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The eMoney Game: February 2023

Thoughts on improving regulations

The eMoney game involves:

a) getting customers to add funds to an eMoney app,

-in order to-

b) earn interest on the customer’s money.

The game is typically enabled by eMoney regulations. With interest rates moving from 0% to 3%+ soon in Europe and 5%+ in the US, the game has become profitable once again. A similar game has emerged for stablecoins in crypto – with one key difference.

We (nearly) all use eMoney.

If you have an app like Revolut* or Venmo, chances are you use or used eMoney.

To understand eMoney, it helps to first understand cash deposits at a fully regulated bank – like Allied Irish Bank or Bank of America, or now also Revolut.

In most developed countries, banks operate under a partial reserve system. Banks only hold a portion of deposits in reserve, while lending out the rest. In brief, banks have less cash on hand than is needed were all depositors to withdraw at once. This partial reserve system requires careful management, and is largely why:

a) Banks are highly regulated entities – meaning that their deposits and lending behaviours have government oversight, and

b) Many countries have a deposit guarantee system, where the government insures each account up to a certain limit. This is to avoid a bank run, whereby all depositors panic and try to withdraw more funds than the bank has in reserve.

eMoney is different. eMoney is typically backed one-to-one (or a little higher) by deposits at a fully regulated bank. For example, for 1 Euro of eMoney issued, there might be a requirement to hold 1.02 Euro in reserve in a fully regulated bank. For this reason:

a) eMoney institutions are regulated but less tightly regulated than full banks, and

b) there is often no government bank guarantee for eMoney.

eMoney is a good idea because it means not every financial services business has to become a fully fledged bank. eMoney opens up the system to to new ideas, companies and competition.

Where does the eMoney Game come from?

eMoney issuers deposit customer funds to a fully regulated bank and then issue eMoney to their customers’ accounts. eMoney balances are tracked by the eMoney company in a ledger (database) and subject to government audit and oversight. The eMoney institution typically earns interest on the deposits at the fully regulated bank. However, eMoney institutions are often prohibited from paying interest to holders of eMoney. So, eMoney institutions earn the interest on their customers’ deposits. This, is the eMoney Game.

Put differently, the interest earned by eMoney institutions is their compensation for services they provide to customers. Such an indirect kind of monetisation is not uncommon in banking and is not necessarily a bad thing. However, it is a volatile business model given eMoney institution revenue depends on interest rates.

Fiat-backed Stablecoins as eMoney

Fiat-backed stablecoins, such as USDC, are similar to eMoney. A US dollar coin (USDC) token is – according to it’s issuer (Circle) and attestations by Grant Thornton – backed by $1 of cash deposits (or US treasury bonds) at a fully regulated bank.

The eMoney game is the stablecoin game. The higher the usage Circle can get of USDC, the higher the interest earned by Circle. With US interest rates above 5%, this is a tasty business – just like the eMoney business.

Open versus Closed

eMoney is a closed system. If I set up an eMoney business tomorrow, typically the eMoney I issue can only be transferred between my customers. I keep track of and control all transfers. I would have to verify all account owners.

By contrast, stablecoins typically operate in an open system. Stablecoins move on open blockchains like Ethereum (think open access payment network, or database). Circle does not control how the network operates. Circle does not have the ability to verify the owner of every address (think “account”) holding USDC. As with eMoney, Circle can (via a blacklisting function) block the funds held within a user’s account.

A key benefit to the open system of stablecoins is that the payment networks themselves are not typically controlled by the stablecoin issuer. The networks can be used by anyone, and software developers don’t need permission to develop applications. Just as eMoney lowered the barrier of every fintech company needing to be a fully regulated bank, stablecoins on open payment networks can open up payment networks to new ideas, companies and competition.

Closed payment networks like eMoney have historically provided a way (although imperfect) to track crime and money laundering. Open networks take a different approach.

For the moment, open networks are pretty good for tracking and limiting money-laundering (perhaps better than traditional banking?) because all transactions are public. This will change over time because it doesn’t make sense for individuals and businesses to have all of their operations open to the public. If you roll forward to open-access payment networks being private, then you need to think about how to trace crime. One potential solution this involves zero knowledge proofs, where users can prove that the origin of their funds is clean – without revealing sensitive information. I’ll maybe write a blog on zero knowledge proofs later.

Regulating Stablecoins (mostly) like eMoney

Broadly, if a company is issuing fiat-backed stablecoins, it makes sense to apply similar rules to eMoney. This is largely what is happening in the EU. There are at least two contentions points – and I’ll give my opinion:

  1. Should stablecoins be allowed on open-access networks? Or, should a stablecoin issuer have to track the identity of every sender and receiver (and, if so, how?). The justified concern here is crime. Public blockchains are straightforward to trace (perhaps easier than eMoney), so I don’t think this is a big concern. The benefits of innovation greatly outweigh the downsides. For private blockchains, the risks are higher, and the approach needs to be different. Technology is evolving quickly, so I think regulators should be careful about being too prescriptive.

  2. Will the Eurozone get more dollarized? There’s a concern that access to US stablecoins will weaken the Euro. Today, 99%+ of stablecoins are dollar-backed. This is higher than the already high percentage of world trade that is done in dollars. However, eMoney and international accounts are already dollarising the Eurozone. Most people in Europe has easy access to dollars in their Wise or Revolut account! The question of the Euro’s strength comes down to fundamental questions of European economic strength and growth. It’s easier said than done, but we need to keep pushing for innovation and economic development in Europe that brings each citizen along. That’s the fundamental solution. I am skeptical (although not adamant) that blocking dollar stablecoins access can reduce threats to the Euro’s strength.

Allow eMoney and stablecoin issuers to pay interest up to the central bank rate

This would a) allow customers to earn more interest (particularly when rates are higher) and b) create more competition for banks from eMoney and stablecoin issuers. By capping interest rates to the central bank rate (perhaps plus some buffer), this would limit short-term schemes with ponzi attributes.

In such a scenario, I would expect eMoney/stablecoin institutions to behave a little like banks do now. They may be slow to increase interest rates as central bank rates rise (but quick to drop when rates drop). That said, in an open system, there would be more competition. I wouldn’t be surprised if some eMoney/stablecoin institutions commit to varying their interest payouts to some high percentage of what is set by the central bank.

Open systems are very competitive. If interest payments aren’t allowed on eMoney/stablecoins, companies will find ways to pay out that interest in other ways (e.g. via sign-up rewards or membership rewards or “cash-back”). It becomes an obtuse system.

Better to have a straightforward and transparent system allowing regulated interest payments up to the central bank rate. Even better to have open-access payment networks and privacy-protecting tools that detect and deter crime.

*Certain eMoney institutions go on to become fully regulated banks, such as what Revolut has done.

I’m founder CEO at . Trelis does not issue any stablecoins or eMoney or custody funds for any third parties. Trelis does provide software tools – starting with automated recurring crypto subscriptions – for merchants accepting payments over open-access payment networks like Ethereum. A full list of my personal financial holdings and disclosures are here.

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