It may have become a cliché, but in this case familiarity ought not breed contempt. Digitization is indeed reshaping society — and matters financial are no exception. So far, the private sector is driving the change: specialized payment providers in China (Alipay, WeChat), Kenya (M-Pesa) and India (PayTM) each offer e-money in specific geographic regions. However, private digital currencies, cryptocurrencies like bitcoin, and “stablecoins” like Tether that are tied in value to conventional assets, have yet to make a dent in mainstream payments.

This could change quickly with the deeper involvement of leading card networks, banks and technology giants. Leveraging their existing platforms and networks could allow these companies to capture a relatively large part of the payment activities. Visa, the world’s largest electronic-payment network, has filed a patent application for a “digital fiat currency.” In contrast, banks, including Signature Bank and Chase, have launched their own digital currencies (token-based Signet and JPMCoin, respectively) and focus on business-to-business payments. Wells Fargo Digital Cash will support cross-border payments. And Facebook is moving forward with a less ambitious version of the much-ballyhooed Libra currency that focuses on creating a more traditional payment network tied to traditional local currencies.

The public sector is in on the game, too. In April 2020, China became the first major economy to pilot a digital currency, while the Bank of England has published the design principles for a similar approach. Overall, central banks are now expressing a keen interest in the topic, and more than 70 percent are engaged in Central Bank Digital Currency (CBDC)-related work.

The multiplication of private digital currencies and the potential for CBDC make all too clear the necessity of creating a global framework. More specifically, it shows the need for regulation to ensure that all these initiatives promote financial inclusion, security and consumer protection, efficiency in domestic and cross-border payments and broad resilience of the payments landscape.

So far, regulations are largely uncoordinated. They are specific to countries and focus on extending existing regulatory models to potential forms of CBDCs, on regulating private cryptocurrencies and on regulating fast payment systems. Most ignore the reality that, in the end, the new money instruments may not be compatible with legacy financial regulations. Indeed, technological innovation challenges current practices and existing legal and regulatory jurisdictions — both geographic or sectoral.

To avoid costly, unnecessary regulation, as well as arbitrage across regulatory jurisdictions in search of the friendliest clime, an international network of regulators such as the G20 needs to play a decisive role in shaping development. This would also help to ensure that the new currencies contribute to global economic growth and financial inclusion.

Setting the Standard: Interoperability and Transparency

Transparency. The creation of bitcoin in 2008 came at a time when the level of trust in both governments and banks was low. Bitcoin’s goal, to shift the issues of trust from financial markets and states to algorithms and encryption software, was only partially realized. Yet Bitcoin does provide an excellent illustration of why a digital currency needs to convince its users of the integrity of its design and overall architecture. This is true whether the digital currency is from a decentralized system or a centralized one overseen by a government or private market-maker.

A distributed network, such as bitcoin, has to synchronize, validate and record token transactions in a replicated database. Such a system includes incentive mechanisms — consensus protocols — to ensure that the group of connected computers agree on the transactions that it is recording. (The best known example in cryptocurrencies is “proof of work,” which is also known as bitcoin mining.)

These consensus protocols are necessary due to the decentralized nature of the cryptocurrency networks: the entities owning the servers that participate in the network need not be trustworthy keepers of the data. A centralized system, such as a CBDC, faces a different problem. Because the set of activities will go beyond the trusted current mechanism, everyone needs to know the CBDC platform’s design and architecture to create an appropriate level of acceptance in the platform’s integrity.

Thus, the central bank must be clear about the activities and capabilities of each participant in the system. It will have to share the code used to disclose the CBDC functions and the responsibilities and liabilities of key actors. The trust in the CBDC will come from the ability of all stakeholders to assess the computer code, to check if it functions as disclosed, to look for bugs and to test its resilience to hacks. Stakeholders need to trust the code in order to trust the CBDC.

Transparency is hardly a new concept in financial services regulation. Indeed, transparency and disclosure by regulated entities is a core element of such regulation. The same logic should apply to all digital currencies.

Interoperability. The digitalization of the economy could lead to a more segmented world as each technological platform may have an incentive to develop its own self-sustainable ecosystem. Yet the public benefits of digital currencies won’t be maximized unless users who hold an account in one financial institution are able to send and receive money across these ecosystems rapidly and cheaply. In other words, a digital currency has to be multi-functional and multi-platform.

Unlike physical cash, whose interoperability declines outside of its domestic context, digital money can have excellent interoperability across systems. Credit cards help illustrate some of the expected benefits. They allow a card holder to spend money in multiple countries (because the credit card company and banks convert to the appropriate fiat currency) and online. In contrast, cash is mostly limited to domestic transactions.

It is highly likely that the future digital world will be a collection of disparate platforms. Indeed, the success of any digital currency, private or public, will depend on its broad usage across these platforms. Furthermore, and especially for CBDC, interoperability with existing and future systems is critical to ensure its adoption and longevity. Finally, a digital currency designed to function universally will have a significant role in commerce: by working almost everywhere, it will create a simple store of value and facilitate fast, efficient and immediate payments.

Putting the Pieces Together

Because there will almost certainly be more than one digital currency, the requirements for the design of a digital currency need to be standardized and implemented very broadly — which in turn demands a global regulatory framework. Such an internationally coordinated effort is really the only practical way to deal with the disconnect between geographic regulatory jurisdictions and coverage of the digital platforms that expand beyond countries’ borders. Time is of the essence. The increasing cross-border use of digital currencies and the growing presence of non-financial companies providing financial services will very soon render the current regulatory and monitoring framework used to assess financial stability obsolete.

The new framework should include concepts such as governance for data usage and exchange. The network of relevant authorities needs to grow beyond financial regulators to include technology-related ones. Finally, the standardized regulations, rules and practices need to consider how digitization affects countries differently. There is a clear delineation between developed and less developed countries for issues related to capital access (between financial inclusion and financial stability), to market structure (between market efficiency and antitrust) and to consumer experience (between consumer welfare and data usage).

Financial Inclusion and Financial Stability

MercadoLibre in Latin America, Alipay and WeChat in China and M-Pesa in Kenya and India are often used to illustrate how tech firms’ involvement in financial services increase financial inclusion. Large tech companies rely on their abilities to pool, process and use information across a network to provide financial services to unbanked populations. Consumers can use smartphones and free internet access to open bank accounts, pay for goods electronically and apply for loans.

But integration of tech and financial giants opens the door to a potential problem, especially in the U.S.: strategic partnerships between large tech companies and incumbent financial institutions raise concerns regarding systemic financial stability. A tech company can provide a third-party service to a financial institution, such as Capital One using Amazon Web Services, or offer a financial service through its digital platforms with a financial institution managing the back-end delivery, such as the Apple Card resulting from the partnership between Apple and Goldman Sachs. In both cases, a single disruption to the tech company could have downstream effects on the financial institutions, magnifying the risk to the broader financial system.

By the same token, a sudden loss in consumer trust in Alibaba could lead to a mass exodus of deposits, with the potential to disrupt the entire interbank funding system in China. Alibaba owns one of the world’s largest money market funds, with over $140 billion in assets under management as of June 2020.

Market Efficiency and Antitrust

A country’s needs in infrastructure (both physical and digital) drive the impact of tech companies on its market structures and regulatory focus. Regulators and international organizations have praised the efficiencies brought by tech companies, from developing the infrastructure to lower transaction costs, to improving the quality of goods and services, to increasing investment in R&D. (In China, for example, Alibaba was essential in the expansion of the freight and logistics infrastructure to rural areas, a necessary step to gain access to their mostly untapped consumer base.)

In contrast, antitrust regulators in developed economies focus on the lack of competition in markets dominated by large digital companies, where network economies tend to produce high market concentration. Their ability to invest large amounts of capital in new technologies such as artificial intelligence and machine learning are allowing them to increase their offerings of products and services while controlling the associated costs.

While acknowledging the resulting efficiency gains, European officials have raised concerns derived from this tendency toward dominance. In part, their concerns are conventional concerns about monopoly pricing power. But the more immediate issues include killer acquisitions designed to build technological moats, limitations on consumer choice and manipulations of the consumer decision-making process.

Consumer Welfare and Data Usage

The contribution of technology to both capital access and market structure relies on the ability to access and process data collected from customers. But what the tech companies use it for has become a looming concern for regulators, mainly those in Europe and the U.S. The issues raised range from the spread of misinformation to systematic bias in the financial services sector, data privacy and data ownership rights.

Data access, usage and management are at the core of the technological innovation that improves access to services — financial and others. This is especially the case for underserved populations, often those in less developed countries. Yet it also seems the priority concern for European regulation, a priority that may pall in the future compared to social issues like dissemination of misinformation, monopoly pricing and inhibition of innovation by non-incumbents. Unchallenged, this priority could become global and could adversely impact economic growth in other countries with different needs and priorities.

One Size Should Not Be Made to Fit All

The digitization of the economy will not lead to one unique, global system but rather to many platforms. Any successful digital currency would have to function in most of them. Yet these platforms will expand beyond countries’ regulatory and monitoring jurisdictions, emphasizing the need for new global oversight.

Interoperability and transparency are essential to ensure that technology leads to financial inclusion as well as to cheaper, speedier cross-border transfers. They will also provide a level of competition that will continue to encourage the fast pace of innovation. But local market designs must coexist with global coordination to maximize efficiency in international financial markets and contain instability in the event of potential contagion.

This will no doubt prove to be a delicate balancing act. But it’s a balance we leave to chance at our peril. Financial technology has the potential to accelerate both economic growth and broad access to the benefits of growth. However, it also has the potential to destabilize the global financial system in ways we are just beginning to understand.