Response from Mastercard to the Treasury Select Committee

Digital Currencies Inquiry

30th April 2018

EXECUTIVE SUMMARY

Innovation and competition in payments

• Digital or crypto-currencies are a genuine technical and economic innovation, allowing internet-scale value transfer/payments to be made in the absence of central oversight or administration.

• Indeed ongoing innovation in payments is necessary – new ideas, technologies and applications can drive toward a better experience for all users – consumers, businesses and governments. However innovation should serve a purpose, addressing market needs not currently addressed by existing payment systems and offering greater choice. 

• The UK payments market is highly competitive, offering consumers and merchants multiple secure and convenient payment options. The imminent advent of the Second Payment Services Directive (PSD2) has the potential to further expand competition and choice. It is unclear what digital currencies offer that current or imminent innovation in the market will not.

• Therefore, Mastercard would caution against digital currencies for the sake of digital currencies; and would encourage the UK Government to undertake a sensible and detailed evaluation of the risks and benefits of crypto-currencies against the context of the functionality of existing digital payment systems; broader innovation already taking place; and the fundamental importance of a secure and reliable payments system to the stability of UK’s economy. 

• We welcome the Treasury Select Committee’s inquiry into Digital Currencies, and the opportunity to contribute to this important discussion.

Non-Government Backed Crypto-Currencies vs National Digital Currencies

• Within the bracket of ‘digital’ or ‘crypto-currencies’ there is a need to distinguish between non-government backed crypto-currencies (e.g. Bitcoin) from National Digital Currencies (e.g. backed/provided by a central bank or government). Both have different characteristics, risks and benefits and should be evaluated as such by the Treasury Select Committee.

• While non-government backed crypto-currencies may have a niche role to play in the overall payment eco-system, concerns remain around safety, security, consumer protection and reliability. This may affect their widespread adoption in the UK. HM Government and indeed all policy makers should be aware of these risks and factor them into future decisions on this issue.

• National Digital Currencies (NDCs), which could be administered by a central bank or potentially a private sector infrastructure provider mitigate some of the anonymity-based risks of non-government backed crypto-currencies, but also introduce a number of other challenges and risks. The Bank for International Settlements has called for more careful evaluation of NDCs by central banks, and has questioned the benefits of NDC’s when instant payments systems (such as Faster Payments in the UK) are already in place or in development. Mastercard agrees with this assessment.

Regulatory oversight

• It is imperative that consumers and merchants are able to conduct business and commerce in a way that is safe, reliable and simple. 

• There should be a level playing field for how digital currencies are approached, regulated and monitored. Governments and regulators have an important central role to play in carefully considering consumer protection, price volatility, scheme rules and pseudo-anonymous aspects of crypto-currencies, amongst other issues, and intervening in the market with caution if they deem it necessary.

• The first step in the UK, as advocated by the Bank of England, is to regulate the ‘on and off ramps’ (i.e. exchanges). So that users can be identified for AML and KYC purposes, the transactions are no longer pseudo-anonymous, aiding the identification of illegal activity (e.g. money laundering terrorist financing). 

Blockchain/Distributed Ledger Technology

• The blockchain – or distributed ledger technology (DLT) – that underpins digital currencies is an example of a potentially promising innovation that merits further review and consideration. However blockchain/DLT will likely be a longer term influence on the domestic UK payments landscape given the timeframe that such significant change to economically and systemically important and complex existing systems will require; and that plans for the UK’s future payments infrastructure do not currently involve blockchain. However, we may see blockchain much sooner in cross-border B2B payments.

• Currently we see no evidence of crypto-currencies being used for transactional purposes at scale; and indeed the regulatory focus is largely centred on cryptocurrencies as a store of wealth.

• It is likely that nearer term uses of blockchain will be in other sectors, for example digitising documents (e.g. mortgages, health records); creating digital identities; addressing inefficiencies in supply chain management; or recording loyalty point transactions or ownership of financial assets (e.g. stocks). This is because of the lower levels of economic risk of deploying nascent blockchain technology in these areas compared to the complex and economically important UK payments system.

ABOUT MASTERCARD

Mastercard is a publically listed technology company in the global payments industry. Our global payments processing network connects consumers, financial institutions, merchants, governments and businesses in more than 210 countries and territories. Mastercard products and solutions make everyday commerce activities – such as shopping, traveling, running a business and managing finances – easier, more secure and more efficient for everyone.

In May 2017, Mastercard completed its £700 million acquisition of Vocalink, the current operator of significant elements of the UK payments infrastructure including Bacs and Faster Payments. This new partnership brings together real-time bank account payments and the Mastercard payments network, providing services for consumers, businesses and the public sector all under one roof. This response represents the views of Mastercard and Vocalink.

QUESTION RESPONSES

Are digital currencies ultimately capable of replacing traditional means of payment?

1.1   Non-government backed crypto-currencies (or non-government backed digital currencies) such as Bitcoin, are a genuine technical and economic innovation, allowing internet-scale value transfer in the absence of a trusted intermediary or administrator.

1.2   They have interesting and valid use cases across a broad range of markets and industries, but currently they do not meet the basic requirements of an effective payments system – safe, reliable, and stable for consumers. As set out in this response, this is because non-government backed crypto-currencies pose a number of challenges including user pseudo-anonymity (where there is no regulation of on and off ramps), processing times, price volatility, lack of regulation, consumer protection & money supply, plus the limited benefits and the negligible cost differential to the end user.

1.3   An increasing number of central banks are assessing the potential for National Digital Currencies (NDCs) to be a future component of national payments systems as they are seen to potentially negate some of the major risks associated with non-government backed crypto-currencies; and help to facilitate a reduction in reliance on (anonymous) cash. However, as the Bank for International Settlements (BIS) has recently stated, central banks should take more time to weigh up the risks to financial stability and monetary policy of introducing such a payment system for public use. BIS also stated that the benefits of a widely accessible NDC may be limited if fast (even instant) and efficient private retail payment products are already in place or in development’[1].

1.4   The UK has Faster Payments, run by Vocalink for the Faster Payments Scheme – which was launched in 2008 and is a reliable and increasingly widely-used payments system in the UK. In 2017 Faster Payments service processed £1.4 trillion of transactions, an increase of 18% from 2016. I.e. there is increasing demand for this system[2]. The blueprint for the UK’s future account to account payments system – the New Payments Architecture (NPA) – designed by the UK payments community (Payment Strategy Forum) with implementation being overseen by the New Payment Systems Operator (NPSO) over the coming months and years, is not currently based upon blockchain technology.

1.5   Therefore, whilst conceivable that an NDC could have a role in a future UK payments system if potential risks are mitigated, for the foreseeable future it is hard to see what the benefits of such a system would be, given the functionality of digital payments systems already serving the UK’s economy.

To what extent could digital currencies disrupt the economy and the workings of the public sector?

2.1   Non-government backed crypto-currencies, present special challenges in both the functioning of the economy and of the state because they are specifically designed to avoid government/regulatory/central bank oversight and control. 

2.2   For example, the foundation of Bitcoin is an open source code created and released by an unidentified individual(s). The Bitcoin network itself is operated by unknown “peers” who essentially donate their computing power to use the source code to release new bitcoins and anonymously validate Bitcoin transactions.  As these peers are unknown they, and their computers, are beyond the reach of governmental agencies (or schemes under the supervision of government agencies) that would typically ensure an appropriate framework for the safe operation of a digital payments network.

2.3   From an economic perspective, operating (allowing) multiple, free floating, parallel currencies in a single market such as the UK would create potential challenges for monetary and economic policy. The Bank of England is aware of the risks to monetary policy and financial stability of non-government backed crypto-currencies should one or more become used on a much wider basis. As the Financial Policy Committee has recently reported ‘In the event that one or more crypto-assets were likely to become widely used for payments, or as an asset intended to store value, the FPC would require current financial stability standards to be applied to relevant payments and exchanges.[3]’

2.4   Currently in the UK non-government backed crypto-currencies, like Bitcoin, also enable pseudo-anonymous electronic transactions as there are no regulation of exchanges (i.e. the on and off ramps where fiat currency is converted to crypto-currencies, and back again).This creates challenges for tax authorities, law enforcement agencies (detecting tax evasion, money laundering and terrorist finance tracking) and other stakeholders in the public sector (e.g. banks, payment service providers, consumers) that require or expect an oversight of the flow of payments.

2.5   If a central bank were to introduce an NDC it would in theory be able to trace transactions but at considerable cost in terms of implementation, and then ongoing compliance with AML & KYC requirements. In the UK where Faster Payments is already functioning well and significant progress in identifying criminal transactions is being made, introducing an NDC would create unnecessary cost and unnecessary risk into an already complex, but well-functioning and efficient payment system.

What risks and benefits could digital currencies generate for consumers, businesses and governments?

Benefits

3.1   Digital or crypto-currencies are a genuine technical and economic innovation, allowing internet-scale value transfer/payments to be made in the absence of central oversight or administration. There are a range of perceived benefits that are widely attributed to crypto-currencies including being highly secure; immunity to inflation; accessible to all with an internet connection; and quicker transaction times than some existing payment systems amongst a range of others. 

3.2   Given the volume of publically available material on the benefits of crypto-currencies, this submission acknowledges, but will not go into detail on them. However, we would recommend that policy makers examine many of these perceived benefits against the context of the functionality of existing UK payments systems.

3.3   If a non-government backed crypto-currency met all the regulatory requirements of an economically critical payments system, it may not provide much incremental benefit over these existing systems. Similarly the advantages of NDCs over some non-government backed crypto-currencies – e.g. removing the pseudo-anonymity of transactions, quick processing times, or ubiquity of acceptance – are already delivered by the UK’s existing digital payments systems[4].

Risks

3.4   For non-government backed crypto-currencies such as Bitcoin, price volatility represents a risk on both macroeconomic [see 2.3 above – challenges for monetary policy and financial stability] and microeconomic levels.

3.5   On a microeconomic level, the price volatility of digital currencies (as a store of value) can lead to greater levels of individual debt as these values fluctuate, often significantly in short time frames. If individuals buy non-government backed crypto-currencies on credit, the price volatility itself can cause negative consequences, such as the individual being unable to pay back their lender (e.g. similar to negative equity). This will have negative impacts on both the consumer and the lender. In comparison, card systems such as Mastercard protect cardholders with chargeback rights.

3.6   There is also no consumer protection/redress for non-government backed crypto-currencies. For example, if a Bitcoin is used to make a purchase and the merchant fails to deliver the goods, the consumer has no recourse because of a) the pseudo-anonymity of the buyer and seller; and b) a lack of central oversight and penalties for fraudulent or disputed payments. 

3.7   Similarly, if the consumer’s private key (i.e. access to their Bitcoin) is lost or stolen, the Bitcoins are lost forever, just like cash. This underscores a risk associated with Bitcoin which is the absence of a central administrator and governance structure, such as a payment scheme, that is otherwise common in other payment systems.

3.8   From the perspective of tax collection, identification of money laundering, tracking of criminal (including terrorist) finances, these efforts are all significantly harder when non-government backed crypto-currencies associated with pseudo-anonymity are used to conduct transactions. [See 2.5 above]. A notable way of addressing this threat would be to require the regulation of crypto-currency exchanges.

3.9   NDCs potentially pose risks for financial stability if consumers move ‘en masse’ to an NDC from their bank accounts (effectively a ‘run’ on banks); and on the ability of a central bank to implement monetary policy by limiting the effectiveness of the tools available to it including interest rates.

3.10           Mastercard would agree with this assessment by the Bank of England[5], and the recent BIS assessment that there should be further evaluation of these risks by central banks around the world, before making any decisions to build/implement NDCs.  

How is distributed ledger technology being applied in the financial services sector, and how might it be applied in future?

4.1   While crypto-currencies raise important regulatory considerations, the underlying blockchain or distributed ledger technology (DLT) is an example of a potentially promising innovation that merits further review and consideration.  

4.2   The blockchain is a decentralised method of processing and storing information all of which may have various applications. These applications – with added promises of fast speed and low costs – could include digitising documents (e.g. mortgages, health records); creating digital identities; addressing inefficiencies in supply chain management; or recording loyalty point transactions or ownership of financial assets (e.g. stocks).

4.3   Use of blockchain/DLT in financial services is still likely to require some role(s) within a private ecosystem to define and operate scheme rules, standards, software, etc. and/or to act as a trusted point of validation for transactions in the network.

4.4   We do not believe that blockchain/DLT is currently sufficiently mature or functionally-rich to meet the needs of the UK domestic payments market, as outlined by the Payment Strategy Forum in 2017. The general consensus, supported by BIS, is that there is limited value in implementing such a system in the UK, where Faster Payments already serves the economy well.

4.5   However, we note that the Bank of England has recently established a new Fintech Hub as a central point of contact for engagement with start-ups and to drive new technological developments within the Bank – including a DLT interface into its next generation Real Time Gross Settlement system.

4.6   Where blockchain/DLT may make inroads sooner, is in cross border payments systems, driven by necessity i.e. the high costs and slow speed of making cross border payments using established account to account systems. Companies like Ripple and Wyre have developed cross border DLT-based systems that are in operation, and more established operators such as SWIFT are trialling similar systems. At Mastercard we are also exploring how blockchain can address these challenges[6].

What work has the Government (and its associated bodies) done to understand, prepare for and, where relevant, encourage changes that may be brought about by increased adoption of digital currencies?

5.1   The UK Government, like many governments around the world, has adopted a cautious ‘wait and see’ approach to intervention in the crypto-currencies market. As a general rule of thumb, the UK Government should continue this considered approach, weighing up risks and benefits of crypto-currencies before making significant decisions.

5.2   As such, the recent announcement by the UK Government, as part of its Fintech Sector Strategy, that it will form a Crypto Assets Taskforce is welcomed; and it will ensure that future intervention decisions are well informed and considered. However, it should be prepared to intervene in the market in an appropriate manner if required. One area the Taskforce should consider is how to regulate crypto-currency exchanges.

5.3   The Governor of the Bank of England has recently stated that the Bank supports regulating crypto-currency exchanges (e.g. on and off ramps for users to convert fiat currency into a crypto-currency, and then back again) to ensure that KYC and AML regulation is applied and pseudo-anonymity is mitigated[7]. In doing so this would address some (but not all) of the risks associated with non-government backed crypto-currencies, such as money laundering, tax evasion and terrorist financing

5.4   The Governor has also stated that the Bank will be taking more time to research NDCs, given the potential risks that such a system could pose for financial stability and monetary policy. Given the importance of payments systems to the functioning of the UK economy, such risks should not be taken lightly and the Bank is wise to adopt a cautious approach.

How might the Government’s processes adapt should digital currencies be adopted more widely (e.g. tax implications, anti-money laundering measures)?

6.1   Where there is no regulation of crypto-currency exchanges (i.e. on and off ramps), non-government backed crypto-currency transactions present challenges for regulatory and law enforcement efforts as identification of the parties to a transaction has become a basic requirement for protecting against and detecting money laundering. 

6.2   In some cases, intermediaries are joining the non-government backed crypto-currency ecosystem to help consumers purchase the crypto-currency; and sellers and others to receive the crypto-currency. It is essential that these intermediaries be subject to the full range of Know Your Customer (KYC) and other anti-money laundering requirements. Otherwise, as criminal activities are driven from more traditional networks they will simply gravitate towards non-government backed crypto-currencies without such regulation, like Bitcoin, which make it challenging for law enforcement to ‘follow the money’. 

6.3   Note that the perpetrators of some ransomware attacks, including the recent WannaCry attack, demand payment in Bitcoin, which shows that these criminals believe they can remain undetected by using non-government backed crypto-currencies as a method of payment.

6.4   Therefore, if non-government crypto-currencies are adopted more widely, Government should consider regulating crypto-currency exchanges to ensure that KYC and AML regulation is applied and, as is the case with other digital payments, those making transactions can be identified. [see 5.3 – above]

Is the government striking the right balance between regulating digital currencies to provide adequate protection for consumers and businesses whilst not stifling innovation?

7.1   It is imperative that consumers and merchants are able to conduct business and commerce in a way that is safe and simple for all, and which engenders confidence in the system they are using. Given the pace at which technology enables change in this space, the Government must act in a considered but effective manner to ensure that all parties are protected as innovations are adopted. If there is no confidence in the technology that is developed in this space, for instance because of a lack of oversight or consumer redress, such innovation will be stifled by not achieving mass acceptance.

7.2   HMT’s announcement of a Crypto Assets Taskforce is a step in the right direction in ensuring appropriate and considered oversight of this issue in the UK. As above, it should examine how to enact the Governor of the Bank of England’s recommendation to regulate crypto-currency exchanges, in order to address pseudo-anonymity associated with some non-government backed crypto-currencies.

7.3   The Government should  also remain wary of crypto-currencies for crypto-currencies sake; and cognisant of the Bank for International Settlements recommendation that if, as is the case in the UK, that a real time account to account payment system is already in place, then NDCs lack justification. 

Could regulation benefit digital currency start-ups by improving consumer trust?

8.1   No response

How are governments and regulators in other countries approaching digital currencies and what lessons can the UK learn from overseas?

9.1   Concerns have driven a number of governments to take action on Bitcoin. For example, China has banned financial institutions from handling Bitcoin transactions.  The European Banking Authority warned consumers about the lack of protections from financial loss associated with Bitcoin use.  In addition, the US government made clear that that Bitcoin exchangers and administrators are money services businesses requiring registration and the US government has been active in taking criminal action against the use of bitcoin for money laundering purposes.

9.2   At the state level, New York has adopted a licensing scheme for digital currency firms and each of the Conference of State Bank Supervisors and the National Conference of Commissioners on Uniform State Laws has issued a model law for the licensing of digital currency firms.

9.3   The Italian Government is currently consulting on a proposition for government/regulators to license those businesses offering digital currencies to consumers i.e. exchanges – a light touch regime which may also work in the UK. The argument being that these businesses should be subject to some scrutiny like the one required by the Payment Services Regulations 2009/2017 for payment institutions.

9.4   The newly created Crypto Assets Taskforce in the UK should take note of other regulatory initiatives across the world. As the UK leaves the EU, it will want to ensure that its financial markets – and the broader functioning of the UK economy – is not jeopardised by a lack of appetite to address the challenges posed by digital currencies. The Taskforce should also ensure that the UK does not lag behind other countries in ensuring an appropriate regulatory regime for digital currencies, where evidence illustrates the need for intervention.

9.5   As Mastercard’s response has highlighted, the Bank for International Settlements has set out a compelling argument for greater and more considered research into NDCs and the risks that they could pose. The Bank of England had already announced that this would be its approach.

RECOMMENDATIONS

10.1 The UK Government should continue its cautious and considered approach to all intervention in the

         crypto-currencies market - non-government backed crypto-currencies or NDCs.

10.2 It must carefully consider whether all crypto-currencies can efficiently deliver benefits for end users  

         that existing digital payments systems do not. If the purpose is to ensure more choice to end users,   

         there have been a number of ways to pay and be paid for some time. The introduction of PSD2 will

         further drive competition in the market for digital payments methods. Mastercard would therefore

         advise a thorough examination of the benefits, risks, and challenges of digital currencies; and whether

         they meet the needs of consumers, businesses and all users of payments systems, better than

         alternative solutions.

10.3 The Bank for International Settlement’s recent paper on ‘Central Bank Digital Currencies’ (or NDC)

        advises central banks to exercise careful consideration and caution when evaluating whether to

         introduce an NDC, given the risks to financial stability that these could pose. The Bank of England

         came to similar conclusions. Mastercard would recommend other UK policy makers to take on-board

         the recommendations of BIS’ paper.

10.4 From a regulatory standpoint, there needs to be a level playing field for how non-government backed

         crypto-currencies are approached, regulated and monitored. There is a central role for the UK

        Government and regulators to play in carefully considering and addressing perceived consumer

        protection, price volatility and pseudo-anonymity risks. One area that should be initially addressed, as

        suggested by the Bank of England, is to regulate non-government backed crypto-currency exchanges

        (i.e. the on and off ramps for users to convert fiat currency into a crypto-currency, and then back

        again), and in doing so allow individuals making crypto-currency transactions to be identified.

10.4 With respect to distributed ledger technology in the financial system, organisations and authorities

         with oversight responsibility should be engaged with industry stakeholders and thought leaders as we

         all share a vested interest in consumers and businesses being able to conduct business and commerce

         in a way that is safe, reliable, and simple. That interest extends to Mastercard’s commitment to

         innovation.   

CONTACT

Ben Wilson, Director, Public Policy UK & Ireland, Mastercard

Ben.wilson@mastercard.com

April 2018

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