Monday, May 12, 2014

When Payments Become Political Weapons of Mass Destruction

By Jon Matonis
Wednesday, May 7, 2014

Executives at Visa and MasterCard awoke yesterday morning to learn that Vladimir Putin’s Russia had passed legislation requiring foreign credit card brands to post $3.8 billion in total security collateral, the equivalent of two days’-worth of transactions processed in the country.

After Russia reunified with (or annexed, depending on your point of view) Crimea, Visa and MasterCard complied with stringent White House sanctions and blocked transaction activity at several Russian banks. Both financial companies rightly feared a backlash from their actions.

Under the new law which goes into effect on July 1st, no foreign payment system may unilaterally cut services to Russian clients and they must base their processing centre in Russia, with transaction data maintained within its borders.

Additionally, there will be fines of up to 10% of the collateral deposit per day for unilaterally stopping services to a bank. For Visa, the required collateral deposit actually exceeds their annual returns from operating in the country.

Earlier, the credit card companies stopped working with Bank Rossiya and Sobinbank due to a previous round of US government sanctions.

Now, per the more recent sanctions, that ban is extended to the Russian banks SMP and InvestCapitalbank. Both banks are controlled by the Rotenberg brothers, Boris and Arkady, who are linked to large gas pipeline contracts and various Sochi Olympics contracts.

Payments networks have now become political weapons of mass destruction. This is a disturbing trend, because if the selective halting of international credit card networks can be deployed against political enemies, then nearly no country is safe.

Business models disrupted

An admittedly nervous Visa statement on Tuesday explained: “We regret any disruptions that the institutions, their cardholders or merchants may experience. All of Visa’s systems are processing normally, and we continue to service our other unaffected Russian clients.”

MasterCard stated that they will remain “open for business as usual with all our Russian banks, with the exception of Rossiya, Sobinbank, SMP Bank and InvestCapitalBank. Service of cards issued by the latter two banks will be stopped shortly according to the revised US sanctions announced today.”

Visa and MasterCard process about 90% of all card transactions in Russia and the new law completely disrupts their business and technological models.

Visa’s Chief Financial Officer Byron Pollitt told the Financial Times that “issues with Russia and Ukraine were already affecting cross-border volume and sanctions would impact on payment volumes.” He added that the company expects several pennies of earnings per share impact for the fiscal year.

However, Visa CEO Charlie Scharf remains optimistic, telling analysts, “If you just get down to reality for a second, we have 100 million cards in Russia today. And it’s not in anyone’s best interest, inclusive of the Russians, to make those cards not available to their own citizens.”

Home-grown system

Similar to France’s Carte Bleue and Germany’s Geldkarte, the Russian central bank plans to establish a national payments system for handling domestic card transactions in Russia.

For international transactions, Russia is inspired by China’s UnionPay, the rapidly growing payments platform whose cards are accepted in 135 countries and is now bigger than MasterCard and second only to Visa in processing volume. Who needs Visa and MasterCard in a world of payments innovation?

We are witnessing more and more of these types of payment blockades in line with broader financial warfare occurring under the surface. In 2012, Belgium-based wire clearinghouse SWIFT discontinued service to 30 Iranian banks following intense pressure from Washington, DC.

And who could forget the proverbial rug being pulled out from under Wikileaks by the Visa, Mastercard, and PayPal giants.

In July, the US plans to unleash the IRS on Russian banks further destabilizing the current situation.

Risky game

Centralized systems have always had the weakness of being driven by both external and political forces. It’s simply an inevitable temptation when a single choke point exists in the network.

The same mischief that plays out between mega-states on the international stage just as easily plays out domestically in inflationary regimes like Argentina, where credit cards are frequently limited to domestic usage only and where hard currency and precious metals are difficult to obtain.

Once the payment mechanism starts to become used for achieving policy goals, the system has lost its integrity. Alternative payment methods that rebuke censorship begin to emerge, attracting new capital and new economic activity.

Meanwhile, in other related news, Ukraine climbed to the No.9 position in global active bitcoin nodes and Russia currently sits at No.7. Global active bitcoin nodes measure number of nodes in the distributed p2p network that maintain and broadcast the full bitcoin block chain.

In the words of Jim Rickards, author of The Death of Money, “only escalate the battle if you know where it’s headed.”

Visa and Mastercard could be significantly harmed by this obvious retaliation. In addition to mandating changes to the rules of the local payments network, Russia could freeze assets of US companies doing business in Russia and also begin to unwind its positions in US treasuries. And, that’s before they even get to the gas and oil markets.

Monday, May 5, 2014

Bitcoin Adoption, Not China's Central Bank, Is What Underlies Legitimacy

By Jon Matonis
Wednesday, April 30, 2014

The bitcoin ‘China Syndrome’ fills the news these days with attempts by Chinese authorities to steer bitcoin legitimacy. This gives us an excellent opportunity to contemplate and reiterate the core attributes of bitcoin’s overall strength.

Bitcoin shows that national fiat money systems are an artificial construct. The debates around regulation are really restrictions on getting into or out of the US dollar rather than getting into or out of bitcoin. Dollar and other national currency endpoints will always be regulated.

Aside from the fact that bitcoin survives and outlasts political institutions just like the Internet does, its greatest strength lies in the fact that it does not require government or other third parties to sanction its legitimacy. Bitcoin’s legitimacy derives from its market adoption and continued usage among its participants.

The exchanges, or on-ramps to the legacy financial world, are just convenient enablers and it makes sense for some threatened political institutions to clamp down on the facilitating enablers. Incidentally, it also reveals to the world which nations feel the most threatened by the existence of an incorruptible, non-political monetary unit.

Far more important to bitcoin’s future are the robust mining communities and the decentralized global nodes. Ultimately, any new bitcoin regulation yields market-based reactions to that jurisdiction’s regulation. Outright bans simply do not work. Price discovery still finds a way.

Of course, people in certain countries get annoyed when they cannot use an exchange to acquire or sell bitcoin and instead must go to excellent sites like LocalBitcoins to arrange a transaction. It can make you feel like you’re engaging in something seedy, but that is the intent of the regulators and the Fourth Estate. They drive it underground to dampen or slow adoption.

The way forward

We can do something. There is a solution. First, don’t worry every day about the USD or EUR price of bitcoin. Manage the risk via currency diversification.

Secondly, don’t fall victim to believing that nation-states can bestow legitimacy on a monetary unit. The most that governments can do is demand a favoured monetary unit in payment for taxes and other payments to the authorities, thus declaring a legal tender. A declaration such as that has little to no effect on person-to-person digital exchanges.

Also, reject the premise that bitcoin must be mainstream in order to be massively successful. Of course, it wouldn’t hurt for bitcoin to go mainstream, but not at the risk of diluting some of its core attributes.

Bitcoin needs to be successful on its own terms unlike PayPal, which capitulated from its original mission to then become a watered-down version of itself, enabling the same third-party choke points and legacy financial roadblocks that it originally set out to challenge.

Lastly, while research articles may tout a seductive future where ‘Bitcoin’s Promise Goes Far Beyond Payments‘, it is unlikely that a future of block chain-like applications will dispense with the original building blocks of bitcoin.

Bitcoin stands to win

Distributed trust networks are built upon gradually expanding computational strength provided by the network’s increasing hash rates. The incentive for continued mining is directly related to the value of the network-embedded monetary unit which is the bitcoin unit.

Side chains that exploit bitcoin’s early mover advantage are more likely to be the future of block-chain applications than government-managed trust networks that centralize and malign the incentives.

Therefore, bitcoin wins more broadly even though payments may only represent the first application of block-chain technology. The bitcoin monetary unit is the inseparable part of the world’s largest and computationally strongest distributed computing network.

Like languages, value standards trend towards commonality, which is why we will never see over 300 independent altcoin valuation standards succeed.

A standard for measuring value is similar to a standard for measuring volume, length, or temperature. The world may accommodate a few competing standards (like Fahrenheit and Celsius), but the market will reject an abundance of counterproductive competing standards.

Issues that broad adoption solves

As bitcoin is a global unit, we must talk about adoption on a global scale. It is insufficient to talk only of bitcoin adoption within a single country because its global nature breaks down borders for more robust international trade and transactions.

Unlike boundary-specific monetary units, bitcoin facilitates exchanges between different jurisdictions, thus weakening the advantage of the providers of the regional monetary unit. Bitcoin does not recognize the relevancy of jurisdictional borders and sees them as damage that it needs to route around.

Many positive things begin to happen with broad bitcoin adoption. For instance, the need for online local fiat exchanges begins to diminish because people on the receiving end of bitcoin are also able to spend bitcoin. A closed loop is created.

Also, the focus of bitcoin-related businesses shifts to usage rather than concerns around regulation, because if people are not exchanging bitcoin with fiat there become fewer regulatory endpoints to the legacy financial system.

All that remains are people trading digital scarcity ‘tokens’ for goods and services via their personal electronic wallets. Economic growth is centred around the participants of that new economy which reinforces market-based legitimacy for bitcoin.

Strategies for increasing adoption

How can we increase bitcoin adoption? This is the famous chicken-and-egg question. Do consumers lead the way for merchants to provide bitcoin payment choices, or do merchants provide fabulous bitcoin offerings that drive consumers to enthusiastically acquire their first bitcoins?

Both can be correct and there is no right or wrong answer. Aggregate consumer purchasing power could indeed influence merchant payment choices, while the fabled ‘killer app‘ for bitcoin will probably be merchant-driven.

Local groups and bitcoin nonprofits around the world could start holding contests with awards for the merchants that have the greatest bitcoin sales in a given period. ‘Bitcoin Accepted Here’ decals could be distributed in the same way that other payment decals are distributed. Large and influential merchants could debut shippable products to parts of the world that have no ability to purchase goods in the global economy without a bank card.

The existing bitcoin merchant processors like BitPay, BIPS, and Coinbase play a significant role in increasing adoption, especially since they provide streamlined apps and plugins for existing e-commerce software packages.

This will continue to be a high growth area as both physical and virtual merchants seek to plug into the rapidly growing bitcoin economy.

Consolidated consumer pressure promising large Groupon-like sales volume could also be directed at favoured merchants, thereby adding new bitcoin merchants to the ecosystem. This also creates a reason for consumers to acquire bitcoin.

Source: MIT Technology Review
As the chart above demonstrates, we are already witnessing greater bitcoin payments turnover than we were in the early years. This is encouraging because it means that new bitcoin is being transacted and used in some manner generally within 24 hours.

Furthermore, all of this has happened without an official government pronouncement or declaration of a legal tender. The future belongs to bitcoin.