We’ll take a break from deposit strategies to explore the world of virtual currencies – Facebook credits, Linden Dollars, World of War Gold. What are the implications of these virtual currencies for banks?Today, few banks are active in building the exploding virtual economy, yet the market value of Facebook and other virtual networks suggest that banks may be heedlessly ceding the revenue streams associated with the settlement, clearing and risk intermediation activities of this new economy. Might we look back in 10 years and find that Facebook is a larger payment intermediary than JPMorgan, Citi and Deutsche Bank combined?
The philosopher Jean Baudrillard argued that advances in media and technology would cause society to shift to a hyper-reality in which experience is detached from the real and we live in a kind of simulation – a reproduction of experience removed from the original. This is certainly true in the area of payments, where virtual currencies proliferate and now interact with real settlement systems in a chaotic and feverish manner.
Consider “second life” – itself a simulation of reality. Participants transact using Linden dollars, which can be used to buy virtual goods. These dollars then trade on eBay and other sites, with a bid/ask spread, which I imagine must be reasonably efficient given the number of transactions that are occurring. This activity is not entirely dissimilar from the spot FX desk of a bank, buying and selling various currencies. Dependent upon the nature of how these virtual currencies are traded for “real” currencies (the quotes are particularly necessary given the state of the Euro!), settlement may have varying degrees of protection from fraud. For example, eBay offers significant protection for fraud via the rules of PayPal.
In “real” economies, the central bank is typically part of the government and directly or indirectly accountable to the citizens, dependent upon the structure of the government. In virtual economies, the central bank is typically the owner of the system – in the case of Facebook, the central bank is Facebook itself, which controls the production, distribution and monetary policy of Facebook credits. Further, because Facebook has its own methods of authenticating users and their transactional experiences, Facebook has significant power to track and control the use of its currency. In contrast, other systems operate in a looser manner, in essence increasing the potential for higher levels of “black market” activities and, potentially, fraud.
Where will this go? The market value of Facebook reflects its unique intersection as a media and payments company. The two activities are fused together seamlessly and symbiotically. Facebook takes a 30% skim on all Facebook credits, yet there is little howling from retailers, consumers or government watchdogs (Dodd-Frank, which pinned back the ears of banks on debit interchange, is silent in this area). Facebook’s ambitions in the payment space are unknown, but likely huge. The company recently created a payments subsidiary and the business objective outlined in its filing is staggering in its scope, “The corporation is organized for the purpose of transacting any or all lawful business.”
Picture a world in which a significant portion of commerce takes place virtually, outside bank settlement systems and largely independent of central bank currencies. In essence, the banks will be left to settle the net transaction flows of these virtual economies – taking on much of the risk, with little of the revenue in return.
What can banks do?
The landscape is still to be developed and there is still time left to act. Banks must think about how their key strengths play in a virtual economy. In many respects, these virtual economies resemble the Wild West, with fraud and hyperinflation common. In one notable case, a game provider sold massive levels of currency on eBay, destroying the basis of the game.
Given the risks of a virtual world, with central bankers that are largely unaccountable to its netizens, banks have opportunities to strengthen virtual commerce through their key competencies:
- Certainty of settlement
- Ability to provide liquidity
- Sophisticated trading operations for purposes of making and sustaining exchange markets
- Processing efficiency
- Risk intermediation
To move into the virtual realm, banks must set aside some of their focus on their core platforms and business models and explore the value-chains, opportunities and threats of the virtual economies. At minimum, any bank that considers itself interested in payments should be doing the following:
- Assess the impact of the virtual economy on commerce – given the growth of these economies, what are the likely impacts on the number and value of payments by channel and payment type?
- What elements of the bank’s business are vulnerable to a virtual player? While consumer-to-consumer and consumer-to-business are obvious areas of vulnerability, it is worthwhile exploring the potential that even business-to-business activity might migrate to a virtual network.
- What opportunities does the bank have to enter the virtual payments space? Begin by exploring the needs your customers have in transacting virtually and in bridging the virtual and “real” economies. What can you, as a bank, do to provide a safer, easier, more reliable and efficient environment?
- For banks with growth objectives, explore the virtual payments landscape for potential acquisitions and growth opportunities – Treasury Strategies assists banks in understanding the size, profit pools and key trends of the payments landscape – both “real” and “virtual” – and in diagnosing the underlying value chains to identify key opportunities and threats. Cataloging the key players in this space and their business models, markets and trends will also help inform the bank as to the potential of this space.
Banks are understandably focused on complying with regulation and tending to their core franchises. But the virtual economy is exploding. Assessing the opportunities and threats of this space at its early stage could position banks to be a significant player in the virtual economy.