The Paradox of Counterfeit Deterrence and Detection

When we look at a piece of art, what exactly are we seeing? This of course depends on who we are, expert or amateur; but it also depends on our mood, our state of mind, and how much time we have.

For example, a connoisseur of, say, the Dutch artist, Vermeer, would instantly spot a bad fake, but might need a little more time if the work had been copied by a competent painter in the style of Vermeer – something which would be beyond the capabilities of the great majority of amateurs, however much time they have.

Most banknotes are small but highly complex works of art: central banks proudly promote their new designs, highlighting the new public recognition security (L1) features so as to make the designs more distinguishable and identifiable, thereby hopefully making any counterfeit more conspicuous… and for the first two or three times we look at our banknotes, we admire the complexity of the designs with their eye-catching new security features, be they ink, thread or foil.

Then our normal life takes over, and, however vigilant we try to be, and however intuitive the security of the design, human fallibility comes into play, and, without any real immediate reason to think otherwise, we just assume the notes are genuine, put them in our wallets and move on, without checking.

Having said that, it is of course this complexity which makes the counterfeiter’s life more difficult; and hopefully persuades them to move on to another currency which is less complex, and where there is more likelihood of success. This is the key to the counterfeit deterrent strategy.

For the small-time opportunist, the counterfeit only needs to be passed once, and therefore they just need to replicate the visual design as close as possible to the original – enough to pass in a busy market or bar. Job done.

For more serious fraudsters, however, who are investing in the production of large volumes of counterfeits, there is a need for their counterfeits to go undetected for rather longer so as to get the best possible return on their investment, ie. by successfully introducing as many notes as possible into the economy. To counter this, the central bank needs to develop a detection strategy, as opposed to just a deterrent strategy, to ensure these counterfeits are picked up as soon as possible.

The challenge for central banks is that the great majority of counterfeits are detected not by individuals but by automated cash handling equipment which authenticate via machine-readable (L2) features, like IR and magnetics.

So far so good – if it seems to be working, then the detection strategy is clearly effective.

Context is important here.

Firstly, most of the recent R&D spend on anti-counterfeit technologies has been on L1 features – and, as stated, good L1 features are clearly essential to deter counterfeiters.

But we have already seen that humans are fallible, subject to both carelessness (even the worst counterfeits will be accepted by some people all of the time), and ignorance (even the best features will never be recognised by some people).

Because we use them every day without a problem we tend to take for granted that the banknotes handed to us, particularly those with less transactional value, are genuine – which means that there is every likelihood that relatively good counterfeits are going to pass their first test: the public recognition test.

If there is even the slightest risk of this, then it is essential that the next part of the anti-counterfeit detection strategy is effective, ie. at the cash handling stage.

However, there has been notably less R&D investment in L2 technologies, and whilst the volume of successful counterfeits of L2 features per se is still relatively low, it appears that serious counterfeiters sense the opportunity.

Herein the second contextual point.

Central banks are increasingly outsourcing the processing of cash to the commercial sector to reduce the logistics cost of cash, and to make the whole cash cycle more sustainable. This requires the commercial sector to invest in cash handling equipment so as to ensure only fit and genuine notes are re-issued to the public. In the traditional cash cycle model central banks processed cash on a daily basis, generally on large banknote sorting equipment, fitted with more sophisticated L2 and possibly proprietary covert (L3) sensors.

Now, however, retailers, commercial bank branches and cash centres need to be able to detect counterfeits using smaller cash handling machines, but do not want to invest in expensive detectors across an extensive portfolio of equipment. The serious counterfeiter is now aware that most run-of-the-mill L2 features are a potential weak link in the banknote cash cycle – and several recent instances of counterfeits successfully passing through the system undetected by cash handling equipment indicate that they are right.

The paradox is that central banks predominantly spend most of the cost of their banknotes (probably >60%) on public recognition (L1) features, when the reality is that it is the L2 technologies, which rarely cost even as much as 10% of the cost of a note, which are detecting most counterfeits – and, as stated – just because it seems to have worked in the past, does not mean it will in the future.

The risk of an opportunist counterfeit being accepted in a dark bar at night is irritating but hardly disastrous. The risk of thousands if not millions of counterfeits passing through the system before the central bank has noticed and had time to warn the public is a potential financial and economic melt-down, prompting a possible run on the national currency, with people only accepting a more stable and reliable currency like the US dollar or euro. This is a nightmare scenario for any central bank – but then why is so little attention paid to where the notes are really being detected?

The conclusion is that, in a changing world, central banks need to recognise that counterfeiters are becoming increasingly technically sophisticated and will take advantage of any breach in the system: the security of a banknote is only as good as its weakest link. The supply industry needs to pay more attention to developing new, more effective L2 technologies to counteract the potential threat.

Central banks need to recognise that human weakness means that both their current deterrent and detection strategies need a bit more care and attention – rather like those banknotes in your pocket.