Cashless society – back to the future?

Government-sanctioned paper money was introduced for the first time in the 10th to 11th century of our calendar – in China. Around 1000 years later, China is again a pioneer in the development of new forms of money and payment. Paper money and cash in general seem to be on the way out. We will continue to use money for the foreseeable future, as it is the “lubricant” of our modern civilisation in many different respects. But cash will increasingly be supplemented with and displaced by new electronic (digital) forms of payment. This includes many changes in numerous areas of business and private life. These developments offer good return potential for investors with foresight but are also a source of additional risks for all companies and investors that ignore these trends.

Cash is king?

Cash and its future is a topic that can quickly spark heated, emotional debates. Some think that it has served its purpose and is now an archaic relic that brings a host of problems and disadvantages. Others see it as one of the most important bastions of personal freedom and independence. Some view it as an inconvenient avenue of money laundering, counterfeiting, and criminal activity and an impediment to effective monetary policy. Others consider it to be a robust, proven method of payment that also works as expected when the electricity or Internet go out and that is safe from hacker attacks. We will not conduct a debate about the sense or validity of cash in this newsletter. This communication will focus on new developments in this area, and what opportunities and risks this presents for investors. Regardless of whether these changes are welcomed or criticised, desired or feared.

The world of payments is being turned on its head

When the average person in Europe, North America, or Japan thinks about cashless payment, this usually means bank cards or credit cards, or online wire transfers. In China, this usually means a smartphone. It is entirely possible that there are young people in Shanghai, Beijing, or Dalian who have never handled cash or credit cards in their lives, and who will never do so. China’s billion-plus population has largely skipped the credit card – much to the chagrin of the industry giants Visa and Mastercard. Instead, the Middle Kingdom is a pioneer in payment software that uses mobile phones for completing banking and payment transactions.

But using a mobile phone to pay at the supermarket is gaining traction in our country now, as well. The COVID-19 pandemic and fear of virus transmission through paper money and coins have given cashless payment a strong boost in Europe, as well. Even in countries where many people still prefer cash, such as Austria and Germany, the share of cashless payments has risen rapidly over the past 12 months. And then there is the strong shift to – obviously cashless – online retailing as a result of lockdowns and contact restrictions. It is important for investors to note that the trend towards cashless payment was not spawned by the pandemic, but just accelerated. So it will also not end when the pandemic is history.

Another strong driver of the advance of electronic forms of payment is now joining the fray: the central banks. China seems to be a pioneer here, as well, but central banks in the Eurozone, USA, Japan and even countries like Venezuela are apparently working hard on introducing “digital currencies”. Among other things, these would provide additional monetary policy tools.

Cryptocurrencies – the money of the future?

When they hear “digital currencies”, many people will think less about the euro or US dollar and more about Bitcoin and its counterparts. These so-called cryptocurrencies have gained many new fans thanks above all to their massive value increases in recent months (versus conventional “paper currencies”), and have also won over many skeptics among companies and institutional investors. But: The term cryptocurrency is misleading. Hardly any of the now thousands of cryptocurrencies even come close to fulfilling the criteria of a currency. This includes Bitcoin and Ethereum, the two kings in the segment. Depending on your perspective, they are primarily investment or speculation vehicles that are hoarded but not used to make payments. Entire books could be written about opportunities, risks, and possible future uses of these applications that are usually based on so-called blockchains. The underlying technologies (such as “smart contracts”) and their successors could substantially alter many processes in modern economies. Especially but not only in the financial industry. At present and for some time to come, the cryptocurrencies will be a purely niche product in terms of being used as a means of payment, and play no appreciable role in global payment transactions. It remains to be seen whether they ever play a major role or even survive.

The new gold rush?

It is obvious that the exciting trend towards new forms of payment can be a true goldmine for the companies that can take the lead in this shift, and a serious threat to those that ignore it. Many companies that facilitate or simplify cashless payment have seen massive value increases over the past years and decades. Starting with the now almost “traditional” seeming credit card providers Visa and Mastercard and extending to considerably younger companies such as PayPal, Square, Apple pay (Apple), and Alipay (Alibaba). One thing that almost all of them have in common is enormous scalability and a comparatively low need to invest in machines, buildings, or personnel. In the end, scalability means generating large volumes of additional revenue with minimal additional capital. The software industry is a prime example of this, and nearly all cashless payment forms are primarily software solutions. But such past value increases are of course no guarantee or reference point for future price developments.

Payment companies – promising, but not a sure thing

Where there are new winners, there are of course also losers. Banks once ruled over payment, until the credit card companies captured an increasing share of this business. This did not really bother the banks for a long time, because they also profited from additional transaction volumes. But now, they are in danger of being more or less left behind in the payment value chain. But credit card companies are also seeing pressure from new competitors that facilitate payments without a credit card (or bank card) online or at the supermarket.

What does this mean for investors? Above all that an apparently clear trend such as cashless payment is no sure road to wealth. And just as in every “gold rush”, there are plenty of black sheep that try to go with the flow and rake in the profits, for example Wirecard.

There will likely be more than one major winner, since cashless payment offers a broad range of profitable activities for creative entrepreneurs. And many payment companies are likely to be a good hedge against potential inflation risks, which have increasingly shifted into the spotlight for many investors. Because as prices for goods and services rise, this also increases the transaction volumes and thus the fees and profits of these companies.