Cryptocurrency: A Risk Too Far for Credit Card Issuers?
By John Jones
Recently, the media reported that Lloyds Bank had followed the lead of various U.S. issuers such as Citi, J.P. Morgan, Bank of America, and Capital One in blocking its UK credit card customers across all of its brands from purchasing cryptocurrencies on their cards. Their action was quickly followed by other UK credit card issuers, and while no bank publicly explained the rationale behind this step, consumer groups welcomed the approach.
Curious about the reasons and implications of this change, Argus delved into its depersonalized anonymous UK payments data to understand the transactions made by consumers purchasing cryptocurrencies during 2017–18. We think the answers to the following questions shine a light on issues surrounding the global cryptocurrency business:
- Were there any significant changes in the types of consumers who were investing over time that the banks would view as increasing the likelihood of risk, such as income distribution shifts or geographic shifts?
- How are consumers funding these investments, and do those choices create longer-term risk?
- What is at stake for the banks themselves in terms of regulatory or reputational risk?
An analysis of those questions allowed us to better understand the possible rationale behind the changes and also assess the likely effectiveness in the UK as credit issuers around the world adapt to the cryptocurrency phenomenon.
Were there changes in the type of consumer investing in cryptocurrency?
The increase in UK spend on cryptocurrency investment is staggering—growing 70-fold from approximately £400,000 in January 2017 to over £27 million in December 2017, outstripping the rapid increase in value of a Bitcoin from £762 to £11,498 for the same period. However, the volatility of Bitcoin was also becoming more evident during 4Q17, subsequently dropping to £7,078 in January 2018.
The potential for gain attracted many new investors to the cryptocurrency market during 2017, many of whom had not demonstrated any prior evidence of credit card investment activity in the past. The images below demonstrate the explosion of spend for London during 2017—starting with very limited numbers of investors within the M25 area but ending the year with investors all across the region as increasing numbers of trading companies advertised their services across all media, making investment easier and quicker.
This behavior was not limited to major cities such as London. Spend increases were evident countrywide as potential investors used credit cards to make investment purchases and hopefully share in the growth. However, if we add consumer income to the national charts, it becomes evident that low- and mid-income consumers are increasingly using credit to fund cryptocurrency investments. The concentration of consumers with lower incomes in cities like Liverpool, Leeds, and Glasgow is far greater than in London, and this phenomenon has increased quarter on quarter and stretched to other cities.
How are consumers funding their investments in cryptocurrency?
From a macro level of the industry, the mix of cyber currency investors when segmented by income has in fact improved—with a larger percentage of new investors in the market coming from high-income households. However, when examined in terms of consumers, it’s clear that there’s an increasing number of low- to mid-income card customers that are also being attracted to the investment, as indicated below—with more than 15,000 new customers in these segments making their first transaction in the fourth quarter (as Bitcoin reached its peak).
The increase in low- to mid-income households using credit cards for this type of transaction may be perceived as risky by card issuers—with consumers potentially using credit to fund investments. Such balances would be at a higher risk of charge-off if investments lost value. Balances “at risk” within these income bands jumped from £2.5 million for new investors in first-quarter 2017 to £30 million for new investors in the fourth quarter, which may well have escalated issuers’ risk concerns.
When diving deeper into the credit card repayment behaviors exhibited by cryptocurrency investors, some further issues are evident, which may have raised risk concerns for card issuers:
- Consumers are funding cryptocurrency investments with borrowings—with more than 40 percent of purchasers revolving (paying interest) on their cards irrespective of income level.
- Consumers are also using 0 percent offers (balance transfer and retail) to fund investments.
- The percentage of low-income consumers who are borrowing to invest is also increasing.
However, cryptocurrency investors do seem “card savvy,” with an increasing percent of investments being made on cards that offer retail rewards for spending—especially among higher-income consumers, and adjustments to reward benefit from the purchase of cryptocurrency could also have helped dissuade this type of credit card transaction.
Consumer behavior changes following cryptocurrency investments
To understand whether investing in cryptocurrency has changed behaviors on consumer accounts, Argus took a sample of depersonalized anonymous investor data across all risk bands that invested in first-quarter 2017 to identify any material changes. We combined transactions and balances across all cards held by an investor (the card used for investment and other wallet cards) to understand whether the investment or other factors were driving any risk-orientated behavioral effects.
When examined at this level, there’s a clear difference in average consumer behavior between high- and low-risk cryptocurrency investors with:
- negligible balance change over time for low-risk customers on their card used for purchases when compared to average wallet balances
- a sharp increase in balances over time for high-risk customers on their card used for investing, in conjunction with a general increase on all cards
It should be noted, however, that the growth in balances on high-risk accounts exceeded the amount invested, and therefore the spend was part of a general adverse behavioral shift rather than a specific cause.
Other risk factors for consideration
The move to block cyber currency purchases, while unusual, is not exceptional, with many UK and international banks already blocking other types of credit card purchases, such as gambling transactions. So, we’ve considered other risks that banks may have considered as part of this decision:
From a compliance and regulatory perspective, it's possible that the protection afforded to UK consumers under s. 75 of the Consumer Credit Act may not extend to investments, and so, banks might not have to compensate consumers for any loss on their investments in this way. However, a key focus for UK regulators recently has been indebtedness, and the correlation of investment with higher levels of debt as shown above (particularly for higher-risk customers) would have been clearly understood.
Finally, as a whole, accounts investing in cryptocurrencies were marginally more profitable than an “average” account. So, a decision to block these transactions and potentially drive adverse consumer action would have been taken seriously and included views of risk and potential loss from future (and indeed current) investment purchases.
While the reason for blocking cryptocurrency transactions was not explained by the banks, the media interpretation of their actions was that it was intended to tackle risky consumer behavior. Our analysis has confirmed that interpretation and shown the following:
- There was substantial growth in investment activity on credit cards—geographically and across risk bands and income levels in the UK, with spend increasing approximately 70 times during the year.
- While low-risk, high-income consumers funded the investment through card repayment (and took advantage of reward offers to do so), higher-risk and lower-income consumers were much more likely to leverage credit to invest—and are paying interest on the principal while also potentially seeing the value of the investment fall below outstanding lending balances.
- The peak of consumer investment also coincided with higher levels of external balance growth on more risky accounts, with other spend contributing to this increase.
In viewing the UK as a microcosm for how the global cryptocurrency business is affecting credit card issuers, it would appear that the banks’ action was a sound strategy in reducing credit risk and also potentially aligning with regulatory focus around consumer indebtedness and was not dissimilar to prior actions to block gambling transactions. Argus will continue to monitor industry and consumer actions to understand any long-term implications of this change and to see whether the high level of investments followed by falls in cyber currency value do result in increased credit losses during 2018.
John Jones is president of Argus International, a Verisk business.