Regulating the Shadow Payment System

Abstract

Recent years has seen the growth of the ‘shadow payment system’. This system includes Bitcoin exchanges, PayPal, Alipay in China, and mobile money services in Africa. On current projections, this global ‘shadow payment system’ will perform an ever-greater portion of payments in most economies in the world. This chapter explores what legal tools can be used to protect users’ funds stored within the shadow payment system. It provides a framework for identifying risks to users’ funds, the range of relevant legal tools and their effectiveness, and uses this framework to make three claims. First, insolvency of an actor in the shadow payment system exposes users’ funds to two risks. One is loss of value, which means the potential write-down of funds when users are characterized as unsecured creditors. The other is illiquidity, meaning users face a delay in converting or transferring funds during bankruptcy proceedings. Second, there is little information about legal tools currently used in the shadow payment system and their effectiveness. There is also little guidance on the desirability of using ex post tools, such as deposit insurance and lender of last resort, to protect users’ funds. This is because the policy community is yet to identify the benefits and costs of different roles for the shadow payment system in an economy. Is it an investment asset, alternative retail funds transfer system, vital payment infrastructure on which the economy relies, or something else? Third, mobile money can provide insights into discussions about using legal tools to protect users’ funds. This is because over the past ten years, this shadow payment system has become subject to increasingly sophisticated legal and regulatory regimes. A key insight from mobile money is ex ante and ex post tools appear required to address loss of value and illiquidity risks. A similar package of reforms may be needed to build strong, stable shadow payment systems in Japan, the United States, and other developed countries. The chapter uses mobile money in Malawi as a case study for developing this point.