Are Argentinians paying for Uber rides with bitcoins?

Earlier this month the following tweet elbowed its way onto my Twitter timeline:

The tweet comes from Anthony Pompliano, aka Pomp, who works at Morgan Creek Digital Asset where he runs a cryptocurrency fund.

So, have I been wrong all along about bitcoin? As anyone who has been reading me for a while will know, I've been skeptical of the bitcoin-as-money story. Rather than fulfilling Satoshi Nakamoto's vision as being a next generation medium of exchange, bitcoin has gone mainstream as a new type of gambling technology—an exciting decentralized zero-sum financial game. This is a somewhat useful role, but let's face it, it's not quite as revolutionary as digital cash.

But if Argentinians are indeed hailing rides and paying drivers directly with bitcoins, as Pompliano seems to be saying, then maybe I've been too quick to dismiss the bitcoin-as-money scenario. Paying for stuff is exactly what Satoshi Nakamoto intended bitcoin to do, right? So I dug further into the tweet.

Twitter: Couldn't find anything in the news about this. Anyone got a solid source?
Pomp: https://cointelegraph.com/news/uber-switches-to-bitcoin-in-argentina-after-govt-blocks-uber-credit-cards
Twitter: Pomp that was 2 years ago
Pomp: Does that make it less important?

And that's how Pomp left things. So it looks like I've got some work to do.

Here's the fine print. In 2016, the City of Buenos Aires ordered the major credit card companies to block Uber's App. Stanford Law School's WILmap project has a detailed post on this. So Argentinians suddenly found that while their MasterCard and Visa cards worked for everything else, they could no longer be used to get an Uber ride.

Contra Pompliano, Uber did not respond by allowing users to purchase rides with bitcoin. Rather, the company pointed out that anyone who had a certain type of pre-paid debit card could sneak by the Uber embargo.

To carry out the hack, the first thing that an Argentinian had to do was to apply for a prepaid debit card from any of Entropay, EcoPayz, Payoneer, or ZapZap. These are non-Argentinean payments companies. Entropay, for instance, is based in Europe and issues Visa-branded debit cards in partnership with a Malta-based bank, Bank of Valletta. Once Entropay had approved an Argentinean for an account, either a physical debit card would be sent by mail to the applicant's address in Argentina or a virtual card would be instantly created. An Argentinean could then log on to Entropay's website and use their local credit card, the same one that had had been neutered by the Uber embargo, to top up the Entropay prepaid debit card. With the debit card now funded, it could be used locally to pay for Uber rides.

Under the hood, prepaid cards issued by Entropay are really just regular Visa cards. So when an Uber ride was requested in Buenos Aires, an Entropay card would have used the same Visa rails that a regular Argentinean credit card used. Why would an Entropay Visa card be accepted but a regular Visa card denied?

The nub seems to be this: the ban seems to only have applied to payments instigated by domestically-issued cards. When payments to Uber originated from Entropay or any of the cards listed above, they were earmarked as originating internationally, in Entropay's case probably from Malta-based Bank of Valetta, and so Entropay payments were able to squeak by. Voila, by swapping domestic cards with international ones, Argentinians could avoid the blockade.

A number of bitcoin debit cards also enabled the hack, including Xapo and Satoshi Tango. Maybe this is what Pomp is referring to in his tweet. But it would be wrong to say that these cards allowed Argentinians to "purchase rides with Bitcoin," as he claims.

Prior to paying for an Uber ride, an Argentinian had to load U.S. dollars onto the bitcoin debit card by selling bitcoins for dollars on a bitcoin exchange. Either the card owner did this manually, or the card provider rapidly sold bitcoin in the very same instant that the payment was requested. In either case, bitcoins weren't flowing from the card holder to Uber. A fiat currency had been pre-loaded onto the card, and everything after that was just a  regular transfer over the Visa or MasterCard network.

These bitcoin debit cards are really no different from gold-based debit cards. Nor are they any different from the cheque-writing and debit card privileges provided by some U.S. money market mutual funds. Neither bitcoins nor gold not mutual fund units are being transferred from the card holder to the seller. Rather, each item is being quickly sold and turned into fiat, then processed along the same rails as any other payment.

In theory, all sorts of assets might be debit card-ized in this way. Buy a coffee with your Facebook debit card, for instance, and underneath the transaction's hood your Facebook share(s) are being quickly sold on the stock market for dollars, those dollars being the medium that ultimately settles the payment between you and the cafe. Complicating matters is that Facebook shares, which trade at $165, can't be cut into fractions, unlike bitcoins or fractions of a gold bar, so paying for a $3 coffee might get a bit awkward.

So returning to the tweet, recall that Pomp proclaimed that "more companies will begin using Bitcoin to fight back against corruption." But this wasn't the case with Uber. As you can see from the above, the company fought back by pointing to a neat hack of the existing credit card networks. The reason that Xapo and Satoshi Tango bitcoin cards were able to enable Uber purchases in Argentina wasn't because of their unique bitcoin nature. In Xapo's case, the card was issued by Wave Crest Holdings, a Gibraltar-based company. Like a regular fiat-based Entropay card, the incoming Xapo card payment was classified as an international one, and thus it escaped the domestic blockade.

Most bitcoin debit cards are no longer functional. Wave Crest, the card provider through which most bitcoin firms partnered, was suspended by Visa for non-compliance with Visa's rules in early 2018. If you go to VoyEnUber.com, an independent Argentinean website that reports on Uber, you'll see that it has delisted Xapo and Satoshi Tango from its list of ways to pay for Uber. The non-bitcoin prepaid debit cards are still there. So Pomp's tweet is twice wrong: 1) not only were Argentinians not using bitcoin to pay for Uber rides in 2016, but; 2) by the time of his tweet, they are not even making Xapo card payments, since Visa has cut that option off.

In addition to using foreign cards to pay for Uber rides, it seems that people in Buenos Aires are also paying with cash. According to the article, when riders pay with banknotes, there is no way for Uber to collect its 25% commission, so driver's are increasingly indebting themselves to the company. Or put differently, drivers are accepting cash, then paying Uber with a personal IOU. The irony here is that a combination of old fashioned fiat banknotes and trust-based IOUs—not bitcoin—are being used to "fight back against corruption."

So be careful what you read, folks. This sort of reminds me of the Zimbabwe bitcoin story from last year, which was seen as a crystallization of the long-held dream that bitcoin would help unbanked Africans. I rebutted that particular myth here.

Pompliano seems like a nice guy, so I'll just assume that excitement got the best of him. I normally try to avoid someone is wrong on the internet posts, but since he has over a 100,000 followers on twitter, and this particular meme has been retweeted over 2,000 times, I feel like it's my duty to try undo some of his error. The good thing with twitter is you can untweet retweets, feel free to go ahead and do that right now. :)

Did Brexit break the banknote?

Nations never experience year-over-year declines in cash in circulation. Sweden (which I wrote about here, here, and here) is one of the rare exceptions. India is another, but this was due to its notorious botched demonetization attempt (which I wrote about here, here, here, and here). But now the UK seems to be joining this small group of outliers.

Why does a nation's cash in circulation generally grow consistently from one year to the next? While economies do experience the odd recession, in general they are always improving. Improving economies coincide with more demand to make transactions, and for this the public needs to have greater amounts of cash on hand. There is a counter-cyclical element to cash holdings. When recessions occur, people often turn to unofficial sectors of the economy to make a living, and this often requires cash. The last explanation for the steady growth in cash outstanding is inflation. Let's assume an inflation rate of 10%. Someone who generally hold $10 worth of purchasing power in their wallet in 2018 will have to hold $11 in 2019 if they want their situation to stay the same. To meet that demand, the central bank has to print more banknotes.

All of this is why the UK's recent flirtation with decashification is so strange. Below is a chart showing the year-to-year change in British paper currency in circulation:

For eight months now, since February 2018, the stock of Bank of England banknotes has been registering below the previous year's count, a phenomenon that Britain has never seen (at least not since the start of the data series I found).

One potential explanation for the recent bout of decashification is increased debit and credit card usage. I am not entirely convinced by this argument. People's transactional habits are notoriously slow to change. When the inevitable card-induced decline in cash does occur, it won't suddenly occur in the space of eight or nine months, but will take place over an extended multi-year period. As in the UK, card usage in Canada is ubiquitous, yet we haven't seen the same sort of effect on the stock of cash. Something unique seems to be occurring in the UK.

The UK has been switching to polymer notes recently, the new £10 being introduced in 2017 and the £5 in 2016. Old paper versions can no longer be spent. The £20 is slated for a switch in 2020. Perhaps this is creating havoc with people's money holding patterns? I suppose it's possible, but here in Canada we went through the whole polymerization process without a hiccup. (See chart here). So I don't see why the UK would experience any sort of discontinuities during its own changeover.

The answer can only have something to do with Brexit. One possibility is that Brexit has reduced immigrant inflows and encouraged outflows, and immigrants are large users of cash. Ipso facto, cash-in-circulation has declined. The problem with this explanation is you'd need really large changes in migrations flows to see that sort of pattern in cash demand, and I am skeptical we're seeing that sort of upheaval.

Another Brexit-based explanation is that Brexit has broken the banknote. British banknotes have suffered a massive credibility shock. All those paper pounds hoarded away under Brits' mattresses, or in criminal vaults, or in foreign pockets, are just not as trustworthy as they were before. So they are being quickly spent or exchanged for other paper, say euros. Eventually these unwanted notes are resurfacing back in the UK where the Bank of England is forced to suck them back up and destroy them.This paints a particularly dour picture. It says that the Bank of England's seigniorage revenues have been permanently damaged, the short-fall having to be made up by the British taxpayer. It makes one worry about potential long-term damages to the Bank's ability to effect an independent monetary policy.

Having had some time to think about this, I think I've got a better story. The changes are indeed Brexit-induced. But the big decline we've seen over the last year isn't a sign of distrust in paper pounds. Rather, it's a reversion to trend. More specifically, the decline in cash-in-circulation so far this year is actually the unwinding of an unusual surge in cash-in-circulation that began in early 2016. Check out the chart below:

Beginning in 2016, as the political competition in the leadup to the Brexit vote intensified, banknotes-in-circulation suddenly started to rise relative to long-term trend line growth (black line). This was the fastest rate at which banknotes in circulation had increased since the 2008 credit crisis. The Bank of England's blog, Bank Underground, commented on the surge in banknote demand back in 2016.

The sudden demand to hold more cash continued through the June 23, 2016 vote into early 2017. I suspect that this was a symptom of an underlying uncertainty shock spreading through the UK economy. Brits were growing increasingly worried about the effects of Brexit. Perhaps they wanted to hold fewer deposits, or have less exposure to assets like stocks and real estate. Cash is a coping mechanism. In uncertain times it one of the few assets that offers the combination of short-term price certainty and the ability to be mobilized in an instant.

This chart from the Bank of England shows that the demand for the the £50 note (pink line) was particularly marked in 2016:

Source: Bank of England

But by mid to late-2017, Brexit-related uncertainty began to subside, and cash began to be redeposited into the banking system. UK cash usage has now returned to the long-term trendline growth rate. Going forward, I'd expect the year-to-year change in cash outstanding to return to its habitual 5%-ish per year. That is, absent more Brexit-induced panics.

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For much of this post, I am indebted to this great round of conversation on Twitter:

That's odd. For most of 2018, there has been no year-over-year growth in the quantity of UK banknotes in circulation. Going back to 1998, this sort of sustained lull in cash demand has never happened. What's going on? Less crime? pic.twitter.com/PXv53oB4E7

— JP Koning (@jp_koning) July 18, 2018

"The Narrow Bank"

 A strange new bank called TNB, or The Narrow Bank, recently applied to get a clearing account at the Federal Reserve Bank of New York, only to be refused. Funny enough, TNB is run by the New York Fed's former director of research James McAndrews, who left in 2016 in order to get the bank up and running. McAndrews and TNB are now suing the New York Fed.

There's a backstory to all of this kerfuffle. While still employed by the New York Fed, McAndrews coauthored a paper in 2015 entitled Segregated Balance Accounts. The paper proposed a solution to the following problem. Interest rates in wholesale lending markets were refusing to align with each other. Wholesale markets are the sorts of markets which neither you nor I have access to but are reserved for large institutions. For some reason, banks that kept interest-bearing overnight accounts at the Fed were not passing the rate they earned on these accounts to other overnight lending markets in which they were active, say the repo market or the federal funds market. The fed funds rate, for instance, tended to always be 0.2% or 0.3% below the interest rate the Fed paid to depositors.

Why wasn't this gap being arbitraged? After all, if a bank can deposit funds at the Fed and earn 1.95% overnight, then by borrowing in the fed funds market at, say, 1.85%, and putting the proceeds in its Fed account, said bank can earn a risk free return 0.1%. The ensuing competition to profit from this arbitrage should drive the fed funds rate within a hairline of the rate paid by the Fed to depositors. But the massive 0.2-0.3% gap implied that this trade was not being made. 

McAndrews and his co-authors posited that the fed funds market was crippled by a lack of competition. Specifically, there seemed to be a limited number of credible borrowers willing & able to wade into the fed funds market to conduct the trade. This group of borrowers was too small to absorb the funds of all the institutions that were shopping around to lend in the fed funds market. For the most part these lenders did not qualify to get interest from the Fed and were confined to buying fed funds. Thus the small group of borrowers operating in this market exercised a degree of bargaining power over the lenders, allowing them to extract artificially low borrowing rates.

The idea behind the paper was to have the Fed fix these rate distortions by re-introducing competition among borrowers in overnight wholesale lending markets. In short, all those banks that were not considered sound enough to qualify as fed funds borrowers would be able to partner with the Fed to offer risk-free accounts. Specifically, these banks would be able to go to a wary lender and say, "hey, if you lend to us we'll keep your funds hived off from all of our other assets by just depositing them directly at the Fed."

To sanctify this promise, the Fed would create a new type of account, a segregated balance account, or SBA. Once a customer had deposited funds at the the borrowing bank, the bank would transfer these funds into an SBA at the Fed. If the borrowing bank went bust, the swarm of creditors pursuing the bank's assets would not be able to touch the funds locked into its Fed SBAs. The bank itself could not use the funds in an SBA for any other purpose than paying back its customer. By hiving off a wary customers' funds, a risky bank could emulate a Fed account and re-enter wholesale lending markets.

The interest that the bank earned on SBAs would be passed-through to its customer, less a small fee incurred by the bank for providing the service. So if the Fed was paying 1.95% on deposits, the bank might be able to offer 1.90%, thus keeping 0.05% for itself. And since borrowers in the fed funds market were only offering 1.75%, say, then lenders would would avoid them, preferring to invest their funds at banks that offered an SBA solution. To compete, a borrower in the fed funds market would have to offer at least 1.90% themselves. Thus the various wholesale interest rates would be in better alignment.

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Maybe upper level Fed officials took McAndrews aside and said, hey James, we're not going to implement this idea. And he thought to himself, but this is a good idea, why don't I run with it by setting up a private bank. I'm not sure, but whatever the case McAndrews quit the Fed and co-founded The Narrow Bank in what seems to be an effort to implement a market-provided version of SBAs.

TNB is a designed as a pure warehousing bank. It does not make loans to businesses or write mortgages. All it is designed to do is accept funds from depositors and pass these funds directly through to the Fed by redepositing them in its Fed master account. The Fed pays interest on these funds, which flow through TNB back to the original depositors, less a fee for TNB. Interestingly, TNB hasn't bothered to get insurance from the Federal Deposit Insurance Corporation (FDIC). The premiums it would have to pay would add extra costs to its lean business model. Any depositor who understands TNB's model wouldn't care much anyways if the deposits are uninsured, since a deposit at the Fed is perfectly safe.

In theory, TNB (and any potential copycat) should fix the competition problem that McAndrews and his coauthors alluded to in their Segregated Balance Accounts paper. Presumably all those lenders in the fed funds market that can't find suitably sound borrowers, and thus submit to being gouged by the only banks that qualify, will turn to TNB. After all, TNB is clean. Unlike regular banks, it doesn't partake in all of the traditional banking activities that make a bank risky, such as lending to consumers or businesses, or trading for their own accounts. TNB does one thing only, it acts as a portal to the Fed. Since TNB collects 1.95% from the Fed and has minimal costs, it should be able to pay interest of around 1.90% to its customers, who might otherwise get a paltry 1.75% from competing borrowers operating in the fed funds market. Thus the presence of TNB should remove, or at least minimize, some of the distortions in wholesale lending markets.   

But all is for nought. The Fed has refused to grant TNB a master account. John Cochrane has recently blogged about this as well as helpfully uploading the lawsuit that TNB has filed against the New York Fed. We don't know why Fed officials are dragging their heels, so all we can do is speculate. Cochrane has a few theories, including potential worries among Fed officials about controlling the size of its balance sheet.

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But even if TNB succeeds in its lawsuit, there is a larger threat. The gap the bank is trying to exploit is shrinking. Back in 2016 when McAndrews and his colleagues first embarked on the effort to build a new bank, the fed funds rate was typically 13 to 14 basis points below the rate offered by the Fed. Fourteen basis points was a lot of rope for TNB to work with. But this gap has since shrunk to just 4 basis points (see chart below). Possibly wholesale markets have become more competitive while the bank was being constructed, in which case there may no longer be much of a role for TNB to play. If TNB borrows at 1.91% and invests at 1.95%, that doesn't leave it much wiggle room to pay its fixed costs and salaries.

Even if the gap disappears, could TNB serve as more than just a conduit for engaging in arbitrage? Let's say that in the future rates have normalized. Banks now offer to lend at an overnight rate that is in-line, or even exceeds, the rate that the Fed pays to depositors. TNB no longer has a sweet deal to offer. Even then, large institutions who can't directly bank at the Fed may like the idea of keeping an account at TNB. Although they will earn slightly less then they otherwise would in competing overnight markets, the Fed is a risk-free place to park one's money, unlike say the fed funds market. These institutions could also invest in treasury bills. But even though a treasury bill would provide a higher return than parking funds at the Fed, there is always a risk that it cannot be immediately sold for its face value. Put differently, a treasury bill has duration risk. Funds held at the Fed via TNB have no duration risk. They can be withdrawn in a moment at par.

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How big might this demand be? Interestingly, TNB isn't the first of its kind. On Twitter, Karl Storvik informs me that an analog exists in Norway, the Safe Deposit Bank of Norway. SDBN is a self described "conduit" established in 2013 to provide ultra-high net worth individuals, asset managers or corporate treasurers a means to park funds at the Norges Bank, Norway's central bank.

According to the SDBN's website, its license prevents it from holding any other asset than Norges Bank deposits. The interest that the central bank pays on these deposits flow back to SDBN's customers, SDBN taking a fee for itself. This is basically TNB, Norwegian style. But as best I can tell, SDNB's function isn't to arbitrage small differences between the rate of interest that the Norges Bank pays and other overnight rates. It is trying to provide a product that is in and of itself useful to folks like high net worth individuals and corporations.

From a glance at its most recent balance sheet, I'd say that The Safe Deposit Bank of Norway hasn't been terribly successful. Sure, it is still in start-up phase, but as of the end of 2017 it had only NOK 53 million on deposit at the Norges Bank, or a piddling US$6.3 million. Assuming TNB gets Fed approval, one wonders if this wouldn't be its fate as well.

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Matt Levine has an interesting take on the whole thing. What if TNB were to allow regular folks like you and me to open an account? The overhead involved in serving a retail customer base would be higher than if TNB served a purely institutional clientele, notes Levine: "you’d need at least a website, a customer service department, ATM cards—but the opportunity is intriguing." But unlike a regular bank it wouldn't need to hire loan evaluators or absorb credit losses. So TNB might be able to provide many of the same payments capabilities as a regular bank (debit card payments, ACH payments, and wire transfers), but pass through a larger share of central bank interest payments to depositors.

If it went this route, TNB wouldn't be the first financial institution to operate as a narrow bank, i.e. to swear off lending in order to focus solely on satisfying the public's payments requirements. This is exactly what mobile money platforms like M-Pesa do. Mobile money providers accept incoming customer funds, park this money in trust at a bank, and issue 100%-backed liquid IOUs to the customer. These IOUs can be used to buy stuff at retailers or exchanged with other users on a person-to-person basis. Unfortunately, liquid deposits held in trust at the commercial bank don't yield much interest, so even if a mobile money operator wanted to flow some interest through to its customers it wouldn't have much to draw on.

The novelty introduced by a retail-facing TNB is that the customer's funds would be parked directly at the central bank instead of an intervening commercial bank. So central bank interest payments could flow straight to the narrow bank rather than being sucked up by an intermediary. And so it would be possible, in theory at least, for TNB to offer retail depositors not only a useful payments option but also a financially meaningful flow of interest.

That seems like a decent financial innovation, no? For instance, the Bank of Canada currently pays 1.25% to banks that have clearing accounts, while I make a meagre 0.15% on my no-fee chequing account. If a Canadian version of TNB could offer me a 1% interest rate on an absolutely-no-frills account with a debit card attached to it, I'd definitely consider it. If James McAndrews and TNB get rebuffed by the Fed, maybe they should come up here and try the Bank of Canada.

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P.S. By coincidence, I recently wrote about some of James McAndrews work on financial privacy at the Sound Money Project. And he commented on my Cato Unbound proposal to introduce taxed $500 and $1000 banknotes. Small world.