Prescott discovered that the Cheque Bank failed in the late 1890s. According to liquidation proceedings reported in the Banker’s Magazine, it was plagued by forgery problems and increased competition for less wealthy depositors from banks. Perhaps the emergence of the postal order also played a part.

I'm not invoking the 1880s as a prediction of what will occur in the 2020s. Rather, it fascinates me because it reveals how old these payments dilemmas are. The same tensions between public and private payments were present then as they are now. And it's also interesting to see how economists have always been engaged in questions of financial inclusion. Not just Fawcett but Jevons too, who we know primarily for his work on monetary theory. 

And over a hundred years later, Edward Prescott delved into the topic, too. In a 1999 paper (which mentions the Cheque Bank), Prescott discusses the idea of opening up an inexpensive type of bank account called an Electronic Transfer Account (ETA) so that all Americans, particularly the unbanked, might receive Federal benefit payments digitally. (Prescott was skeptical that ETAs might work out. The program, introduced in 1999, was discontinued in 2018 and has been replaced with a prepaid debit card program.)

In closing, the topic of how to help the unbanked is a complicated one with many moving parts. Which is why we should explore how things played out in different times. Perhaps history can get us to see the debate in a new light.

Merry Christmas and a Happy New Year!

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P.S. If you're interested in learning more about Jevons's thinking on payments, he was a big champion of the idea of creating an international coin standard. I wrote about it here. Think of it as a proto-version of the Euro. Jevons came up with a "tidy English solution" for fitting Britain into this proposed international coin union. The project never came to fruition.

Programmable money isn't new, we've had it for ages

I often hear that modern money just isn't up to snuff because it isn't programmable. That's why we need Ethereum, stablecoins, and other exotica like central bank digital currencies. These platforms will provide the world with much needed programmability.

Stablecoin issuer Circle is one of the bigger marketers of this idea, but it's far from being the only one: 

"While value exchange may be the initial killer app, it’s the programmability of digital money that will ultimately usher in business model breakthroughs." [link]

I disagree. We've had programmable money for ages. Let me offer a quick guide.

Microsoft doesn't have a bunch of employees who sit at desks and manually sign paper checks all day. No, it uses software that automates payments to its tens of thousands of suppliers, employees, contractors, investors, and the tax authorities. Every day this software relays payment instructions to the Federal Reserve's clearing house for processing. The Fed doesn't rely on physical labour either. FedACH, as it is known, is an automated clearing house. It uses software to automatically clear all incoming payments.

Fred Wilson thinks programmable digital money is a big deal https://t.co/4DJRAVBDEH

I mean, we've had programmable digital money for decades. The A in ACH payment stands for automated. Just program in the date & amount, recurring or not, and voila. pic.twitter.com/W5ouXlZDqT

— John Paul Koning (@jp_koning) February 11, 2020

By the way, ACH go back to the 1970s. If Microsoft's software-based payments and FedACH aren't programmability, I don't know what is.

Another example of programmable money is the recent Korean COVID-19 stimulus payments. Koreans had the choice to receive either a prepaid debit card, credit card points, or gift cards. Since the idea was to help local businesses, the prepaid cards and card points were programmed with certain limitations. To begin with, the funds expired by August 2020 in order to discourage hoarding. Secondly, money could only be spent at qualifying shops. That meant no online shopping, no purchases at large-scale supermarkets or entertainment places, and the money had to be spent in the district where the recipient lived.

I like how Korea paid out its COVID relief.

Koreans received either a prepaid card, card points(!), or gift cards. The advantage: programmability. Funds expire by August and can only be be spent at a qualifying shops. No Robinhood/bitcoin speculation! https://t.co/pseJaaIIvy pic.twitter.com/wxcLggV6Sj

— John Paul Koning (@jp_koning) July 23, 2020

Programming COVID relief didn't require anything fancy like Ethereum or stablecoins. The card networks make it easy to do this sort of thing.

We scan see another example of card programmability in Australia with its controversial cashless welfare card (or "Indue" card), currently in pilot mode. Once government benefits are deposited onto the Indue Visa debit card, the money is "quarantined" such that it can't be withdrawn as cash from automatic teller machines or used to shop at merchants that sell restricted items like alcohol, tobacco or gambling products. The idea, presumably, is that low-income people can’t control their spending, and thus their money has to be programmed to overcome their shortcomings.

Source: The Gaurdian

Again, this didn’t require Ethereum or stablecoins or a Australian digital currency.

Automated escrow is another example of programmable money. Using Ethereum’s programming language, Solidity, one can create an escrow contract that locks up some Ether until certain conditions are met and a payout is made. But Ethereum isn't the only platform that can do automated escrow. Escrow.com, for instance, lets users code up escrow arrangements using its application programming interfaces, or APIs. Escrow.com stores the dollars and then automatically pays out once an event has been triggered, say a used car inspection has been passed. 

No fancy blockchains here.

Speaking of APIs, the Europeans are probably the leaders in bank account programmability. Thanks to the Second Payment Services Directive, or PSD2, European banks are now obligated to grant fintechs access to customer accounts via APIs. (Some people refer to this as “Open Banking.”)  This provides fintechs not only with the ability to peer into what those bank accounts hold, but also the ability to program those accounts to make transfers and such. And thus they can provide the public with new financial tools, built on top of banks.

Monzo, a UK-based digital bank, provides a taste of what this sort of programmability might offer. In 2018, it introduced functionality that allowed its customers to connect their bank account to a range of other web services and create automated rules or ‘recipes’. Such recipes could allow customers to use data from, say, a weather application to trigger a change in their Monzo account, say to move money to a savings pot.

Programmable money, the non-bitcoin/blockchain version.

This paper analyzes the automated rules created by the users of Monzo, a mobile-only bank. i.e. "If I spend money at Domino’s Pizza, McDonalds, KFC or the local pub, then move £5 to my penalty pot." https://t.co/nXrIlqiAvP pic.twitter.com/7kCVIXs62T

— John Paul Koning (@jp_koning) April 21, 2019

Even my plain vanilla Canadian bank account grants me some basic programmability. I can set up my Tangerine bank account to pull money from my Royal Bank account, and choose how often this will happen (daily, weekly, monthly), and select how long these periodic transfers are to last. Sure, it's limited. There are no if-than statements. But most regular folks probably don't require much programmability. And banks may not be too keen to provide it to us anyways. We'd probably mess it up, and then they'd have to spend time and money cleaning up our mistakes.

So to repeat, programmability is already here. Has been for a while.

If anything, public blockchains like Ethereum offer a different sort of programmability. Rather than the code being hosted by a commercial or government entity, it is hosted on a neutral, decentralized platform. 

There is a niche for this sort of programmability. Jack may not trust the automation provided by a payments company or a central bank utility. He could be cut off, say because they deem him to be a risky customer, or maybe because he is doing illegal things. But Ethereum isn’t controlled by anyone, so Jack can be sure that the automation provided by Ethereum won’t suddenly stop.

---

P.S.: Antony Lewis has also been thinking on this topic. Head on over.

Want to open an account at the central bank? I'll pass, thanks

The only type of central bank-issued money that we hoi polloi can own are banknotes. But over the last few years, researchers at central banks have been increasingly toying with the idea of issuing digital money for public consumption. I count 380,000 search results on Google for the term "central bank digital currency," up from zero just a few years ago.

There are two types of proposed central bank digital currencies, or CBDCs. The first, Fedcoin, is implemented on a blockchain. I wrote about it here. But the odds of Fedcoin happening are minuscule. This post will be about the second type.

The second is a basic bank account, sort of like PayPal except run by a central bank like the Federal Reserve (or the European Central Bank or the Bank of England.) Just like you go to PayPal's website to register for an account, you'd head over to the Fed's website to open an account. A Fed version of PayPal would let you pay your friends, accept donations and business income, and buy stuff at stores. Except you'd be using Fed money, not PayPal money.

I'm not philosophically or ideologically opposed to the idea of a Fed PayPal. If the Fed (or any other central bank) wants to get into providing payments services to regular folks, fine. The same goes for Walmart. If it wants to start providing retail bank accounts, great. Ditto for Facebook. I think Libra is an admirable project. Oh, and I also want more co-operative banks and credit unions. What about community currencies? By all means, let's get more alternative systems like Ithaca Hours and the Bristol Pound up and running. And while were at it, commercial banks, credit unions, and municipalities should be allowed to issue banknotes. Heck, why not a Nike banknote?

In short, the more payments options people have, the better. (My one caveat: If a central bank is going to introduce a central bank version of PayPal, it should be obligated to recover its costs. FedPal shouldn't have an advantage over regular PayPal, the Michigan First Credit Union, or a commercial bank like Wells Fargo.*)

All that being said, I'm not terribly optimistic about the prospects for a central bank version of PayPal.

With paper money, central banks already have an incredibly popular product. Banknotes are anonymous. People can use them for activities that might be frowned on, and this is a pretty big market. Bills have another nice property; they are ungated. Anyone can accept a dollar without needing to open an account. This accessibility has made paper dollars, which can move fluidly across borders, wildly popular in nations with poorly functioning banking and monetary systems. Most importantly, central banks have a monopoly on the business of issuing cash. So they don't have to worry about competition.

But the success of central banks' cash line of business won't translate into success for a central bank version of PayPal. Given the current state of anti-money laundering regulations, we probably wouldn't be able to open a Fed PayPal account anonymously. Furthermore, it's unlikely that the Fed, or any other central bank for that matter, would open up eligibility to non-citizens living in foreign countries.

So forget about catering to the huge market of anonymity seekers and foreigners who would love to hold a U.S. dollar account directly at the Fed. FedPal would probably be a US-only product. (Likewise, the Riksbank's e-krona would be a Sweden-only product).

But this is a crowded field. Whereas cash is a government-run monopoly, thousands of competitors offer digital payments accounts. Can the central bank differentiate itself from a slew of other digital account options? I'm skeptical.

1. Features?

You've gotta keep in mind that CBDC is a brainchild of macroeconomic theoreticians, not product designers. Macroeconomists don't have any expertise in designing retail banking products. And so I'm not terribly bullish on the Fed or the Bank of England coming up with new features that would differentiate a central bank account from any other payments accounts.

2. Safety?

Not really. In the U.S. (as in most developed countries), bank accounts and prepaid debit cards are already insured up to $250,000. For most regular folks, dollars held at the Fed won't be any safer than those held in banks.

3. Fees?

The Fed might try to offer a low-fee option, perhaps to the unbanked or the underbanked. But in the U.S., this is getting to be a crowded field. Chime, Varo, Ally, and Simple offer no-monthly fee accounts. There are plenty of no-fee prepaid debit cards out there, too. Just last week, I spotlighted the PODERcard, which is marketed to unbanked immigrants.

Nice to see. Green Dot & Welcome Technologies are introducing PODERcard, a debit card targeted to U.S. Hispanic households (14% of which were unbanked in 2017). No monthly fee: https://t.co/T0PGZX5CJ4

I've said it before, but competition is the best way to help the unbanked. pic.twitter.com/j2tzQqvVwB

— John Paul Koning (@jp_koning) May 30, 2020

The public sector is already active in this field, too. The Federal government already offers a no-fee prepaid debit card, the Direct Express card, to over 60 million Americans who receive Federal benefits. And state governments often provide no-fee debit cards for tax refunds, unemployment, and other state benefits. It's hard to see what a CBDC can bring to the table.

4. Higher interest rates?

Might a CBDC be able to offer higher interest rates than the competition? A few commentators have suggested that a Fed version of PayPal offer regular Americans the same interest rate that the Fed pays large banks that keep accounts at the Fed. Banks maintain accounts at the Fed so that they can make interbank payments and meet reserve requirements.

In the chart below, the Fed pays banks the blue line, interest rate on reserves. This rate has historically been far higher than the two red lines in the chart: the average rate that banks pay customers on a checking or savings account. (For its part, PayPal pays its customers 0%).

Were the Fed to pay FedPal account holders the blue line, i.e. the same interest rate it pays banks, this would effectively convert a FedPal account into an incredibly high-yield checking account. No doubt it would become a wildly popular product.

But serving millions of retail customers is a lot more expensive than serving a couple of hundred banks. Think customer help lines, fraud prevention, advertising, paper check processing, ATM network fees, and more. As I stipulated at the outset, FedPal shouldn't be allowed to operate at a loss. This would be unfair to the thousands of community banks, credit unions, fintechs, and commercial banks that are trying their hardest to provide payment services to the public.

To recover its costs of serving a retail customer base, the Fed would have no choice but reduce the interest rate it offers. How low would it go? As a monopoly, the Fed is unused to the rigors of competition. I wouldn't expect it to be able to run a tight enough ship that it could afford to pay customers an especially high interest rate.

5. Speed?

Nope. With the introduction of Zelle, it's possible for Americans to make free instant payments, 24/7. Many other nations (like Sweden) also have real-time payments. We've got it here in Canada, too.

--------------

So central bank version of PayPal would be just another middling bank account. Sure, roll it out. But don't expect it to change the world. 

Funny enough, central bank macroeconomists are worried about the opposite: that CBDC could change everything. In the papers they write on the topic, macroeconomists fret that any CBDC they introduce will be so attractive that consumers will rapidly desert their regular bank and open an account at the central bank. This would cause the whole banking system to implode.Without a stable base of deposits, banks would be unable do any lending.

In my view, the real threat is the opposite. Given the institutional constraints I listed above, a central bank version of PayPal is destined to be a middling payments product. But it gets worse. Because central bankers are so worried about the macroeconomic effects that a FedPal will have on the economy, they will inevitably underdesign these accounts, turning a middling product into a crappy one. Adoption will never occur, and so FedPal will be wound down. This failure will go on to undermine the reputations of central banks.

The lesson is, either do a stellar job designing these things... or don't do it at all.

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* If the U.S. government is going to get more actively involved in offering low cost payments services to the public, there's a better way to get there than starting up a new CBDC-based system from scratch. Just offer government-sponsored prepaid debit cards. 
The neat thing is, it already does this. Millions of Americans who receive Federal benefit payments like social security already use the Direct Express card, a no-fee debit card issued by the government in partnership with Comerica. And to help disburse coronavirus relief payments, the government recently issued millions of EIP card, a no-fee prepaid debit card in partnership with Metabank. As I suggested here, why not make these cards better by letting card owners send/receive real-time payments via Zelle, attaching a savings account to the card, and giving users the in-app option of buying Treasury savings bonds.

...A few ways to improve the Direct Express card:

-let card owners send/receive real-time payments via Zelle
-attach a savings account to the card
-give users the in-app option of buying Treasury savings bonds
2/2 pic.twitter.com/tLSLfqujWW

— John Paul Koning (@jp_koning) May 1, 2020

In a recent article for the Sound Money Project, I suggested that the IRS start issuing debit cards too.

Buying coffee with Tesla shares

It's fascinating to see how brokerages these days are offering no-commission trades, fractional share ownership, and debit card-linked accounts. With this combination of features, maybe we're getting closer to the day when we can buy a $2.50 coffee with 0.007 Tesla shares.

Right now, a debit card purchase can only proceed if there are uninvested cash balances in the linked-to account. But what if the securities held in your brokerage account could also be debit-cardized?

Imagine going to Tim Hortons, ordering a double double, and paying with your RobinHood MasterCard debit card. Behind the scenes RobinHood, an online brokerage, checks your account. All you own is a few shares of Tesla. RobinHood won't actually transfer the shares to Tim Hortons. Instead, it quickly sells a small fraction of these—0.007 shares—for $2.50 cash.

Since RobinHood doesn't charge commissions, selling the shares costs you nothing. MasterCard signs off on the transaction and presto, you've got your coffee. You own 0.007 fewer Tesla shares while Tim Horton's will soon get $2.50 in cash from RobinHood.

Stock markets aren't open on the weekend. So what happens if you want to buy groceries on Sunday? Maybe you've got 2.1 shares of Tesla in your RobinHood account. They were worth around $825 at Friday close. Something catastrophic could occur over the what remains of Sunday, but RobinHood is pretty sure that come Monday morning, those shares probably won't be worth less than $500. And so it will allow you up to $500 in weekend debit card payments. When the market opens on Monday it sells whatever Tesla shares are necessary to settle up your grocery purchase.      

If the option of paying with volatile assets like Tesla were to be widely adopted, you'd expect traditional banks to get into the game. Right now banks offer deposits denominated in fiat units like dollars or yen or pounds. But there's no reason they couldn't provide Tesla-denominated checking deposits. The fact that banks don't do this is a good tip-off that there isn't a very big demand to make transactions using volatile instruments.

Why do people prefer to pay for things using stable instruments rather than volatile ones like Tesla shares? My guess is that it has something to do with FOMO.

Given a choice between paying with their regular bank debit card or a RobinHood card, most people will choose their regular card. Spending away Tesla shares could mean that they miss out on a potentially big jump in price. But spending away fiat-denominated deposits doesn't produce any negative emotions, since deposits can always be replaced at the exact same price come next week's paycheck.

(As I suggested last year, this is a weird example of Gresham's law, where lottery-type instruments like Tesla don't get recruited as money because the market puts less value on them than a hopeful individual does.)

If no one wants to use Tesla shares to buy coffee, they might prefer to set up their RobinHood debit card to sell lower-risk securities. For example, a RobinHood customer could have their card draw down on a bond ETF like the iShares Short Treasury Bond ETF (SHV), which primarily invests in US Treasury bills.

Since SHV's price hardly fluctuates, anyone who uses SHV units to buy coffee needn't fear missing out on a big payday.

At the same time, they'd earn far more than they would on checking account. SHV currently pays around 1.68%, which after a 0.15% management fee comes out to around 1.53%. That's about the rate you could get on a high-interest saving account, which aren't usually designed for everyday spending.

Will this sort of debit-cardization of stocks & ETFs ever happen? I don't know. There could be regulations that prevent the practice, or maybe some sort of hidden cost that makes it too expensive. On the other hand, cryptocurrencies and gold have already been debit-cardized, the gold and bitcoins being sold the moment that a card purchase is initiated. I don't see why it wouldn't be technically possible to do the same with other exchange-traded liquid assets like stocks.

Crypto-linked cards haven't been very successful, probably due to the FOMO problem I mentioned earlier. (Last year, Coinbase shut down its Shift crypto card). Tesla shares would probably suffer from the same. But a low-risk ETF held in a Robinhood account wouldn't be quite so hobbled. 

A way to make anonymous online donations

Paying for things online usually means giving up plenty of privacy. But this needn't always be the case. Last night I donated to a local charity via their website and didn't have to give up any of my personal information.

The trick for achieving a degree of online payments anonymity? Not bitcoin, Zcash, or Monero. I used a product created by old fashioned bankers: a non-reloadable prepaid debit card. (I wrote about these cards here and here).

Had I used a credit card or PayPal, all sorts of parties would have gotten access to my personal information including the site owner, the payments processor, my bank, the site owner's bank, the credit card networks, my partner, and many more. To get a good feel for how many different parties touch an online payment, check out this graphic by Rebecka Ricks, which shows how PayPal shares your information.

A powerful visualization by @baricks showing how PayPal shares your data: https://t.co/vd8w8d8xn6 ht @akadiyala

Due to Europe's new privacy laws, PayPal is obliged to make this information public: https://t.co/xmOpfXkNGG pic.twitter.com/vMTQCRfdLA

— John Paul Koning (@jp_koning) August 31, 2019

I bought my prepaid card--a Vanilla card--with $25 cash at a pharmacy. For it to be usable online I had to register it at Vanilla's website. That meant inputting my postal code. But that's all the information that Vanilla asks for. In my case I used my actual postal code, but I doubt that the system would have protested if a privacy-conscious user were to submit the wrong one.*

So at this point I've got a fully-loaded online-enabled card that has not been directly fed any information about my identity. (Note that this is how the process work in Canada. It may be different in the U.S. and elsewhere).

Next step, choose a charity. At the charity's website I entered my Vanilla debit card number, the CVV, and $10 as my amount to donate. The site also asked me to enter the name on the card. Because a prepaid card only says "For You" on it and not your name, just enter that or John Doe. Voila. Payment made:

Why on earth would anyone want to make an anonymous online donation? For my part, I was simply experimenting with my prepaid card. But I can think of several licit reasons for why people might want to donate anonymously with prepaid debit cards:

1. Many people share bank accounts. They might not want their partner to know that they are donating to a cause that their partner might not support.
2. A donor may not want the donee to know their identity lest the donee use it in a way that hurts the donor. For instance, if in public life I am a well-known conservative Evangelical, but I donate to a cause (say abortion education) that I privately support, I might prefer avoiding any chance that the donee leak my information in an attempt to 'out' me.
3. I like the charity, but don't trust it or its chosen payment processors to protect my information from hackers.
4. I don't want the charity to have my information so it can't inundate me with spam.

If non-reloadable prepaid cards can meet people's legitimate privacy needs, there is also a nefarious side to them. Anonymity allows people to evade rules about donations. For instance in Canada, there is a certain type of donation that is highly regulated: political donations. Below I've listed a few keys regulations:

• No cash donations above $20
• No anonymous donations above $20
• The identities of contributors that have given $200 or more must be reported to Elections Canada, which will publish them
• No single individual can contribute more than $1600 in a year.

Canadians have good reasons for supporting these limits. We don't want wealthy people to have an outsized influence on politicians. And we want donations to be transparent so we can see how politicians might be influenced by certain donors.

I can imagine plenty of scenarios in which motivated donors may want to break these rules. Say that a set of business owners in the restaurant industry stand to profit if the Liberal candidate wins because she supports removing regulations that increase restaurant operating costs.

After legally donating $1600 to the Liberals, some less savoury restaurant owners might want to illegally funnel more funds into party coffers. Cheques, credit cards, and other banking routes would be too risky. They establish a clear connection between the owner's identity and the donated funds.

A motivated restaurant owner can instead use $10,000 in cash to buy prepaid debit cards. They then go to the Liberal's website and donate $199.99 fifty times (for a total of $9999.50) using bogus names like John Doe, Jane Doe, etc. Since each transaction is under $200, they won't trigger the rule that requires such donations be reported to Elections Canada. And the Liberal Party probably doesn't have the capacity to cross-check each of the fifty payees to verify that they are associated with real identities.

This rinse-and-repeat strategy highlights one of the ambiguities of prepaid regulations. To reduce the potential for fraud and money laundering, regulators in Canada and the U.S. disallow non-reloadable prepaid cards with a face-value in excess of $500 (I believe that's the number). But since these cards are relatively anonymous, there's nothing preventing a would-be fraudster from using multiple cards to get around the cap.**

In any case, I'm not saying that this sort of donation fraud is occurring. But it's plausible. There's a reason that gift card and prepaid card fraud is rampant in North America. The relative anonymity that cards offer makes them a tempting tool for criminals.

As always, there is a yin/yang nature to anonymous payments. Anonymity is great when it protects well-meaning people from harm, but not so great when it protects bad people from good rules. Striking a balance is tricky.

---

* To access Vanilla's website, I had to disable my tracking blocker. Which means that the website probably has all sorts of processes going on in the background while a Vanilla user enters their postal code. These processes could link the user to their identity by cross-referencing the data gleaned by Vanilla's trackers against other data that has been collected elsewhere. This is probably an issue for these who want all-out privacy, and steps would have to be taken to mitigate information leakage. As they say, there is probably no such thing as pure anonymity, only degrees of anonymity. But for anyone who simply wants to enable a prepaid card in order to prevent their partner or the donee from seeing their transactions, then it's probably not a big deal.

**The way to nip donation fraud in the bud would be to require payment processors to avoid processing any prepaid debit card payment for political parties, or to limit cards to some inconvenient amount like $5 so that a rinse-and-repeat strategy is too costly to perform. It is possible that this tactic has already been adopted by payment processors.

In-game virtual items as a form of criminal money

A few weeks back Vice had an interesting story about Valve, a game maker, putting an end to trade in various in-game items because "worldwide fraud networks" had been using these items to "liquidate" their gains. You can see the blog post from Valve here:

"Why make this change? In the past, most key trades we observed were between legitimate customers. However, worldwide fraud networks have recently shifted to using CS:GO keys to liquidate their gains. At this point, nearly all key purchases that end up being traded or sold on the marketplace are believed to be fraud-sourced."

Having not played a video game since the original Super Mario Bros, this all sounded all very strange to me. But I couldn't resist digging a little deeper. After all, strange media-of-exchange are a major theme here on the Moneyness blog.

Let's set the stage. Anyone who plays Valve games can access something called the Steam Community Market. Players can go to this market to buy and sell in-game items from each other. So for instance, a Counter-Strike: Global Offensive game player may want to buy (or sell) a "skin" which is a texture that can make their gun look fancier. Some skins are apparently quite rare and valuable.

To make a purchase, players will need to have some funds in their Steam Market wallet. Wallets can be funded by credit card or a gift card. The catch is that once funds are on Steam, they cannot be directly transferred to other players. I can't send $100 in Steam balances directly from my Steam wallet to my friend's Steam wallet. Funds can only be used to buy items from other players. Furthermore, there is no way to cash-out of the system. Once money is deposited into Steam, it never leaves.

Now let's get to the fraud stuff, and we'll circle back to Steam later. Say that I'm a fraudster. My shtick is to dial up corner stores, claim that there is a bomb hidden in one of the aisles, and ask for a ransom of $5000 or I will set it off. The store owner has 30 minutes buy five $1000 MoneyPaks, then text me their PIN numbers. Upon which I quickly load the funds into my reloadable Green Dot prepaid debit card, the bomb being a hoax. (I kid you not, this is a true story).

Below is another variation of the scheme, the fraudster claiming to be law enforcement:

Bitcoin extortion scams are all the rage, but other semi-anonymous payments options like Green Dot prepaid MoneyPak cards will do in a pinch: https://t.co/gT2eEItrOw pic.twitter.com/xJCG1W1iDs

— John Paul Koning (@jp_koning) September 11, 2019

There are many versions of these prepaid scams.

In any case, say I pull this threat off fifty times. This leaves me with $250,000 and a pile of prepaid cards. The Green Dot cards aren't linked to my identity, so I needn't worry. But I really want to do something with my money, say buy a house. To do so I will somehow have to get the $250,000 into my bank account, and probably quickly before the money gets frozen. How do I do this safely? Obviously I can't just directly transfer the money from my card to my account. The authorities will connect the dots pretty quick and arrest me. I need to obfuscate the transaction chain.

And that's presumably where Valve's Steam Community Market comes in. If I can send the stolen funds through a market like Steam, maybe I can throw off anyone who comes after me.

First, I go to as many drug stores as I can and use my prepaid cards to buy up Steam gift cards. I'd have to buy around 500 or so $500 cards. And then I upload the $250,000 in card value to a bunch of online Steam accounts that I've created.

Remember, Valve doesn't allow for cash-outs, so the money is effectively frozen in Steam. This is where the items listed on the Steam Market come into play. I now buy $250,000 worth of skins or some other digital knick-knack. These items are now my get-out-of-jail card.

I proceed to sell the items I've stockpiled to other players who desire them for legitimate in-game use. The important thing here is to get actual dollars in return, not Steam dollars. I won't use Steam's in-game market for this, but third-party venues like OPSkins, Bitskins, or Skins.cash. Each of these sites provides an external trading venue where buyers and sellers of in-game items can meet and advertise prices. They also offer a wallet and escrow service to ensure neither buyer nor seller scams the other.

Since I'm in a rush to sell my virtual items, I'll probably lowball my prices on OPSkins, which means I may only get $150,000 for the original $250,000 I've spent. This is a great deal for regular game players. They don't have to fund a Steam account with, say, a $100 credit card transfer. Instead they can buy items from me for $70 on OPSkins and sell them on Steam for $100, saving themselves $30!

I then have OPSkins wire the $150,000 I've earned to my genuine bank account. And now I buy a house. Voila, I've hidden the source of the my money by running it through Steam. Somewhere between converting my prepaid funds into Steam gift cards, and then buying digital items with them, and then selling them, a would-be law enforcement agent will likely lose my scent.

Now that's roughly what I think that Valve is talking about in its blog post when it talks about "fraud networks", add or subtract a few steps. I wouldn't know, I'm just a writer.

What about Valve's response to the fraudsters? From what I gather, one of the most liquid items on the Steam Market are Counter-Strike: Global Offensive (CS:GO) keys. The price of keys is quite stable. Valve sells them at a fixed price, whereas the price of other goods are set by the Steam community, and fluctuate. And so keys have become a sort of currency. By adopting keys as their exit route, fraudsters would have made them even more liquid, and thus better capable of serving as a medium of exchange.  

Valve's defence is to freeze keys. "Starting today, CS:GO container keys purchased in-game can no longer leave the purchasing account," it said. This effectively cuts off any fraudster from existing the system... via the key route. However, there remain many other CS:GO items that folks can buy on Steam and sell on third-party exchanges like OPSkins. And there are other games that provide in-game items, like Dota 2 and Team Fortress 2. One wonders if some other item will become a go-to digital currency for fraudsters now that the CS:GO key route has been terminated. On Reddit, a few players speculate that Dota 2 Arcanas will take the place of CS:GO keys.

Usage of in-game virtual items as a bridge currency of sorts isn't without precedent. When conditions are right, instruments that we don't traditionally use as money, like CS:GO keys, get recruited for that purpose. Usually this occurs because there is some sort of hurdle or friction that prevents mainstream media-of-exchange from functioning, and only an exotic instrument can overcome that speed bump.

Equities are one of the more common exotic media-of-exchange. For instance, to avoid exchange controls Zimbabweans have traded in the inter-listed shares of Old Mutual, lifting them from the Zimbabwe Stock Exchange to London. Argentinians used American Depository Receipts in 2001 to dodge the "corralito". I wrote about both of these here.

More recently, gold was recruited as a payments rail for evading Obama's sanctions.

Heck, even I'm guilty. In Canada, retail foreign exchange conversion fees are ridiculously high thanks in part to our banking oligopoly. So I use Norbert's Gambit to get around the blockade. The gambit involves using dual-listed stocks or ETFs as a bridging asset between U.S. dollars and Canadian dollars. Debit card fraudsters are doing the same when they use CS:GO keys as a go-between asset for cleaning their money.

The desire to engage in trade is voracious. Blockades may be put up, but people will devise all sorts of ingenious monetary solutions for getting around them.