Digital Finance (L3-Digital Payments and Digital Currencies)

Digital Payments and Digital Currencies Notes

Topic Learning Outcomes

  • Describe major payment systems and solutions.

  • Distinguish blockchain payments and other digital payment solutions.

  • Identify successful digital payment platforms.

Digital Payments

  • Types of digital payments:

    • Credit Card

    • Debit Card

    • Bank Transfer

    • Prepaid Card

    • Digital Wallet

Credit Card

  • Commonly used online payment mode with a financing limit.

  • May not be suitable for small businesses and small payments due to high fees.

Credit Card Authorization and Settlement

  • Authorization Process

    • Cardholder presents card.

    • Transaction data sent to Payment Gateway or Terminal.

    • Request goes through VISA/MasterCard association.

    • Cardholder's bank (Issuing Bank) responds.

    • Authorization either approved or denied.

    • Merchant completes sale.

  • Clearing & Settlement Process

    • Transaction data sent to VISA/MasterCard association.

    • Debit occurs at cardholder bank.

    • Payment to the merchant's bank occurs.

Credit Card Processing Charges Breakdown for a $100 Dinner

  • 0.30 goes to Payment Processor.

  • 0.13 goes to Card Association.

  • 0.20 goes to Payment Gateway.

  • 1.87 goes to Issuing Bank.

  • 97.50 goes to the restaurant.

Debit Cards

  • Most popular non-cash payment instrument globally.

  • Payments withdrawn directly from the consumer's personal account.

  • Lower interchange charges compared to credit cards.

Bank Transfer

  • Payment made using online banking.

  • Popular in countries like Germany due to reluctance to use credit cards.

  • Key reasons for adoption: Access, convenience, and low risk of fraud.

Prepaid Cards

  • Two forms:

    • Cards on traditional networks (VISA, Mastercard).

    • Prepaid accounts not on credit card systems.

  • Requires loading cash in advance.

  • Acts like spending limits.

Mobile Wallets

  • Smartphone as a digital wallet for coupons, money, cards, and receipts.

  • Enabling technologies: Near Field Communication (NFC), QR Codes, Bluetooth (potential).

  • Provide convenient payment solutions.

Providers of Mobile Wallets

  • Hardware Makers (e.g., Samsung, Apple).

  • Operating System Makers (e.g., IOS, Android).

  • Payment Platform Providers (e.g., PayPal, AliPay).

  • Financial Institutions (e.g., Citibank, Visa, Mastercard).

Mobile Wallet Providers: HW/OS Makers

  • HW based payment services dependent on specific hardware makers.

  • OS based payment services dependent on specific operating systems.

Mobile Wallet Providers: Payment Platforms

  • Payment services developed based on their products or services.

Mobile Wallet Providers: Financial Institutions

  • Payment services through financial institutions using IT or converging with other services.

Apple Pay

  • Dependent on both hardware (Apple devices) and operating system (iOS).

AliPay

  • Payment platform provider that works regardless of hardware or OS.

  • Introduced by Alibaba.

PayPal

  • Launched electronic payments and transfers in the 1990s.

  • PayPal Here is a mobile POS for merchants.

Citibank

  • Offers accounts, credit cards, and Citi Pay mobile payment service.

Remittances

  • Transfer of money from one party to another, usually overseas.

  • Can be personal or business payments.

Remittances using Fiat Currency

  • Bank Remittance

  • Money Transfer Operator

  • FinTech Remittance

Bank Cross-Border Remittances

  • Remitter initiates payment.

  • Remitting bank sends payment instructions via SWIFT.

  • Settlement occurs via Nostro/Vostro account or third-party bank.

  • Beneficiary receives payment.

Money Transfer Operator (MTO)

  • Sender provides funds and receiver info.

  • MTO initiates transaction.

  • Funds transferred through correspondent banks.

  • MTO pays funds to the receiver.

FinTech Remittances

  • Example: TransferWise (now Wise).

Payment System in Malaysia

  • Various systems facilitating different types of transactions.

Malaysia’s Payment Systems

  • eSPICK: National cheque clearing house.

  • IBG: Interbank GIRO for account-to-account transfers.

  • JomPAY: National bill payment scheme.

  • MyDebit: Domestic debit card scheme for point-of-sale payments.

  • FPX: Direct-to-bank internet payment gateway.

  • Direct Debit: Recurring payments from consumer bank accounts.

  • DuitNow: Instant payments to accounts or DuitNow IDs (mobile/NRIC).

  • DuitNow QR: National QR standard for payments.

  • Shared ATM Network and MEPS ATM: Access funds from 10,000+ ATMs.

  • Cross-Border Cash Withdrawal: ATM withdrawals in participating countries.

  • Smart Card and Certification Services: Testing and certification of chip cards and payment systems.

  • Currency Notes Processing: Sorting and redistribution of banknotes.

Cryptocurrency

  • Digital currency using cryptography to secure online transactions and blockchain technology.

Top 5 Cryptocurrencies (as of May 11, 2023)

  • Bitcoin

  • Ethereum

  • USD Coin

  • Binance Coin

  • Tether

What is Blockchain?

  • The technology that underlies cryptocurrencies.

  • Analogy to a phone network or a specific use of it.

Blockchain Characteristics

  • Transactions gathered into blocks and recorded.

  • Peer-to-peer distributed ledger.

  • Records kept across different computers.

  • Records are immutable.

Distributed Ledger vs. Centralized Ledger

  • Centralized Ledger: Multiple ledgers, with the bank holding the master. Clients must reconcile with the bank.

  • Distributed Ledger: Only one ledger. All nodes have the same access and agree to a protocol determining the true state.

Basic Technical Elements of Blockchain

  • Cryptography

  • P2P networks

  • Program (blockchain's protocol)

Cryptography in Blockchain

  • cryptographic hash function to generate a Digest.

  • Hash functions use input, a cryptographic hash, and generate a digest.

Cryptography Use Cases in Blockchain

  • Digital Signatures

  • Private/Public Keys Initiation and Broadcasting of Transactions

  • Proof of work and other consensus mechanisms.

  • Validation of Transaction Chaining Blocks

  • Hash Function

Public and Private Keys

  • Public Key: Used to encrypt data and prepare transactions.

  • Private Key: Used to decrypt transactions belonging to you; must remain secret.

How Bitcoin Works on the Blockchain

  1. Sender notifies recipient of Bitcoin transfer with a digital signature.

  2. Notification goes to the closest public node on the Bitcoin Network.

  3. Verification process authenticates the transaction, sending it to the Mempool.

  4. Miner picks up transaction from Mempool and performs a proof of work to solve a complex mathematical problem, producing a hash.

  5. Nodes authenticate the block and add it to the blockchain.

  6. The miner bundles all the work into a single block and sends it back to the network

  7. Recipient is notified of the transaction and uses their private key to access the Bitcoin

Types of Crypto Tokens

  • Security Token: Ownership of an asset, expectation of profits, regulated offerings (KYC).

  • Utility Token: Used to buy products/services from the company/platform that made the ICO.

  • Currency Token: Classic cryptocurrencies like Bitcoin, meant for daily transactions.

  • Reward Token: Rewards for using a particular platform’s cryptocurrency.

Investment Potential and Concerns of Cryptocurrencies

  • How and Where to Invest:

    • Crypto Exchanges

    • Peer to Peer

    • Exchange Traded Fund

    • Futures

    • Hedge Funds

    • Initial Coin Offering

Tax Concerns

  • Income: Market Value of Currency, Good, or Service Provided.

  • Property: Cost Basis - Capital Gains.

Traditional Payment vs. Blockchain Payment

Feature

Traditional Payment

Blockchain Payment

Central Authority

Yes

No

High Security Budget

Yes

No

Instant Cash Out

No

Yes

Reasonable Commission Fees

No

Yes

Fast Global Transactions

No

Yes

Detailed Comparison

  • Central Authority: Traditional systems have central authorities (banks). Blockchain transactions are public and immutable.

  • Security Budget: Traditional systems require high security. Blockchain data's immutability reduces security needs.

  • Instant Cash Out: Banks have settlement times. Blockchain allows instant cash out.

  • Commission Fees: Blockchain's community-driven governance reduces fees.

  • Fast Global Transactions: Traditional cross-border transactions are slow. Blockchain provides faster approvals.

Why Blockchain Is Not Widely Applied in Payments

  • Scaling: System clearing and transaction speed are still issues (e.g., Bitcoin, Ethereum).

  • Lack of Trust: Cryptocurrencies are perceived as mysterious or dangerous.

  • Restrictions of State Regulators: Requires permission of state authorities.

  • Anti-competition by banks: Banking system's reluctance to share.

  • Doubts of Big Business: Concerns about government restrictions, legislative regulation, and cryptocurrency rate fluctuations.

  • Sustainability: The technology is young and untested in global market conditions.

Preparation for Class

  • Read relevant articles on the topic.

Next Week's Class

  • Lecture and Class Activities on FinTech solutions in wealth management, lending, and insurance.