Virtual Cash in My Virtual Wallet

Daniel A. Northway - EVP, Chief Financial Officer, Scott Valley Bank

by Daniel A. Northway - EVP, Chief Financial Officer, Scott Valley Bank

About a year ago, I wrote an article for this publication about the Next Big Thing in mobile payments: the “virtual wallet”.  Today, I can report that virtual wallets are still coming, still being developed and improved, and still – albeit ever so slowly – being adopted by the public.

Most of these applications work by storing your credit, debit, and loyalty card information on your Smartphone, and then processing transactions through an intermediary, usually an affiliated bank.  Application development thus far has been focused primarily on handling point-of-sale transactions, where the virtual wallet would appear to have a convenience advantage over using cash or a traditional plastic card to process a transaction.  In addition, a fair amount of development effort has been devoted to how to push coupons and ads to your mobile device, based on your transaction and location history.

There are a host of reasons why adoption has been slow: the need for Near Field Communications (NFC)-equipped readers, generally at the merchants’ expense; competing and often incompatible systems promoted by the various players in the Smartphone world (e.g., Google, Apple); customer apathy (is it really more convenient to wave your phone than swipe a card?); and, of course, concerns about privacy and security. 

Furthermore, when it comes to more complex online purchases – the kind where you browse a website, place items in a virtual shopping cart, and check out – Smartphone-based virtual wallets have not even scratched the surface.  Mobile devices are at an inherent disadvantage because few merchants have mobile-optimized websites.  Market research indicates that Smartphones are generally used for price comparison purposes when consumers shop online.  Shopping cart abandonment rates have been reported as high as 97% for transactions involving mobile devices, compared to 60% for browser-based transactions.

Some of this will be resolved by the availability of your virtual wallet in browser form, but PayPal already has a commanding lead in this area.  Google is trying to chip away at this lead with enhancements to Chrome, and Apple may be working on something similar with Passbook, but PayPal is not standing still in the mobile world and their Smartphone apps are gaining wider consumer acceptance.  

Eventually, I believe we will see a handful of big-name providers with applications that can be easily accessed across multiple devices.  Smaller developers will lead the way with innovations, but this is a tough niche for a small player.  Lemon Wallet of Palo Alto and Escardgot of Sacramento are two local examples of Davids competing with the Goliaths in this market.  It will be interesting to see how they fare in the coming years.

So, as I watch the continuing evolution of virtual wallets, my attention lately is drawn to recent developments in virtual currency.  Virtual currency takes the premise of paper currency one step further.  That is, paper currency represents value in spite of its lack of relationship to a hard asset such as gold, provided that both parties in a transaction involving paper currency agree about that value.  In modern times, it is backed by a central bank or national issuing authority.  Virtual currency dispenses with the need for a symbol such as paper, relying instead on an encrypted string of digital characters.  In addition, it is not linked to any traditional national currency or regulated by any central authority.

One party exchanges a given amount of traditional currency for a character string, sends it to another party in exchange for goods or services, and the other party converts the string back to a traditional currency.  The system still requires some intermediary to exchange your traditional currency for the character string, but the intermediaries are often decentralized and unrelated. 

You may be thinking that this does not sound too different from what PayPal or Visa or MasterCard do on a regular basis, but there is a crucial difference: there is no information gathered that identifies either party in a virtual currency transaction.  Virtual currency, therefore, has all of the benefits of an electronic payment mechanism and the anonymity of cash. 

Two relatively well-known examples of virtual currencies are Liberty Reserve and Bitcoin.  You may have read the recent news about Liberty Reserve being shut down by federal prosecutors.  They allege that Liberty Reserve was designed to help criminals conduct illegal transactions and launder the proceeds of their crimes.  It does not seem too far-fetched to me that there were indeed participants in the Liberty Reserve network who were using it to move funds out of sight of law enforcement agencies.   Whether or not Liberty Reserve was expressly created for this purpose remains to be seen. 

Bitcoin, on the other hand, does not appear to have been created for nefarious purposes, though the anonymity it affords will no doubt attract participants who formerly used Liberty Reserve.  The shutdown of Liberty Reserve was possible in large part because there was an identifiable central figure who could be arrested and funds that could be seized.  Bitcoin, by contrast, is far more decentralized – an open source currency network, if you will – with no central figure in charge and no repository of funds stored by intermediaries.  The decentralized nature of Bitcoin is going to give federal regulators headaches when it comes to enforcing Anti-Money-Laundering laws.

As a currency, Bitcoin has some fascinating features: it can be “mined” by anyone who has the time and inclination to solve certain complex mathematical puzzles; ownership is uniquely identifiable, which means it cannot be counterfeited; and it is inelastic – only a limited quantity (21 million units) can ever be created based on the algorithm used to generate the character strings.  This last feature makes Bitcoin harder than gold, at least in theory.

So far, Bitcoin represents the classic innovation and evolution trajectory that we are accustomed to seeing in the Internet Age: lots of buzz, a few early adopters, and a bunch of folks trying to figure out if they can profit from it and whether or not it can be duplicated or improved upon.  Will it pass the ultimate test of a currency, public willingness to exchange it for goods and services?  I am skeptical, but I am reminded that paper money was once a new payment technology, too.

View Look in The VAULT - Scott Valley Bank - June 2013