Case for CBDC – Market Efficiency

Given that I’m building a new Company focused on Crypto acceptance in physical assets (stealth – pilot in 3 weeks), I thought I would share some perspective on the drivers of Crypto, CBDC and Decentralized Finance (DeFi).

There are about 50,000 people that read this blog.. Glad you enjoy it.. I’m most surprised anyone can stand my writing style for that long (sorry for all the typos – no editor). 

As most of you know I love to read the arcane (ex favorite book is Weak Linksrelated blog) and I love economists. Today I’m reading some of Thomas Phillippon’s research (NYU’s economist and author of The Great Reversal: How America Gave Up on Free Markets). Many of you will recall I covered Dr. Phillppon’s work in my 2015 blog Changing Economics of Payments. My summary of Phillippon’s work:

    • Financial market efficiency is going down, with the cost of financial intermediation going up.
    • Finance is one of the few sectors in the history of man where networks have grown less efficient with scale (and data), proving the market forces are not operating.
    • There is no “one” identifiable cause .. however power is concentrating in Oligopolies and efforts to regulate seem to only further insulate established firms from new competition (see his article – Has the finance industry become less efficient? Where is Wal-Mart when we need it? – Thomas Fillippon 2011). 

Two WSJ articles prompted today’s blog. One was completely ridiculous Ban Cryptocurrency to Fight Malware (by a Duke professor that likely never used a hotwallet and could not name a single purpose for crypto). This week’s WSJ article was just fantastic Cypto Needs Regulation, but it Doesn’t Need New Rules.  Talk about alternate views.. 

Given that I’m building a new Company focused on Crypto acceptance in physical assets (stealth – pilot in 3 weeks), I thought I would share some perspective on the drivers of Crypto, CBDC and Decentralized Finance (DeFi).  


At the Macro level, modern finance is not available to a large portion of the planet. While finance is a wonderful high service for those that have money, or live in a top 10 market, it is completely broken for most of the rest of the world.  This is not to place blame in financial markets or companies alone.. As Law, consumer protections, property ownership, enforceable contracts, access to the legal system and equal treatment bear a greater share of the challenge in emerging markets (see Small Wins – 2016 and View from Pakistan).

For the US (and G7 countries) Fillipon’s research paper Rethinking Finance, clearly shows intermediation costs increasing (below).  For a short example, we need only look at bank efforts to move businesses off of check and ACH onto RTP or Card based payment schemes.  Given that the payment networks and PayPal are among my largest holdings.. I do believe this will work and continue to grow at 25%+ CAGR. I’m providing the background for the opportunity of alternate approaches to solve these same problems. 

As I’ve stated in Changing Economics of Payments, broken market forces are clearly demonstrated by the growth in card rates. 

As a stock holder one can clearly argue that the value of the card increases with growth of the network. Large merchants have negotiated down the cost of both credit and debit for both CNP and CP, with smaller merchants paying a LARGER portion of the network cost. 

Efficiency in value exchange and in commerce is of great concern. Think about it this way, retail is very competitive, Walmart’s net operating margin for 1Q21 was 2.18%. Thus Visa/MA premium reward card interchange is listed as  2.3%+ $0.10 is material to earnings.  You can see why WalMart, and other retailers, care deeply about the cost of payments. 

Retail is a very very long tail business (~30M US small businesses). The 80/20 rule in payments is that 80% of margin is created by the 20% of volume that comprises small merchants. Is it any wonder that Jack Dorsey announced Square’s intention to develop hardware terminal for crypto acceptance, or PayPal’s focus on crypto in wallet and POS? If Square and Paypal can enable crypto, their take rate will be better than an ACH funded account. 

Emerging Markets – Macro

In emerging markets we have seen China adopt 2 massive changes to payments in 15 years: China Union Pay, Alipay and soon to be Digital Yuan?  In India, while the banks successfully worked to stymie efforts by the leading MNOs to deliver MPESA like services in the mid 2000’s (see blog), the government provided 2 basic services (Aadhar and IMPS/UPI) that enabled an end run around the banks that enabled many massive successes: Tez, PayTM, ….etc. 

Key point. In Emerging Markets the demand for financial services is high. Existing banks do not want to serve underbanked. They don’t want them in their branches, and their products provide no margin to this segment. Emerging markets demonstrate the efficacy of a banking model that is integrated into something else (like Alipay and commerce). 

Real World Examples

Today, try to send $0.25 from the US to any emerging market. There are fees in sending and there are fees in receiving. I was fortunate to serve as a Director of hyperWALLET After I led Series A (now part of PayPal), their focus was disbursements across 80+ countries. Think of a small sales agent, or worker for Amazon’s Mechanical Turk, historically the beneficiary would be paid in a USD paper check. This cost them $20-$30 to deposit, took a hit of 2% on FX and also took 3+ weeks to clear. These beneficiaries were also faced with bank fees for maintaining the account. hyperWALLET brilliant CEO (MIT grad Lisa Shields) built a global settlement network that provided for local ACH and integration into just about any distribution “cash out” point that was available (think WU or MNO mobile payments). She also let beneficiaries retain balances in MCY until MSB requirements forced conversion.. Allowing beneficiaries to choose when to cash out into LCY or reuse balances to purchase in USD. 

At the other end of the spectrum, a crypto custodian transferred 1 billion USD across borders for less than $10 via Ethereum, in under 24 hours. Why would any bank advocate for this channel? Who is the economic beneficiary (of the savings over a bank rails)?  Both sender and beneficiary benefit if risk can be managed. The unbundling of risk and trust (see Trust Networks) in the transaction to specialists provides for enormous gains in efficiency. Pipes become virtually free of charge. BTW… this is the focus of my NewCo. 

Important to note that Alipay, the world’s fastest growing scheme solved the value exchange problem by embedding frictionless “free” payments within a market scheme. Think about what value could be unlocked in among the poor, or within unbanked economies. In 2009, Cap Gemini’s excellent world payment report showed that 90% of the world’s payments were done by just 10% of the population. 

This is is the case for CBDC.. a frictionless payment scheme… a structure where money itself becomes an immutable digital object that is assigned. CBDC’s within emerging economies could eliminate cost to serve, scheme networks costs and centralize the solution for consumer rights and contract enforceability. The requirement? KYC and a digital identity that can be assigned to a person. 


Let me be clear…. As I wrote in Digital Dollar: The Biggest Threat to USD Hegemony I see no financial case for established players to support a CBDC. Market forces are working in their favor (ie not working at all).  However there is a very very strong case for Central Bank support, particularly around the underbanked and also in enabling market forces to act on banks. For example, the Bahamian Sand Dollar enables the Bahamas to avoid costs associated with US payment schemes and creates an efficient “on us” domestic network where money can never be lost or counterfeited.  

Whereas non-asset backed crypto (ie Bitcoin, Dogecoin, …) is known for anonymity and a speculative investment vehicle, asset backed stablecoins are known for strong KYC and efficiency of exchange. The driver of Facebook’s effort in Libra (now Diem) was not to create a new payment system to disintermediate banks, but rather an efficient set of rails for value exchange among its 2B+ users (think WhatsApp). As I stated in my Libra/Diem Blog,

There is more than one flavor of a CBDC model.. At one extreme the Central Bank takes a direct role in the issuing and KYC of every unit.. In another model the central bank delegates the issuing/KYC role to member banks, and keeps the centralized function of permissioning banks, maintaining the ledger and permissioning the transactions. Which model is right?  No one knows..  Much depends on the KYC infrastructure within a given market.

Within the US I see B2B large value transactions going this way (among trusted parties) and small value transactions (moving in Diem).  Is this a threat to V/MA or PayPal? No way… not in next 5 yrs.  Can the networks play here?  Only to co-opt..  Their PR around this is just plain silly. In the Bahamas.. Mastercard’s innovation was to tie a Plastic card to CBDC “wallet”.  This defeats the purpose.. no?

De Centralized Finance (DeFi)

I’ll leave the definition of DeFi to investopedia (please read). For those unacquainted with the term, I would summarize as the services, technology and processes to deliver financial services without traditional bank involvement.  Where as banks and markets operate on a hub and spoke model, decentralized systems operate in a distributed model typically based upon blockchain or some other distributed ledger technology with trusted agents. 

This all sounds great.. But problems in DeFi abound.. Mature markets have developed systems to manage trust, risk and settlement between accredited parties.  While technically feasible, the ability to enforce a contract with a known, accredited and insured counterparty is not that simple. Logically, the first uses of DeFi will likely be established entities using the TOOLS of DeFi to eliminate un-necessary counterparties. For example, in the $1B transfer above.. B2B transactions would be most likely to move to this structure between established businesses and supply chains. 

Investor Take Aways

  • Margins in Financial Services are improving
  • Established Payment Networks are growing in scale and in margin with few competitive pressures. Neither CBDC nor Crypto prevents near term threat.
  • Most likely flows to “go crypto” in OECD 20 will be high value B2B and low value payments. 
  • Watch Square and Paypal for Crypto acceptance, particularly interested in how these companies could assist Diem/Stablecoin. 
  • Emerging Markets are most likely to drive CBDC adoption due to central bank desire to  serve unbanked, ability to cut out US dominated schemes, and the added efficiency of the sponsoring Central Bank. Watch the Bahamas project. 
  • China is leading large market innovator. Their development of CBDC could drastically change B2B flows and impact USD trade standards. 
  • DeFi is interesting.. But will be focused in edge cases and B2B for next 3-5 yrs
  • Crypto Acceptance will be successful in markets with trusted CBDC or with trusted merchant service provider (Alipay/Square/PayPal). 

5 thoughts on “Case for CBDC – Market Efficiency”

  1. Rumblings that Paypal and likely Square are creating their own stablecoins for transactions among its users/merchants. Seems more likely to succeed than Diem which has zero acceptance right now from anyone?? Why are you so bullish on diem

    1. I know the Diem team, and from my discussions with them they will initially focus on P2P cross border funds transfer. Merchant acceptance is still far down the road.

      1. When they were based in Switzerland I believe that was the case.. now that they have given up on their European charter and gone back to the US, I’m wondering if P2P is still the focus.

        Assuming it is.. then there is an opportunity for PayPal/Square to follow a “Libra Road” in developing a stablecoin for use in commerce. The commerce road is so much easier..

  2. Great article. I do wonder how much of the reported inefficiency of finance stems from inaccurate measurement of GDP contribution. Financial sector output is notoriously difficult to estimate (or even define – like are compliance costs an input or an output). It just seems hard to believe that with all the investments in on-line banking, real-time credit scoring and faster payments over recent years there hasn’t been some productivity improvement.

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