Friday, 3 October 2014

The rise of the alternative (loyalty) currency


You can’t have failed in recent months to see the rise of alternative currencies like Bitcoin.

With SIBOS, one of the worlds premier financial services events dedicating a whole day to Bitcoin discussions and Paypal enabling Bitcoin support amongst it’s digital merchants, there is no doubt that this crypto-currency is heading mainstream.

Whilst there is a lot of focus on the fluctuating price of Bitcoin and the how the currency itself comes into existence, there really isn’t that much difference between it and a more traditional currency like Sterling.  In both cases, there is essentially a digital ledger that manages payments and deposits.  Within a traditional system, these ledgers are managed by a trusted 3rd party such as the users bank and these in turn are typically managed through some form of central bank such as the Bank of England.  The money itself is held as a digital record and we simply place trust in the centralised 3rd parties that this will be managed accurately.  With Bitcoin, this ledger is decentralised and essentially owned by all users (know as the block chain).  Trust is managed through sophisticated cryptography to ensure that changes are accurately represented and can be trusted.

As with any currency then, whether centralised or de-centralised, it really just comes down to whether the users of the currency place a value on it as a medium of exchange, a trust in it as a store of value over time and a unit of account that can be used to measure any particular transaction.

In this sense, you could argue that loyalty points are a currency.  They are a closed loop currency and you work to attain it by doing specific behaviours with the value issued directly in relation to your “effort”, be this purchase behaviour, frequency or other interactions such as social activity.  This makes it a medium of exchange which is normally measured based on the corresponding value to the issuer such as the retailer.  

The problem with this currency however is that in many cases, it's simply not that good.

It has relatively low liquidity - I can have lots of loyalty currency, points or miles from lots of programmes, but essentially they are all siloed.  I can’t move them, share them or aggregate them easily.  I can of course convert them to other assets such as rewards, gift vouchers or other loyalty program currencies, however the transaction costs for this can vary, making the exchange in many cases less attractive.

I’m also constrained by how much I can earn/attain based on other behaviours.  As these other behaviours are related to share of wallet activities like grocery shopping, it’s harder to increase my earning velocity past what I naturally need - so a change in pricing for example would not necessarily result in a significant change in demand and hence loyal behaviours recognised.  Sure I can centre my purchases with one retailer and possibly up-sell to higher value products - but there is essentially a ceiling to how much I can spend and hence earn.  Coalition programmes like Nectar help this to some degree by widening the opportunities to earn, but it’s still limited based on the amount I can actually spend.

It’s interesting however to look at a loyalty currency as an actually currency - a retailer issued, closed loop monetary supply.

As a retailer currency, why can’t I purchase currency upfront?  Why can’t I exchange the currency with friends?

Sure there are good reasons when you look at it as a reward mechanism.  

If it’s too portable, then does it lose it’s stickiness?  If I can simply give my points to someone else, am I less likely to try to build a balance?  If my points can be shared with others will this increase breakage and mean that high numbers of points will ultimately be redeemed?

The answer is likely yes to many of these questions.

However, if people can “pay” each other in loyalty points, will this increase the attractiveness of the currency (and hence the retailer)?  If customers could convert real money into a retailers closed currency upfront, how much is this “potential purchase value" worth? 1% discount? 5% discount?  If other, complementary retailers can issue the loyalty currency, does this increase the liquidity of the currency and create more customers and more purchases?

It has been reported that Starbucks now see 30% of their purchases being made with their loyalty currency, Starbucks Stars.  Of course, Starbucks could have just reduced their prices, but in doing this, the customer saving would have been in the most liquid asset - cash - and the chances of Starbucks seeing that cash being spent back with them would have been low.  However, with their loyalty currency, they’ve managed to both discount their product whilst keeping the value within their own closed loop currency.

Now at this point, that currency is no different to any other loyalty program we’ve been doing for the last 80 years, whether physical stamps or a digital record.

However, what if Starbucks allows the currency to be exchanged between people - what if they increased it’s liquidity?

Could I pay for a taxi ride with Stars?  Could I pay for a haircut with Stars?  Could the barber issue my change in Stars?

How much is a Star worth to me if I have all the coffee I need - would I trade it for less than it’s value at Starbucks to someone who values it more?

This may sound a little farfetched, but it’s happening today.  The Economist reported last year that in many markets in Africa, mobile airtime is becoming a defacto currency, with retailers issuing small amounts of change in mobile airtime rather than cash.  People are settling personal debts through the transfer of airtime and with the ability to move airtime credit globally, it’s not just a local phenomenon, it crosses borders and continents.

It’s even more interesting when you look at this through the lense of the new crypto-currencies like Bitcoin.

Rather than being “earned” based on behaviours, these crypto-currencies are typically mined - in a virtual sense.  Based on a complex algorithm which takes (ever increasing) computer power to work through, the algorithm rewards the computer user with coins every so often.  For a currency like Bitcoin, there is a finite number of coins to be found and as more are found, the remaining ones get even harder to find, taking longer and taking more processing power.  In this way, the Bitcoin market is essentially constrained, making a Bitcoin value flexible depending on what the market will pay.

Back in 2011, Stan Stalnaker, founding member of the Ven currency wrote an article entitled Bitcoin, Ven and the End of Currency built on this theme saying:-

“To be traded, [a digital currency] must be assigned a value.  And if it can be assigned a value, it can be interchanged with anything else of assigned value.  The Internet is enabling exchange of all types of value, and helps us to measure and publish these values. [..] How many Likes is a Facebook Credit worth? How many Credits make a Ven? How many Ven make a lasagna at the Olive Garden? How much do you have to Like the Olive Garden to get a lasagna? We’ll know soon."

As alternative currencies rise in popularity, we’re going to see more examples of people exchanging products, services, time, attention and share of voice for something other than the national currency.  I think loyalty currencies have a positive role to play in this new and emerging economy and it will be interesting to see how they change and are transformed to become more flexible and possibly decentralised.


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