Fintech Competitiveness: The Importance of Rational Regulation

The Emerging Global Battle for Control of International Payments

Recent events – including Tesla’s substantial investment in bitcoin and Gary Gensler, Chairman of the U.S. Securities and Exchange Commission, characterizing the cryptocurrency landscape as the “Wild West” – highlight a complex shift in the financial world. Simultaneously, China has launched its own digital currency while halting the IPO of AliPay, a leading fintech company, citing regulatory concerns. These developments signal a significant turning point.

Amidst the intense technological competition between the United States and China, a crucial area often overlooked is the race to innovate and control the technologies underpinning international payment systems.

Why This Race is Critical

This competition holds importance for two primary reasons.

• Firstly, Western leadership in international payments enables the enforcement of sanctions against entities like Iran and North Korea. A dominant Chinese presence in the developing world would significantly complicate this capability.
• Secondly, Western leadership in fintech allows for the establishment of global standards focused on environmental protection, prevention of illicit transactions, and consumer privacy. Clear and sensible regulation is what responsible U.S. companies are seeking.

Currently, China has established a leading position in mobile payments, both in terms of sophistication and overall scale. Companies like Ant Financial, AliPay, and WeChat Pay represent the most advanced mobile payments market globally.

Alipay, for instance, boasts over 1.3 billion users, exceeding the entire user base of PayPal. The total volume of mobile transactions processed by Chinese merchants annually reaches $45 trillion, double the combined volume of MasterCard, Visa, and PayPal.

China’s Digital Currency Initiative

Beyond private sector innovation, the Chinese government has developed the world’s most advanced central bank digital currency. Since its launch earlier this year, over 70 million transactions, totaling over $5 billion in revenue, have been completed.

The digital yuan is a centralized currency backed by the Chinese government, contrasting with the speculative nature of traditional cryptocurrencies. While its stated purpose is financial inclusion for the unbanked Chinese population, its centralized structure allows the government to monitor transactions and potentially restrict access based on an individual’s social credit score.

Should these Chinese technologies gain international traction, enforcing sanctions against undesirable actors could become considerably more challenging, as noted by former Treasury official Justin Muzinich and others.

The U.S. currently enforces sanctions by preventing Western companies from conducting business with sanctioned nations and by restricting banks from facilitating payments through systems like SWIFT and correspondent banking relationships.

U.S. fintech companies, including those involved with crypto, adhere to “know your customer” and anti-sanction regulations. The sheer size of the American financial system has proven effective in deterring illicit activities.

The rise of the digital yuan and Chinese payment platforms could circumvent these existing systems, enabling companies to bypass U.S. and Western banks, making sanctions enforcement difficult and facilitating illicit transactions. The reduction in correspondent banking relationships by U.S. and European banks – 75% according to Sigal Mandelker and others – further diminishes America’s influence over international banking and its ability to combat illegal behavior.

The Need for Western Standards

Beyond sanctions, Western governments have a vested interest in shaping the rules of the emerging digital financial system. Existing banking practices incorporate numerous safeguards against abuse, and the West must establish similar standards for these new technologies.

For example, preventing criminals and terrorists from anonymously transferring funds through cryptocurrencies like Bitcoin is paramount. Safeguards to protect investors from scams, such as those seen during the 2017-2018 initial coin offering boom, are also essential.

Environmental concerns also demand attention. Proof-of-work (PoW) cryptocurrencies, like Bitcoin, consume vast amounts of computing power and electricity, resulting in significant carbon emissions. Bitcoin mining, utilizing the PoW model, consumes roughly the same amount of electricity annually as the entire country of Norway.

Tesla’s $1.5 billion bitcoin purchase, some reports suggest, may have offset a substantial portion of the carbon emission reductions achieved through its electric vehicle sales.

These issues require careful consideration, but swift action is crucial. China recognizes the power of leading in key technologies and actively seeks to establish global standards. It has already proposed digital currency concepts for governing data transfer between financial institutions.

The U.S. Regulatory Challenges

Unfortunately, the U.S. is lagging behind due to a fragmented regulatory landscape. Agencies like the CFTC and SEC are struggling to effectively regulate blockchain, cryptocurrencies, and other fintech innovations.

The SEC has pursued legal action against, or threatened to pursue legal action against, responsible and innovative companies like Coinbase and Ripple (where one of us serves on the board), despite their repeated calls for reasonable regulation. Simultaneously, the SEC has seemingly, though not explicitly, approved Bitcoin and Ethereum, despite their inherent challenges.

Many other fintech companies operating in international payments and blockchain/cryptocurrencies remain in “regulatory purgatory,” uncertain about future enforcement actions.

The “Wild West” that Gensler described is not in anyone’s best interest. Fintech, particularly international payments enabled by blockchain, holds immense potential. It can expedite and reduce the cost of remittance payments, expand financial access for the 1.7 billion unbanked individuals globally, and offer numerous other benefits.

However, a complex web of conflicting regulations and arbitrary rules primarily benefits those seeking to undermine the American financial system. By coordinating across agencies and establishing clear, reasonable rules, the federal government can foster the next generation of fintech entrepreneurs and maintain U.S. leadership in this critical domain.