guest FUTURIST Trend, economics

MONEY Smart Banknotes A proposal for bank notes that bridge the gap between physical and electronic money.

By Ignacio Mas

text: Cash imposes large costs on society, yet it is hard to envision moving to an entirely cashless society. If we cannot get rid of cash, then we need to change it in a way that makes it less costly for all to handle. A new kind of “smart banknote” could be created that can be activated or deactivated electronically; you would transfer value between a banknote and your bank account, right from your mobile handset. Deactivated cash could be transported cheaply; stores could make their accumulated cash balances vanish at will by simply deactivating it; and bank customers would be able to convert their bank account into cash or vice versa anywhere, anytime. With these new smart banknotes, mobile banking could flourish in developing countries without requiring complex and costly cash agent networks. In this fashion, the mobile handset can truly integrate the capabilities of an Internet banking terminal and an ATM. A large portion of the population depends on cash as a form of saving and as a means of exchange, but there are three big problems with it:

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Electronic copy available at: http://ssrn.com/abstract=1687368

• Cash is not easily used for remote payments, such as sending money to your college kid in another state. • It is difficult for people to hang on to small cash balances beyond pure pocket money. As a store of value, physical cash creates problems of self-discipline and security. • It is unsafe to transport and travel with cash. Cash handling also imposes a large cost on banks, and this high cost critically constrains the ability of banks to increase the capillarity of their distribution networks (through branches or ATMs). Banks transfer the cost onto customers by requiring them to travel to more distant cash aggregation centers. This may not be much of a problem in developed countries where banks have deployed a dense network of branches and ATMs to cater to their customers’ cash needs, but this infrastructure is largely lacking in slums and rural areas in developing countries. Despite these problems, cash has benefits that electronic money cannot deliver: It is universally accepted. Transactions are quick. The bills are of fixed denomination (unlike payment cards, which are linked to variable account values), making them very useful for limiting the amount of money you risk spending (or losing) when you take a trip to the casino, for instance, or out on a late-night jog. And of course cash can be used anonymously, while electronic payments always leave a trail. The advantages of electronic money are virtually the flip side of the advantages of cash: E-money consists of storable and readable information, and its transactions are transparent and traceable. While electronic money will inexorably displace cash, electronic money and cash will need to coexist at least into the medium term. That’s

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Electronic copy available at: http://ssrn.com/abstract=1687368

particularly true in developing countries, where there is a tiny installed base of acceptance devices. If we can’t get rid of cash, then we need to change it in a way that makes it less costly for all. It is figuring out the interface between these two forms of money—cashing into and cashing out of electronic money—that will be the key.

Bridging the Gap between Cash and Cashless Systems Imagine a new generation of bills embedded with a radio-enabled chip that could communicate at close range with a mobile phone or a point-of-sale (POS) device. The chip could essentially turn the bill “on” or “off,” and that bill’s state would somehow be visible to the user (e.g., its color might disappear when the bill is “off” and reappear in full splendor when it is “on”). Cash could then be transported at low cost in its deactivated form. In order to be used, bills would need to be “activated” by electronically transferring value to them from a bank account. Users could do that by passing their bills over their radio-equipped mobile phone or at an enabled POS terminal, and agreeing to a transfer of value from their bank account to the bill. Like any debit transaction, this would be authorized and recorded in real time by the user’s bank. The process could also be reversed: Bills could be deactivated by having their value transferred back (i.e., credited) to their bank account. There would be a security protocol ensuring that, when one source of value is credited (e.g., activating my cash bill), another one must be debited (e.g., my bank account). In this fashion, the mobile phone truly becomes an ATM. People would be able to instantly deposit money into their accounts and create immediate liquidity from their bank accounts, without requiring any

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banking infrastructure in their neighborhood. Bills would be like prepaid cards that have value loaded and expended, but unlike prepaid cards they would remain of a fixed denomination. In their active state, they would be tradable without requiring a card reader. In their deactivated state, they could be distributed very cheaply, and stacks of deactivated bills could be purchased for pennies at the supermarket. With these “smart banknotes,” monetary authorities could reduce the security costs of producing and distributing cash because it could be handled in its deactivated form through normal distribution channels. The chip would offer a higher level of security on the bills, as it would be able to hold an encrypted unique serial number. The validity of bills could be established unequivocally in real time. Implementing this scheme would require central banks to issue these new smart banknotes. There is a long tradition of embedding new technology into bills, such as anti-counterfeiting holograms, so this scheme would fit in the natural evolution of physical currency. The issuance of new bills can also be gradual; new and old bills could coexist. Security standards will be needed to ensure that activation or deactivation of the smart banknotes would be through authorized devices and authorized accounts. In addition, the scheme would require a deployed base of cash-activating devices (mobile phones or POS terminals), with real-time connectivity to banks for banking transactions, RFID capabilities to interact with cash bills, and loaded with the bill management application. So far, all attempts to eradicate cash by replacing it with electronic forms of money have failed. People don’t want to entirely let go of the physicality of cash. Moving toward the much-vaunted cashless society is often invoked as a social-engineering task. While

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technology can be an instrument to change society, it seems unreasonable to change society so that we can adopt technology. So let’s change our banknotes instead. In fact, this scheme is in the historical tradition of issuing pieces of metal as coins by the act of stamping a wedge (Latin: cuneus, from which the word “coin” is derived) on them. The wedge “activated” them in the sense of certifying their value.

Ignacio Mas is deputy director in the Financial Services for the Poor team at the Bill & Melinda Gates Foundation, www.gatesfoundation.org. The author would like to thank Paul Makin and Andrew Whitcombe of Consult Hyperion for their work in assessing the technical feasibility of the smart banknotes described here. They in fact came up with the term smart banknote.

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