The role of e-money in the digital banking world, by Andrea Travis-Matthams, Chief Finance Officer.
Electronic money (e-money) is cash that exists in digital form. Its popularity has increased rapidly in recent years, with the European Central Bank reporting that the value of electronic money issued in the Euro area almost tripled between 2014 (EUR 5.4bn) and 2021 (EUR 15.4bn).
The creation of new electronic currencies has resulted in generic terms such as “digital”, “virtual” and “electronic” being used interchangeably to describe various types of non-physical money. So here we take an in-depth look at e-money and how its own specific characteristics have established it as a widely accepted, convenient and safe payment solution, and one that is here to stay.
The Ins and Outs of E-money
E-money offers consumers a highly convenient and secure means to pay for goods and transfer money with ease. The technology behind it was invented in the 1980s, but is has taken several decades to become the ubiquitous payment method it
is today, recently accelerated by the effects of the Covid-19 pandemic and the consequent surge in demand for contactless and mobile payments.
E-money is created – or issued – on receipt of funds, for example an e-money issuer will take cash from a distributor, retailer or customer in exchange for the same value in e-money. As a digital form of cash, the value of e-money is therefore fiat (government) backed and can be exchanged back to its original value in fiat currency (although due to the sheer convenience of e-money, this is uncommon and most is spent or transferred in its e-money form).
Another way to think of e-money is as a prepaid product. As e-money can only be issued on receipt of funds, the customer is essentially paying for the spending power in advance. Their e-money is then stored as a digital record in banking computer systems, on a prepaid card, or in a digital wallet or payment app, such as PayPal, in their mobile device.
E-money is fundamentally a record of value of physical cash that exists elsewhere. E-money is a method of payment – a mechanism to interact with government issued and regulated currencies. Unlike a deposit in a bank, e-money is not an asset that can be loaned for a return, therefore e-money is not considered as a deposit and so is not covered by government compensation schemes.
So is e-money safe?
All financial institutions are subject to some elements of risk but, by its very nature, an electronic money issuer, known as an Electronic Money Institution (EMI), is licensed only to carry out a limited range of banking activities, such as offering current accounts and payment cards, carrying a relatively low level of risk. The EMI License does not allow the e-money issuer to offer loans, which would pose a much greater risk to its cash deposits.
The Electronic Money Regulations, which came into force in 2011, provide the regulatory framework for e-money issuers. The Regulations state that cash deposited with the e-money issuer in exchange for e-money must be pooled and ring-fenced in a separate bank account so that, in the event of the e-money issuer becoming insolvent, its creditors cannot make a claim on it and it could therefore be repaid to the account holder.
Regulation is a key beneficial feature of e-money – as e-money is backed by a centralised (government issued) currency, it is subject to its nation’s regulations, and therefore widely accepted as a safe and secure payments solution, unlike some decentralised (private sector issued) digital currencies, which are in the main unregulated and therefore pose more volatility and risk.
Is Digital Money different to E-money?
It is worth briefly covering other types of digital money so as not to mistake it for e-money. The main types of digital money are:
- Central Bank Digital Currencies (CBDC) – issued by the public sector, a CBDC is a digital version of fiat currency and can be stored or transferred using internet and mobile applications. According to Atlantic Council, 11 countries have fully launched a CBDC, with a further 130 countries, representing over 98 percent of global GDP, currently exploring a CBDC. Not to be confused with e-money, CBDC is digital in origin and issued only by the central bank. The UK, for example, is currently exploring the impact of a digital pound, which would be issued by the Bank of England and would hold its value just like banknotes.
- Cryptocurrency – some of the most widely known examples of which are Bitcoin and Ethereum. Cryptocurrencies are digital assets that exist across multiple computer networks. Peer-to-peer transactions are verified using cryptography, rather than a central third party. This decentralised structure means that the currency operates independently to centralised currencies and the value of the currency is determined by supply and demand. Cryptocurrency has no physical form and is stored it in a digital wallet where it can then be used to make purchases. Whilst Statista reports that in February 2023 there were 8685 cryptocurrencies in existence, many of those have little significance, with the top 20 making up nearly 90% of the total market. The crypto market plummeted in 2022 and the extent of its recovery is uncertain.
The future of E-money
The digital payments market may well have been disrupted by the introduction of cryptocurrencies, but they are not yet – and some argue never will be – a viable alternative mainstream currency. A typical consumer likes to know that their money is backed by a central authority, which is the backbone of e-money’s success story.
The explosion in e-money as a method of payment perhaps then indicates that monetary systems will evolve to a purely digital model – the seeds of which we are seeing with tentative steps into CBDCs. But, if this happens at all, it is a long way off.
And, for now at least, cold hard cash appears to be going nowhere. Whilst we are making far fewer physical cash payments, the physical presence of banknotes is of course the very thing that is upholding a booming e-money movement.
E-money has established itself with a leading role in a digital currency revolution where fintechs and regulated companies are competing to offer ever more innovative e-payment products. As customers now view factors such as safety and speed of digital payment transactions, that once were attractive features, as mere hygiene factors, this is driving the development of improved payments and e-wallet solutions tailored to exacting customer demands, offering highly personalised and intuitive payment experiences.
At Transact Payments we enable a broad range of cardless technical solutions, offering bespoke support to bring our clients’ payments ideas to life. As a licensed Electronic Money Institution in the UK and Europe, we provide BIN sponsorship, settlement and payment service solutions. This means that our clients can leave the time-consuming and expensive licensing, compliance and Scheme side of things to us, turning their attention to focus on innovation to differentiate their products in the thriving, but fiercely competitive world of e-money and e-payments.