Let me start from Brazil, where I am from and have more experience. The Brazilian central bank started flexing its payment regulation to incentivise innovation. It was a smart move. New frameworks were created, new types of payment institutions (“PI”) were invented, and many entrepreneurs and investors decided to take their chances in Brazil's highly concentrated payments and banking sector.

I was at Stone by the time, and we took direct advantage of this by becoming an Acquiring Payment Institution - but that is a conversation for another moment. At the same time, the central bank created the Electronic Money Issuer Payment Institution. As the name suggests, this was a specific PI focused on the activity of issuing electronic money. By hearing that, you could say: “It’s like the balance that appears on my bank app when I deposit or transfer money to it”. Well, not exactly. Bank deposits are slightly different.

The Difference Between E-Money and Bank Deposits

E-Money: Short for electronic money, e-money is digital value stored on electronic devices or remote servers. It's issued against the receipt of funds and is intended for executing digital transactions or peer-to-peer payments. E-money can be accessed via digital wallets, online accounts, or smart cards, embodying the concept of 'money on the move'.

Bank Deposits: These are funds placed into banking institutions for safekeeping. Deposits can take various forms, including savings accounts, checking accounts, and fixed deposits, among others. Unlike e-money, bank deposits are not specifically designed for rapid digital transactions but serve as a safe store of value, with the added potential for interest accrual.

E-Money was specifically conceived so non-bank institutions could participate in the payments and financial services industry without doing a bank's core activity: receiving deposits from part of its customers while lending funds to another part. In economic terms, monetary base expansion is when a bank takes $100 as a deposit, lends $50, and keeps that $100 redeemable for the original depositor. After repayment, the new monetary base increased from $100 to $150 plus interest charged. Meanwhile, funds received by e-money issuers must be safeguarded either by segregating them in a bank account (or by securing them through an insurance policy or guarantee in the UK’s case). E-money issuers cannot use these funds for lending but can invest a small fraction of the total in low-risk assets like government treasury bonds.

As an innovation framework, e-money in Brazil started with a blank canvas but was constrained by a 100% minimum deposit ratio in a segregated account. However, each institution was allowed to design its own rules of engagement. This resulted in each institution writing very detailed rules and registering them as its own payment scheme. As time went by, Brazil had more than 100 newly registered payment schemes - each e-money issuer trying to come up with its own set of rules. The situation becomes even more complex to manage if you imagine that each of these payment schemes is usually interoperating among themselves.

From the liabilities standpoint, both bank deposits and e-money are claims against the institutions that are issuing the papers. So why would the central bank allow this? I don’t think It was a conscious decision, and its always an easy job to make claims after many years have passed.The brazilian central bank goal was to set up the industry for innovation to thrive, and you can say this was achieved in the past few years.

It is important to note that e-money issuers, most of the time, don’t have direct access to their respective central bank’s infrastructure, so they hold their assets and cash positions in banks, who are the de facto holders of central bank deposits.

Banks like Clear.Bank in the UK and Star Bank in Brazil are specialised in providing services to e-money issuers.

Why E-Money Became So Relevant In The Payments Industry?

The ascent of e-money as a dominant force in the payments industry isn't coincidental; it's a direct response to the evolving demands of the digital economy and consumer behavior. Several key factors contribute to its growing relevance and adoption:

Financial Inclusion: E-money has a pivotal role in extending financial services to unbanked or underbanked populations, especially in developing regions. By bypassing traditional banking barriers, e-money platforms offer access to financial services via simple mobile devices, bringing millions into the fold of the formal economy. E-money per se has no innovation, but the regulatory apparatus around it facilitated the boom of companies that innovated in the sector.

Regulatory Support and Innovation: Governments and regulatory bodies worldwide have begun to recognise the potential of e-money to enhance their digital economies. Regulatory frameworks are evolving to support the safe and responsible growth of e-money systems, fostering innovation while protecting consumers.

Impact on the Payments Landscape: E-money's ascent has profoundly reshaped the payments landscape. It has introduced dynamism and flexibility previously unseen, challenging traditional banking institutions to innovate or partner with e-money providers. The rise of e-money also heralds a shift towards a less cash-dependent society, with digital transactions becoming the norm for a wide range of services and purchases.

The relevance of e-money today is a testament to its ability to address the needs of a digital and globalised economy, offering a glimpse into the future of financial transactions. But as we continue to move towards an increasingly digital world, new forms of digital assets circulating in new shapes of networks can change the entire landscape once again.

Introduction to Crypto dollars, Reais, Euros: Fiat-Backed Stablecoins

Diving into the digital finance revolution, one might ask, "What are stablecoins, anyway?" They're not just another buzzword in the cryptocurrency frenzy; they represent a groundbreaking bridge between the traditional stability of fiat currencies and the innovative, borderless world of blockchain technology. Fiat-backed stablecoins, like cryptodollars, cryptoreais, or cryptoeuros, stand out as digital tokens pegged to the value of traditional currencies, ensuring they maintain a stable value akin to the fiat they represent.

Issued on blockchain platforms, these stablecoins carry the promise of global financial inclusion and efficiency by being easily transferable across borders without the typical constraints of traditional banking systems. They are designed to be as stable as the currencies they're tied to, such as the US dollar, offering a less volatile alternative to traditional cryptocurrencies. This approach allows them to gain life "on-chain," free to be traded on secondary markets and programmable into a myriad of applications, starkly contrasting with the geographically and jurisdictionally bound nature of e-money and bank deposits.

While our focus today zeroes in on fiat-backed stablecoins for their direct linkage to well-understood monetary values, it's crucial to acknowledge the broader stablecoin ecosystem, including crypto-backed and algorithmic stablecoins. These variations promise a rich tapestry of innovation yet to be fully explored in future discussions.

Cross-Border Constraints: E-Money, Bank Deposits, and the Freedom of Stablecoins

When examining the cross-border constraints of e-money and bank deposits, it's crucial to understand that both are fundamentally tethered to their monetary jurisdictions. This limitation stems from the regulatory oversight, the nature of the deposits, and the traditional banking infrastructure, which is inherently localised. Both e-money and bank deposits operate within the confines of national boundaries, influenced by specific countries' regulatory frameworks and economic policies. This creates a natural barrier to their global fluidity and interoperability.

Regardless of their digital or physical form, e-money and bank deposits are confined by the monetary policies and regulatory oversight of the jurisdictions in which they are issued. This means that for both, expanding services across borders involves navigating a complex web of international regulations, banking partnerships, and compliance requirements. Retail banking, with its roots in serving local communities, particularly exemplifies this, as its model is built around national network effects that rarely extend beyond its home country's borders.

In stark contrast, stablecoins — especially those pegged to fiat currencies like the dollar, euro, or real — transcend these traditional barriers by existing on blockchain networks. Once issued, stablecoins are not just digital representations of money; they become part of a global, decentralised ledger that knows no borders. This unique characteristic allows them to be freely traded on secondary markets, integrated into digital applications, and programmed for a wide array of financial transactions without the direct oversight of a central monetary authority. This is interoperability by design.

Unlike e-money or bank deposits, stablecoins can effortlessly cross borders, enabling instant and cost-effective international transactions. Their blockchain-based nature facilitates a level of interoperability and accessibility unparalleled by conventional financial instruments.

The ability to be embedded in smart contracts and other decentralized applications (dApps) further amplifies their utility, allowing for innovative financial services that can operate globally without the need for traditional banking infrastructure.

In the realm of international commerce, stablecoins have already begun to demonstrate their transformative potential. Take, for instance, the case of a small business owner in Brazil, importing goods from a supplier in Europe. Traditionally, this transaction would entail navigating multiple banks, incurring hefty fees, and waiting days for payment processing. However, by leveraging a fiat-backed stablecoin like the cryptoeuro, the Brazilian entrepreneur can instantly and cost-effectively send payment across borders. The supplier, in turn, receives the cryptoeuro and can choose to convert it to their local currency or keep it as a stable digital asset. This not only simplifies the transaction but also significantly reduces the costs associated with currency conversion and international money transfer fees.

Furthermore, remittances, a lifeline for millions of families worldwide, have seen a similar enhancement through stablecoins. Consider workers abroad sending money back home; by using stablecoins, they bypass traditional remittance channels, avoiding exorbitant fees and delays. A real-world example is a blockchain platform that enables Filipino workers in Japan to send remittances home in the form of a fiat-backed stablecoin, which their families can easily convert into Philippine pesos. This method has proven not only faster and cheaper but also more reliable, offering families immediate access to funds.

Navigating the New Risks Associated with Cryptodollars

As we peel back the layers of innovation surrounding stablecoins, it's crucial to confront the risks associated with their use, especially considering their burgeoning role in the digital economy. One notable concern is the secondary price risk, which hinges on market pricing and confidence in the stablecoin issuer. Unlike traditional fiat currencies, whose value is relatively stable and backed by government entities, stablecoins rely on the trust that issuers have correctly managed and reserved the assets backing them. This confidence is paramount; a wobble in trust can lead to fluctuations in market pricing, potentially causing a stablecoin to drift from its peg, thereby affecting its stability and utility.

The reserves of the issuer present another critical point of vulnerability. The ideal scenario is one where each stablecoin in circulation is backed one-to-one by fiat currency or equivalent assets held in reserve. However, the reality is often more complex, compounded by the difficulty of auditing issuers, especially those operating outside the jurisdiction of the fiat currency to which their tokens are pegged. This geographical and regulatory disconnect can obscure the true state of reserves, raising questions about the issuer's ability to maintain the peg in challenging times.

Moreover, the issue of redeemability casts a long shadow over the stablecoin landscape. Conceptually, holders should be able to redeem their tokens directly with the issuer, assuming a clear contractual relationship exists. Yet, in practice, many holders may find themselves at a disadvantage if the secondary market tanks. Issuers, particularly those with whom the holders have no direct relationship, may refuse redemption claims for myriad reasons, including compliance with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. This situation underscores a critical gap in understanding and expectations: just because a stablecoin theoretically offers a mechanism for redemption doesn't mean every holder will be able to utilise It Under All Circumstances.

What To Expect From The Future?

In the swiftly evolving narrative of digital finance, stablecoins emerge as both a testament to human ingenuity and a reminder of the complexities inherent in pioneering new monetary forms. They encapsulate the drive towards a more interconnected and accessible global economy, unshackled from the cumbersome constraints of traditional financial systems. Yet, as we chart this unexplored territory, we're reminded that innovation, while exhilarating, carries its share of risks that must be navigated with vigilance and a forward-thinking mindset.

The conversation around stablecoins, particularly fiat-backed variants, is just starting. It opens up a broader dialogue on how we perceive, utilise, and govern digital money in an increasingly decentralised world. As we delve deeper into the potentials and pitfalls of stablecoins, our journey is as much about shaping the future of finance as it is about understanding the intricate balance between innovation and stability, freedom and regulation. In this dynamic landscape, our collective challenge is to harness the revolutionary promise of stablecoins while ensuring they serve as a secure and stable medium of exchange for all, heralding a new era of financial inclusivity and empowerment. How powerful can a public blockchain token representing a claim on a JP Morgan deposit be? Can you imagine a future where all bank deposits are on-chain, being traded and priced in real-time? What

Long Reads

I would highly recommend that you read Nic Carter’s Cryptodollar paper published in 2021. It’s probably the one document that made me realise what I was missing before:

https://niccarter.info/wp-content/uploads/Cryptodollars-Castle-Island-Ventures-2020-07-07.pdf

The EU is front running the entire discussing on regulated stablecoins and has already published its first set of rules here:

https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32023R1114

This smaller piece from coinmetrics breaking down Tether meteoric rise and dominance among stablecoins is also quite interesting:

https://coinmetrics.substack.com/p/state-of-the-network-issue-243

We are now entering a new terrain, where the idea of PIX starts to materialise in the market through a relentless pursuit of efficiency, competitiveness and evolution by the Central Bank of Brazil. In this second part, I explore the main elements of PIX’s foundation, the past issues that were solved by the new system and the complexities of its creation.

The Issues

As we have explored in Part 1 – Beyond Cards and Codes: Unraveling Brazil’s Pre-Pix Payment Maze, the STR, created in 2002, is the backbone of the Brazilian Payments System, where money actually exchanges hands between institutions. But this infrastructure was already 20 years old. Although it performed quite well for the simple purpose of money flowing between large financial institutions, its design had a few limitations for further use cases:

• Not 24 / 7 – STR worked from 6:30am to 6:30pm on weekdays, skipping weekends and national holidays. Any other financial system working on top of it would have to work in the same time window or create a workaround to solve liquidity out-of-STR-hours.

• No confirmation message – the STR protocol didn’t have a proper message designed for the confirmation of deposit by the payee’s institution. Consequently, transactions given as settled were refunded hours later without any specific reason, creating complexity in the ecosystem and limiting the development of other payment flows and use cases.

• Protocol limitations – The protocol was designed to move money between two user accounts, two institutions or between a user account and an institution. But this was all. The old protocol was too rigid in terms of extensibility to allow the creation of other payment flows and secondary products.

• Infrastructure access – the Settlement Account, created as an instrument for Payment Institutions to access the backbone, was too complex to operate, and few institutions applied for it.

In addition, STR was only running a small portion of the TEDs in Brazil since all the banks were sending most of the transactions through SITRAF. Imagine what would have happened if, during its creation, Pix was optional. This was the exact case before.

To summarise, we can say that while TEDs had a great infrastructure for that time, the payment scheme above lacked more rigid rules to shape the evolution of the transactions in terms of REACH, TRUSTNESS and COST EFFICIENCY.

In an amazing technical analysis called Lessons From Pix: How to Build a Real-Time Payments Platform at its Full Potential, Mariana Cunha e Melo and Jonas Abreu give us a great summary of the issues the CB stood out to solve with the new design:

The Protocol Issue – It must be standardised but not over-specified. The communications protocol of many payment rails suffers from over-specification. Over-specification happens when, during the protocol design process, one establishes all the use cases to be supported instead of creating a backwards-compatible extensible structure that is able to represent all those use cases through extension. A familiar example in the world of payments is the ISO 20022 payment messages. Everything that goes into the payment needs to have a specific and already specified field in one of the messages. When another type of payment appears, instead of simply extending the message in a backwards-compatible way, you need to standardise the new type of payment and fully specify it in the protocol, which can take years to happen.

The need for standardisation is apparent. Without it, the many participants of the system cannot communicate with each other. But once the protocol is built to accommodate one specific need with specific fields and flows, it has to be extended by adding more specific fields and re-signifying old fields to evolve. The result is an intricate, inexpugnable web of old grammar with new semantics to decipher, and a big pile of unnecessary data travels in the system.

The Trust Issue – is twofold. From a regulatory standpoint, moving money around requires the guarantee that money will not disappear or multiply by mistake or by malicious design. For financial system regulators, that is an issue of systemic resilience and of currency stability. If a player is able to print digital currency or loses track of where someone’s money is located, the value of the national currency or the trust in the financial system may be severely affected. The risk of a systemic failure is at the heart of the Brazilian Central Bank’s concerns in regard to payment systems.

The second aspect of trust in this context is that connecting the financial system takes an arrangement between any two account service providers in the land. This requirement unfolds into several issues, from the complexity of business arrangements to the technical arrangements and issues, such as determining the source of truth.

The Issue of Reach – The issue of reach comes from the fact the payment system needs to connect any two accounts from any two account service providers. Solving this issue is the difference between having a walled garden where only a few member institutions can provide access to the payment service and having an ecosystem where every user knows that whatever economic transaction they are making, they can use the payment service to liquidate the price because everyone is reachable. That is what enables users to leave their houses with only one payment method because they know they will be able to use it for their every need.

Solving The Puzzle

However, solving that was no easy task. There were infinite paths to take, from promoting a new regulatory framework, allowing for a private infrastructure to take place, creating a public payment scheme but handing over the infrastructure, or building both but making them optional. A lot of trade-offs were on the table.

The final approach is, in my opinion, one of the strengths of PIX’s success over the last 3 years:

1. Create a new financial market infrastructure called SPI – Instant Payments System – another real-time gross settlement system, working on top of STR but 24/7. Link to SPI webpage here.

2. Create DICT – a centralised payment alias database that facilitates the identification of bank and payment accounts by linking personal keys like phone numbers, CPF (personal tax number) or emails to them. Link to DICT API specification here.

3. PIX, the scheme – a payment scheme created, incentivised and managed by the Central Bank, containing rules about how participants interact, what use cases are supported, what types of transactions can be charged and how, dictating minimal UX / UI parameters. Link to PIX rules here.

4. PIX, the brand … I know, I know, branding is just as part of a payment scheme as deposits and loans are part of banks. Some people say that Visa and Mastercard are brands first and networks second. I can’t disagree. The CB also did that, and quite well. They’ve chosen a name that was easy to say, easy to use and very catchy. They created brand guidelines, applications, DO’s and DONT’s. Link to the brand book here.

5. Direct and Indirect Access – From the start, the CB understood that access and reach were essential to full adoption. They created two types of access to make the system and scheme adoption mandatory to every institution in the S1 and S2 tiers but easily available to every other registered institution. In one shot, the CB gave full access and created another market for the BaaS – bank as a service – players.

   1. Direct Participants would hold accounts in SPI called Instant Payments Accounts, accessing them directly through the RSFN (National Financial System Network).

   2. Indirect Participants would be able to access all functionalities but through a Direct Participant, borrowing their access to the infrastructure and paying a fee for that.

This is what the new high-level architecture looks like after the SPI and DICT introduction.

I highlighted the Payment Institution E and Indirect Participant, accessing SPI through Bank C. To make this happen, Bank C would have to offer a transactional account with specific API functionalities designed for Indirect Participants. In this case, Payment Institution E exists in the PIX scheme, has its identifier and can be found by other institutions, but all its transactions are sent and settled through Bank C.

All other institutions in the drawing above are directly connected to SPI and have Reserves or Settlement accounts underneath – in the STR instance. They use their accounts in the STR system to feed their Instant Payment Accounts in the SPI instance. During STR non-working hours, institutions can borrow money from the central bank to solve liquidity issues, similar to what is done in STR.

This is how a set of transactions would look like:

• Payment Institution E is an indirect participant and uses Bank C as its direct participant

• Bank C uses its Reserve Account to top up its Instant Payment Account with R$ 1000

• Customer C (from Bank C) sends R$ 100 to customer D (in PI D) via PIX

• Customer E (from PI E) sends R$ 200 to customer A (in Bank A) via PIX

Real-Time Transactions Everywhere, Anytime…

What if we invert STR and SPI? Could the entire market drink from a continuously available font? Imagine card transactions settling on weekends, securities too… One of the core characteristics of STR is its specifically built messages supporting 2nd layer infrastructure systems like SILOC, SITRAF or even BM&F for securities settlement. All those secondary systems were restricted by STR working hours. Building those messages into SPI could create second-effect changes of the same magnitude as PIX. Could that change in the near future? What are your thoughts?

Creating a new payment paradigm

Creating a new payment system like Pix and ensuring its adoption in a market dominated by entrenched players like Visa and Mastercard is a complex challenge. The incentives that card schemes have put in place over many years make them an integral part of the financial ecosystem. However, introducing a new system isn’t solely the domain of policy-making; private markets can play a significant role as well. Here’s a breakdown of the various aspects involved:

1. Forming a Market & Breaking Through:

   • Regulatory Push: Policy-driven initiatives can provide the initial momentum. A central authority’s backing can build trust quickly, streamline implementation, and ensure widespread collaboration. In PIX’s case, the Central Bank enforced adoption through mandatory implementation by S1 and S2 institutions.

   • Cost Advantages: If the new system offers cost savings over traditional card schemes (lower transaction fees, reduced infrastructure costs, etc.), it becomes attractive for both merchants and consumers, as was the case with PIX.

   • User Experience: Speed, convenience, and versatility in transaction methods (like QR codes and instant transfers) can make the new system more appealing. But not just that. The Central Bank also created a very compelling and detailed guideline of the UX UI for end users of PIX, mainly inspired by the UK Openbanking Initiative that has pioneered this approach – link to the UK Openbanking UX UI Guidelines here.

   • User Experience: Speed, convenience, and versatility in transaction methods (like QR codes and instant transfers) can make the new system more appealing. But not just that. The Central Bank also created a very compelling and detailed guideline of the UX UI for end users of PIX, mainly inspired by the UK Openbanking Initiative that has pioneered this approach – link to the UK Openbanking UX UI Guidelines here.

   • Integration: Ensuring that the new system integrates seamlessly with existing financial infrastructures is crucial. This reduces barriers to entry for banks and merchants.

2. Policy Making vs. Private Markets:

   • Policy Making: Government or central bank initiatives can quickly roll out and mandate the adoption of new systems. This is particularly true in markets where the public good is prioritised over commercial interests.

   • Private Markets: While private entities can develop innovative solutions, their challenge lies in achieving scale and trust. Collaborations or consortiums of private entities can introduce new systems, as seen with cryptocurrency-based solutions or platforms like UPI in India.

3. Externalities:

   • Positive: A new system can promote financial inclusion, reduce transaction costs, and boost economic activity by offering a more efficient method of payment.

   • Negative: Potential risks include cyber threats, initial resistance or distrust, and disruption for businesses that need to integrate new payment methods.

4. Incentive Contrasts:

   • Pix vs. Card Schemes: While card schemes might offer loyalty points, cashback, and credit facilities, Pix focuses on instantaneous transactions, lower fees, and universal accessibility.

   • Pix vs. TEDs/DOCs: Pix operates 24/7 and settles instantly, while TEDs and DOCs had time restrictions and could take longer. Also, Pix often has lower or no fees compared to these traditional transfer methods.

   • Pix vs. Boletos: Boletos are payment slips often used for bill payments. They’re not instantaneous and require manual processing. Pix, being digital and immediate, offers a significant advantage in terms of speed and convenience.

In summary, while policy-driven initiatives like Pix have an edge in terms of trust and widespread adoption, private markets can also introduce disruptive payment methods. The key lies in understanding the existing market incentives and offering significant advantages in terms of cost, efficiency, and user experience.

The Main Elements that Led to Pix’s Adoption

• Accessibility: Pix was designed to be inclusive. Being smartphone-based (though not exclusively), it tapped into the widespread use of mobile devices in Brazil, making it more accessible to a broader demographic.

• Speed: Instantaneous transactions, regardless of the hour or day, were a game-changer. Unlike TED or DOC, which had restrictions, Pix operates 24/7.

• Cost: Transactions through Pix are often cheaper, especially for personal use cases. Businesses also benefit from it, usually paying less than a TED for a transfer and less than a debit card transaction for an in-store or online payment. This economic advantage drove adoption among merchants and consumers alike.

• Online User Authenticated Transaction: As it’s based on account-to-account transactions, PIX transactions are always authenticated by the sender through its own bank’s app. Card transactions online, especially debit ones, were usually more risky as cards didn’t offer an authentication method. Even after PSD2, Brazil was still lacking functionality, and when present, the user experience was often very poor.

• Flexibility and Versatility: With various ways to transact (e.g., using a QR code, phone number, email, or Pix key), it appealed to a wide range of users and use cases. The way PIX’s protocol was designed allowed for the expansion of use cases without compromising the core functionalities of the system.

• Aggressive Promotion & Education: The Central Bank and other stakeholders carried out widespread campaigns to educate the public about Pix’s benefits, ensuring users understood and trusted the system.

Central Bank Roles

As highlighted by Mariana and Jonas in Lessons from Pix, a lot of the project’s success is based on the fact that PIX was a government-driven full-stack payments initiative:

The Brazilian Central Bank created the rail, its rules, and its systems. It is also the one who operates the system and provides the necessary infrastructure. BCB is the financial and payments market regulator. The fact it was the financial system regulator that drove the whole project had many advantages in Brazil’s case. Although it might be possible to make different arrangements work in other countries, there are few incentives for a market-driven solution to strive for global optimisation and build a truly open, cost-effective, and flexible rail. To facilitate the process of extrapolating Pix’s case to a broader set of circumstances, however, the role the BCB plays in the Pix rail may be identified in this paper more generally as a Payment System Operator or PSO.

Let’s detail the roles to make it clearer to our readers:

1. Regulator:

   • As the monetary authority of Brazil, the Central Bank is responsible for overseeing and regulating the financial system, ensuring stability and integrity.

   • Within the context of Pix, the Central Bank extrapolates the typical Scheme Institution role below to make some of its rules mandatory. Additionally, with its mandate of promoting competitiveness in the market, the CB can prioritise user benefits and market development instead of participants’ margins. That was the case when they made all P2P and P2B transactions free for all users. Participants may charge businesses when they are receiving payments through PIX, though.

   • It also mandates standards for interoperability, ensuring that all banks and financial institutions in the system can seamlessly transact with each other.

2. Payment Scheme Institution:

   • The Central Bank defines Pix’s operational, security, and business rules. This means it sets the guidelines for conducting, settling, and reporting transactions.

   • As the payment scheme institution, the Central Bank also manages risks within the system, ensuring Pix remains a safe and trustworthy payment method.

3. Settlement and Accounts AliasInfrastructure (SPI and DICT):

   • SPI is the core infrastructure that underpins Pix. It’s the backbone that processes and settles transactions in real-time.

   • The Central Bank is responsible for maintaining and overseeing this infrastructure, ensuring it remains robust, secure, and efficient. This is crucial given the need for instant settlements.

   • By being in control of SPI, the Central Bank ensures the high availability of the system and its resilience against potential cyber threats and technical glitches.

Here, you can see the difference between PIX, where the Central Bank plays multiple roles at once, and a Private Card Scheme, where multiple institutions are playing different roles:

By playing these roles, the Central Bank guarantees Pix’s smooth functioning and instils public trust in the system. Their involvement ensures that Pix adheres to the highest security, reliability, and efficiency standards. Moreover, by being both the regulator and operator, the Central Bank is uniquely positioned to swiftly adapt and innovate the system as required.

This multi-faceted role of the Central Bank is crucial for the success of an instant payment system like Pix. It ensures not just technical robustness but also systemic integrity and public confidence.

Concerns About Central Bank’s Roles

When a single entity, like the Central Bank of Brazil in the case of Pix, assumes multiple roles traditionally distributed among different organisations, concerns about potential conflicts of interest and concentration of power arise. Let’s break down these concerns:

1. Concentration of Power:

   • With the Central Bank acting as both the regulator and operator of Pix, it consolidates a significant amount of power and control over the payment system. This concentration can potentially reduce checks and balances.

2. Regulation vs. Operation:

   • As the regulator, the Central Bank’s role is to establish rules, oversee the system, and ensure fair competition. As the operator, its interest lies in the smooth functioning and adoption of Pix.

   • There could be situations where what’s best for the operation of Pix might not align with broader regulatory goals. For instance, a decision that boosts Pix’s performance might inadvertently sideline other payment methods or reduce competition.

3. Commercial Interests vs. Public Good:

   • The sustainability of the payment market as a business is very important. While the Central Bank’s primary role is to serve the public interest, managing a system like Pix could also present commercial conflicts, especially related to other private Payment Schemes and Infrastructures that are core businesses of publicly traded companies.

   • There might be concerns that decisions taken by the central bank could harm or even kill private profitable businesses.

4. Transparency and Accountability:

   • With multiple roles consolidated, there could be concerns about the transparency of decisions. It might be challenging to discern whether a decision was made with the regulator or operator hat on.

   • This blurring of roles can lead to accountability concerns. If an issue arises with Pix, the Central Bank would oversee and potentially critique its work.

5. Risk Management:

   • Having the same entity regulate, define the payment scheme, and operate the infrastructure means the Central Bank assumes all the systemic risks. A failure at any level could have cascading effects on the entire payment ecosystem and potentially the broader financial system.

To address these concerns, the Central Bank maintained stringent internal checks and balances and kept a very transparent decision-making process, while making sure that all participants – represented through the market associations – were heard. By doing so, it ensured that its roles did not conflict and that the integrity of the Pix system and the broader financial ecosystem remained intact.

The final result is the incredible adoption seen in the last years, with PIX now accounting for more transactions than credit or debit cards.

If you are like me and want to dive even deeper, please read the amazing technical analysis called Lessons From Pix: How to Build a Real-Time Payments Platform at its Full Potential from Mariana Cunha e Melo and Jonas Abreu.

This is it! I will start with a three-part series exploring Brazil’s payment landscape before and after Pix. The dynamic world of payments is ever-changing, and Brazil stands as a testament to innovation, growth, and transformation. From the complex web of traditional payment methods to the groundbreaking introduction of Pix, the country’s financial landscape is rich with lessons, triumphs, and glimpses into the future. In this comprehensive three-part series, we’ll guide you through Brazil’s intriguing payment history, unravel the core elements that made Pix a remarkable success, and venture into the exciting possibilities ahead. Whether you’re a financial enthusiast, tech aficionado, or curious explorer, this series promises a captivating ride through the maze of payments in Brazil.

• Part 1 – “Beyond Cards and Codes: Unraveling Brazil’s Pre-Pix Payment Maze” – I explore the fascinating world of Brazil’s payment systems before Pix. From the everyday ‘Boletos’ to the entangled world of TEDs and DOCs, we uncover the systems, schemes, and strategies that shaped Brazil’s financial ecosystem.

• Part 2 – “Pix Foundation: The Elements of Success” – Discover the secret recipe that led to the success of Pix. I’ll dissect the infrastructure, policies, and innovations that allowed Pix to take the country by storm.

• [Coming soon] Part 3 – “Future Discussions: From Nupay to Payment Initiation, What Does the Future Look Like?” – Fasten your seatbelts as we travel into the future of Brazilian payments. What awaits beyond Pix? I’ll delve into emerging concepts like Payment Initiation in the scope of Open Finance and explore interesting strategies some players are adopting, like Nupay from Nubank.

Join me as I dissect, analyse, and forecast the trajectory of Brazil’s payment landscape. I want to engage, enlighten, and provoke thought. Your insights and perspectives are valuable to me. Feel free to share your thoughts or ask questions in the comments section. I look forward to hearing different ideas, perspectives and thoughts on this exploration with you.

Part 1 – Beyond Cards and Codes: Unraveling Brazil’s Pre-Pix Payment Maze

Before diving into the state of the Brazilian payment landscape leading to the introduction of Pix, it’s essential to understand the various components that make up a payment ecosystem. Each component plays a distinct role, often intertwined, to ensure the smooth functioning of the system. In this specific case, understanding the complex set of incentives created through card schemes, bank conventions, and other dynamics is a key element to solving the puzzle of ‘what made Pix such a tremendous success’.

• A payment scheme is the “rulebook” of a particular payment method. It sets out the rules, standards, and procedures that dictate how transactions are executed, cleared, and settled. This encompasses the rights, responsibilities, and obligations of all participants.

• The payment infrastructure is the “machinery” that facilitates transactions. It includes the technological and operational frameworks, like hardware, software, and communication channels, ensuring transactions are efficient, secure, and reliable.

• A payment scheme institution is the “architect” behind a payment system. This entity usually designs the payment scheme and could also be involved in developing or commissioning the required infrastructure.

• Payment institutions act as intermediaries in the payment process. These entities are licensed to provide payment services to end users. Their roles vary, from facilitating funds transfers to managing electronic money.

• The regulator, often a central bank or a designated governmental body, oversees the entire payment landscape. It ensures the payment system’s stability, reliability, and fairness, setting standards and guidelines and ensuring compliance.

With these components in mind, let’s explore Brazil’s payment landscape before introducing Pix and see how these various elements interacted and evolved.

The Last Decade

Before the introduction of Pix, Brazil boasted an intricate patchwork of payment schemes in different flavours. Open schemes managed by government authorities like TED, open schemes managed by private companies like Visa and Mastercard and yet closed schemes managed by the banks themselves.

Card adoption surged over the five years leading up to Pix’s launch with a consistent CAGR of 17%. Though Visa and Mastercard retained their dominance, Elo – a homegrown initiative co-founded by leading banks like Caixa, Bradesco, and Banco do Brasil – rapidly gained traction using the issuing power of its shareholders. The industry was reasonably advanced, with NFC gaining traction, settlements centralised in a regulated system and the presence of mobile wallets. The Central Bank and CADE – the antitrust authority – were already fomenting a lot of competition and innovation through new regulation, attracting more investments to the market.

Brazil also had significant use of wire transfers and invoice-based payments outside of cards. There were two predominant wire transfer forms: TED (Express Wire Transfer) and DOC (Credit Transfer Document). “Boletos” were the Brazilian version of invoice payments, but they utilised a standardised barcode format readable by any bank, containing not just payee details but also payment terms like due dates, penalties, and interest.

Both TED, DOC and Boletos are in fact payment schemes, like credit and debit cards from Visa and Mastercard. They defined the rules, dynamics, economics, and structures behind each instrument.

Wire Transfers in Brazil – Why So Many Flavours?

TED – The Express Wire Transfer Payment Scheme

It was an open public scheme, which was open to new participants adhering to a set of rules and managed by a public institution – the Brazilian Central Bank. To send a TED or a DOC, the user had to fill in the same fields: Transaction Value, Bank Number, Bank Branch Number, Account Number, and CPF (Brazilian Personal Fiscal ID) or CNPJ (Brazilian Business Fiscal ID). TEDs were supposed to be cleared and settled in just a few seconds, but the protocol didn’t account for a confirmation message from the receiving bank, properly notifying the deposit of funds. This was basically done on an assumption basis after 120 minutes – the TED rule’s SLA for returning failed transactions to the original institution. Besides that, TED was a fast instrument, but it was also expensive for end users as we are going to see later on.

DOC – The Slower Wire Transfer

Meanwhile, the DOC was another scheme, for values up to R$ 5000 that was supposed to be cheaper than TEDs. The transactions were cleared by midnight and settled the next business day, which meant the money took at least one full working day to arrive at its destination. The reason for that latency is that this conversation starts to get tricky. Underneath each payment scheme were different Payment Systems, the so-called Financial Market Infrastructures – or FMI in short. Let’s dig into them.

STR – The Reserves Transfering System: A 1st Layer Financial Market Infrastructure

Launched in 2002, STR served as a real-time gross settlement system, acting as the foundation of the Brazilian Payments System (SPB). All financial entities held reserve accounts at the central bank, with STR facilitating transfers between these accounts. Think of the Central Bank as the bank of the banks, their reserve accounts are basically a checking account, and the STR is the internal transfer system that moves money between two banks. Transactions on STR were fast, often settling in seconds. Pricing was based on a cost-coverage model. Despite its efficiency, STR wasn’t intended for consumer or commercial transactions. It only operated on weekdays from 6:30 am to 6:30 pm, and transfers didn’t have a message from the receiving bank confirming the deposit of funds. Additionally, the official SLA defined by the TED scheme refunds in case of failure was two hours, and reinforcement was lacking. Coupled with the rising liquidity demands, banks felt the need for an additional layer atop STR. One that would reduce their cash needs, leading to the creation of SITRAF.

Example of 3 TEDs sent using STR:

1. User A sending R$ 30 from bank A to user B in bank B.

2. User B sending R$ 50 from bank B to user C in bank C.

3. User C sending R$ 30 from bank C to user A in bank A.

SITRAF – Funds Transfer System: A 2nd Layer Infrastructure. Redundancy For What?

While the STR was created and operated by the Central Bank, SITRAF was a product from CIP – the Interbank Payment Clearinghouse created by the Bank’s association FEBRABAN. SITRAF was a “near real-time” net differed settlement system that utilised small intervals of 5 – 10 minutes to clear transactions between banks, calculating net positions and reducing risk and the demand for cash in the system. Even though SITRAF aimed for efficiency, it came with its own cost. The banks created a private convention – a parallel set of rules – to guide TED transactions sent through SITRAF. Remember that the TED scheme already had a set of rules defined by the Central Bank and mandatory for every institution using TED.

Since transactions were usually charged from the user sending money – the Payer – a particularly contentious rule was introduced, creating the TIB (later RCO) – a fee paid by the payer’s bank to the payee’s bank – for operational costs reimbursement purposes. Reimbursing a bank for the ‘burden’ of receiving more deposits sounds almost unbelievable, but it is still true today.

In 2017 the TIB was set at an astonishing R$ 1,19 per transaction, more than 10x STR transactional fee. Even more interesting was that the private convention determined that any TED was subjected to TIB charges, regardless of the system used for settlement. Ultimately, banks might charge R$ 10 for a single TED, despite an additional and slower layer meant to ease liquidity constraints… Let’s put it together if it is unclear: they created another redundant, slower, more expensive infrastructure with an extra fee embedded as an operational cost reimbursement to limit their cash needs, and they managed to still charge everyone north of R$ 10 per wire transfer.

Example of 3 TEDs sent using SITRAF:

1. User A sending R$ 30 from bank A to user B in bank B.

2. User B sending R$ 50 from bank B to user C in bank C.

3. User C sending R$ 30 from bank C to user A in bank A.

4. Transactions are calculated in SITRAF and the resulting net position bank B needs to send R$ 20 to bank C.

Introducing Payment Institutions in STR

In the world of finance, accounts often play unique roles. Such was the case when the Central Bank created distinct accounts for banks and payment institutions. Settlement Accounts were the new addition to the system, designated for payment institutions, existing for the sole purpose of settling transactions. Imagine an account with very simple functions of sending money – both to other institutions and customers of those institutions – and receiving money from both types of senders. Meanwhile, Reserve Accounts allowed banks to conduct interbank operations and multiply currency, something that payment institutions could not do.

Besides that, Payment Institutions were also allowed to have bank accounts themselves. In fact, this was Stone’s main settlement mechanism for many years – every morning, we would send money to our account in Itau and spread the money with internal transfers to Itau’s customers.

Banks were not allowed to do that. They operated interbank operations through STR, where borrowing and lending money from each other was conducted directly in the system.

The Money Printing Machine for Stone

Stone’s venture into the STR (Brazil’s real-time gross settlement system) began with a simple need to test their newly opened Settlements account. A R$ 0,01 transaction was sent from Stone’s checking account in Itau to their STR settlement account, arriving a few seconds later. We repeated 9 more R$ 0,01 transactions and the tests were declared a success. We celebrated!

But the next morning brought a surprise. Itau had sent Stone R$11.90 for the TIB fee. After sending R$ 0,10 cents in 10 different transactions from one account – in Itau – to another – in the STR – we made R$ 11,90 minus STR operational costs of a few cents. So we repeated the tests, this time with 100 transactions. Repeating the test yielded another R$119.00.

Breaking the Convention

Stone’s team quickly realized what had happened. In their efforts to understand the system, they’d stumbled upon a loophole, inadvertently creating a money-printing machine for themselves. With deep knowledge of the rules, they knew this was a mistake and promptly sent the money back to Itau, explaining they weren’t adhering to the convention that created the TIB. The problem was, when fully operational, Stone’s STR account would make millions of transactions every month, creating an unbearable and artificially created cost.

The situation sparked confusion among the banks, leading to an endless exchange of emails, policies, guidelines, and documents. It took the intervention of the Central Bank to clarify that the TIB was not a mandatory fee. Stone had proven its point.

Emboldened by this victory, Stone began providing settlement APIs to other fintechs, rapidly becoming responsible for a significant portion of the STR transactions in a day. Realising they’d been outmanoeuvred, the traditional banks were forced to change the convention rules, reducing the TIB from R$1.19 to a few cents per transaction.

This tale of innovation, understanding, and agility paints a vivid picture of Stone’s entrance into a complex financial landscape. Through detailed study, clever innovation, and open communication with regulatory bodies, Stone challenged traditional banking norms and paved the way for a more cost-efficient and equitable system.

Boletos: A Unique Payment Method in Brazil

In Brazil, the “Boleto Bancário” is not merely a barcoded payment slip; it’s a financial instrument that carries a wealth of information and specific terms. A Boleto can contain a due date, clearly informing the payer of the payment deadline. If a payment is missed, the Boleto can contain calculated fines and interest, enforcing a penalty for late payment.

Additionally, Boletos can include other terms and conditions, such as discounts for early payment or specific instructions related to the purchase. These parameters are embedded within the barcode of the Boleto, allowing for automated processing by banks and payment institutions.

The adaptability of Boletos makes them suitable for various purposes, such as paying bills, purchasing goods, or even making loan payments. The ability to embed complex terms within a simple payment slip has turned Boletos into a versatile and widely accepted form of payment nationwide. Whether paid online, through a mobile app, or at a physical location, the Boleto system ensures a consistent and comprehensive payment experience, reflecting the multifaceted nature of financial transactions in modern Brazil.

SILOC

SILOC, which stands for “Sistema de Liquidação Diferida das Transferências Interbancárias de Ordens de Crédito,” is a net deferred settlement system used in Brazil.

In this system, financial transactions are not settled individually as they happen. Instead, they are accumulated over a specific period, typically a business day, and then settled all at once at the end of that period.

Here’s how it works:

1. Accumulating Transactions: Throughout the day, banks and other financial institutions record the transactions made between them. This includes all kinds of payments and transfers, such as interbank operations.

2. Netting Process: At the end of the specified period, all the transactions are netted out. This means that the payments and receipts between each pair of institutions are summed up to a single net value. For instance, if Bank A owes Bank B $100 and Bank B owes Bank A $60, the net value would be a $40 payment from Bank A to Bank B.

3. Settlement: Once the net values are calculated, the transactions are settled in a central location, typically the Central Bank. This might involve transferring money between the reserve accounts of the institutions involved. The deferred nature of the settlement allows for efficiency, reducing the number of actual transactions that need to be processed.

4. Reconciliation and Reporting: After settlement, reports are sent to the participating institutions, allowing them to reconcile their accounts and ensure everything is processed correctly.

The SILOC system provides efficiency and reduces costs for the financial system. Handling transactions in a net deferred manner minimises the immediate liquidity demands on banks and allows them to manage their funds more effectively. At the same time, the consolidated and well-regulated nature of the system ensures its reliability and robustness, contributing to the stability of Brazil’s financial infrastructure.

BPS – Brazilian Payment System Overview

After diving into the different pieces of this puzzle, it’s nice to look at the whole picture together. This scheme shows Brazil’s payments market layers through the last decade.

• Layer 0 – STR – where the money actually exchanges hands from institution to institution. Each participant institution has to open an account with the Central Bank. Payment institutions have settlement accounts, while banks have reserve accounts. SELIC serves as a central hub where federal government bonds are held, and transactions related to those bonds are settled.

• Layer 1 – Other financial market infrastructure – SITRAF, SILOC, Visa and Master legacy clearing houses and COMPE for checks.

• Layer 2 – The payment schemes – with their guidelines, networks, authorisation systems and institutions.

• Layer 3 – Market participants – mainly banks and payment institutions.

A second snapshot shows the addition of SLC – Sistema de Liquidacao de Cartoes – another piece of infrastructure created by CIP and made mandatory by the Central Bank for the settlement of card transactions. SLC was just a clearing layer to calculate the net position of all participants in the card schemes, using SILOC underneath to finalise the settlement process. The system went live in 2017, replacing legacy clearing houses from Visanet and Redecard.