Traceable Digital Currencies - is it time to let the bad guys in?

Identity, Security, Time. What’s required for Traceable Digital Currencies to succeed.

The technology for instant cross-border payments is already here – and the operational reality of mass adoption is just moments away. This will transform the international payments landscape. The technology dramatically reduces the time for money to be transferred by using instant buy and sell of stablecoins across borders, taking advantage of multiple endpoints managed by different paytech businesses. But instant cross-border is just one element of the new opportunities that digital currencies and the tech behind them offers. As part of this mechanism, there are a few more ingredients are needed for it to truly succeed; identity, security and time – but not necessarily in that order.

Technology is here to drive faster payment systems. Ironically, time is needed. All futurologists hit few bumps in the road and it’s possible the recent instability in crypto coin and stable coin is just that - a bump. It is the technology behind these currencies, including blockchain and distributed ledgers, that remains and will in time emerge as the key enabler to much faster domestic and international payment systems. While markets still grapple with how to convert fiat currency into digital currency from a valuation perspective, the wider use of digital currencies in other capacities is being ignored. In time that will change too as the market starts to understand its implications and learn to use it.

From small things, big things grow – but a catalyst helps – and that couldn’t be more true for digital currencies. There is a tendency to overemphasise the speed with which technology will change and we often underestimate the impact of small changes on people's lives. This is true of payments, where technology has moved on, but adoption hasn’t - yet. As PayPal founder, Peter Thiel, famously said, “Back in the day when we were looking into the future, we were promised flying cars and all we got was 140 characters.” Covid was a godsend for a businesses like Zoom, despite its technology being around for years, now it has become indispensable. The same is true of digital currencies – currently only the catalyst is lacking.

Digital payments are the norm and the move to larger more complicated payments is no longer a stretch. People are already used to personal digital payments, and this is indicated by the drop in use of cash. Since 2017 cash use in the UK has declined by 15% p.a. In 2020, with the onset of Covid, this drop accelerated to 35%. Business too has switched. Digital payments help to increase convenience, reduce security risks, handling costs and health concerns. So far though, the larger or more complicated transactions remain the realm of institutions, but as technology improves, adoption by households and business will likely be swift.

Identity and anti-money laundering regulation is a key factor in the lag to larger digital payments, but this too can be solved by blockchain. Many of the current payment system problems stem from a pre-industrial era designed to support face-to-face transactions. Our new digital economy still relies on physical records to establish identity. In any payment today, the payment entity wants to know the client’s name and background along with source of funds. Often this requires physical paper evidence, despite in most cases, the evidence being digitally available anyway. This nonsense that many financial businesses spout about requiring proof of payment purpose misses the point - since without providing a complete verifiable and immutable audit trail of where the funds originated from and where they are going it is near impossible to successfully monitor payments. This process may create friction for launderers and fraudsters but it does not eliminate the activity. And only creates friction for the vast majority of legitimate users. For payment mechanisms to work well in the future, look no further than the technology that blockchain provides, with immutable, traceable, auditable transactions that can carry all other elements needed for effective crimefighting – it is a fallacy that digital currencies are inherently dodgy or dangerous, the truth is that they use a technology that can build identity into payments and leave no uncertainty as to client and the source of funds. It is also a fallacy that regulators are unable to manage, trace or monitor transactions. On-blockchain analysis tools provide traceability from original mining to current ownership TODAY. And regulators worldwide are using these tools.

Identity will remain in payments – digital or not.**While identity remains a vast subject, and, I firmly believe that anonymity in a social sense is a human right, anonymity in payments is unlikely, as risk around money laundering and improper purpose will remain. Whether it’s a bank or another institution, from a legal perspective, in a sophisticated society, we need to know what the money flows are. Whether this happens from laborious paper evidence-based system or more accurate and faster yet to be adopted blockchain system is what is at stake. The end goal is the same.

**New digital identity systems must improve security to provide faith in the process. We tried to keep the bad guys out – and we ended up with a fragmented system whose cracks are showing in the security vulnerabilities that still exist. Whatever new security element is introduced by the regulators, fraud persistently rises. And leaves consumers confused. Rather than feeling safe and secure in the access and transfer of personal funds, many users feel overwhelmed and frustrated by a monstrously complicated process of identity credentials and passwords, two factor authentication, text messages, calls and browser windows. A system which in its attempt to be secure by its design, instantly raises question about just how risky it is to transfer funds digitally. Additionally, within payment companies there are still significant inefficiencies and compliance risks undermining the product delivery. While changes are happening, evidence of security will significantly help with adoption of this new technology.

Once identity is finally embedded in traceable digital currencies, so too is the identity of scammers. If security issues are eliminated and identity included, then there is no need to exclude a user. Once they are in the system, those with the regulatory authority know both the identity and source of funds with certainty. It is of course no different to the current system - if you could keep track of every transaction and bank note serial code then no problem. It’s just that with blockchain it is easier and more efficient. For all the failings of cryptocurrency and its derivatives, the technology behind these currencies is fabulous and for those with regulatory authority technology, it is not anonymous. The blockchain will record every single exchange where it has been legal or otherwise. This is a technology for a world and society which is looking to improve itself from so many angles.

The author is Rupert Lee-Browne as part of the Future of Payments Newsletter