Category Archives: New Payment Systems

Double Spending

Is the Bitcoin protocol like http or smtp or does one have to abstract up one level higher where Bitcoin is just one implementation of a http/smtp standard for digital money?  The passage below from Brian Armstrong illustrates the issue that such a protocol would solve:

Clearly open networks offer a number of benefits, so why hadn’t an open payment network existed previously? Until recently, many people thought it wasn’t possible to build a payment system on an open network. The core issue was around preventing duplicate spending without using a central company to verify each transaction. Nothing prevents you from sending duplicate emails multiple times, for example, if you wanted to do this.

This problem (the “double spending” problem) is what Bitcoin solves, and in this sense it truly was a technological breakthrough or invention (one that I think will be viewed as very important historically). If you’re someone in the business of verifying transactions on a proprietary network, the invention of Bitcoin cannot be safely ignored. It will change or disrupt the providers of most proprietary payment networks in the coming years.


The New Prison Labor

From Felix Salmon’s article about Bitcoin and digital currency more generally:

That said, credits in World of Warcraft are valuable enough that Chinese prison guards reportedly force convicts to perform monotonous tasks within the game for 12-hour stretches at a time, building up credits which can then be sold for many times the guards’ official salary.)

Perhaps more seriously, there is a great discussion of the relationship between a currency and commodity:

In reality, then, bitcoin doesn’t really behave like a currency at all. In terms of its market value, it looks much more like a highly-volatile commodity. That’s by design: bitcoins were created to be the most fungible commodity the world had ever seen – to the point at which they would effectively erase the distinction between a commodity and a currency.

But is that a good idea?

Dollars are a universally accepted unit of account: if something in the world has a price, it has a price in dollars. Dollars are not, on the other hand, physical commodities. The overwhelming majority of dollars in the world are deposited safely and electronically in banks: there’s something weird and self-defeating about the kind of people who keep their savings stuffed under the mattress. In Hollywood, if you show someone counting out huge sums of cash, that’s an easy way for the director to say that he’s a criminal.

Bitcoin was constructed to behave like a currency: it’s very easy to use bitcoins to pay for goods and services, especially if what you’re buying is in a different country. Right now, there’s literally no way to build a website selling some kind of service, and have a meaningful fraction of the world’s online population be able to pay you for that service. Bitcoin was designed to solve that problem; to be, in effect, thelingua franca of online commerce.

But it’s very hard to be a currency when you’re also a commodity, governed by rules of scarcity and subject to speculative attack. And it’s also very hard to be a currency – or even a commodity, for that matter – when you’re as smallas bitcoin is. Even now, at the top of a huge bubble, the total value of all the bitcoins in existence is the equivalent of about 2,000 standard gold bars– not remotely enough to revolutionize the global payments and currency systems as we know them. Given the choice between something old and solid, on the one hand, and something new and virtual, on the other, the market is still voting for the asset class which has proved its worth over millennia.

Cash Poor, Digital Rich

If you’re flaunting wads of cash, turns out you are poor.

In many respects for most people other than the poor, currency has become a private function rather than a traditional public function.  This is one of the most powerful arguments as to why there is place for entry based on real innovation in the payment systems market in 2013 and beyond.

This is how much cash is used as a share of U.S. spending based on household income for 2011.  (Source: Barron’s)

$35,000 60%

$50,000 15%

$60,000 10%

>$60,000 2%

Thus, for 98% of spending for folks of annual income, payment systems are taking a private cut of aggregate spending.

Here are links to past posts regarding the opportunity in digital payment systems.  Here, here, and here.

Currency: The Original Social Network

Before the tweet and the Facebook post, I was surprised to learn that the atomic unit for the original social network was currency.  Bills and coin had the rare character of being objects that reached every person in a society and circulated at very high velocity.

Centuries before Christ, someone realized that one could piggyback off the full reach and high circulation of the currency network to spread political messages from the ruler.  More fascinating was that by hijacking the circulation through defacement of the coin or bill, dissidents could spread their political messages even where other communication networks were cut off to them.

The Economist explains the theory and some recent uses of the currency social network:

IS MONEY a good medium to spread messages? At first Alexei Navalny, a Russian opposition activist and noted blogger, was sceptical. But then he did the maths: if 5,000 Russians stamped 100 bills each, every citizen would encounter at least one of the altered notes as they passed from person to person.

Members of Iran’s Green Movement used this tactic in 2009, writing slogans on banknotes during their anti-government protests. This prompted a ruling that defaced notes would no longer be accepted by banks. Similarly, supporters of the Occupy movement have added slogans and infographics about income inequality to dollar bills. And members of China’s Falun Gong movement wrote messages on banknotes attacking government persecution.

As we move more and more to new payment systems and fully digital money, it’s worth reflecting that not only has the state gained an effective way to track the flows of money through society, but dissidents have also lost a historical weapon by which they could spread their message far and wide against the will of the state.

Give Us Your UnBanked

Once upon a time, banks paid customers to hold their money.

That was a long time ago.  Today, banks pay little interest and charge high monthly fees relative to the balances held by account holders.  This change-in-tack corresponds to a time when having a bank account is increasingly more important as we move toward a cashless society.

Enter Wal-Mart and Amex’s introduction of the BlueBird service.  There is probably more than some overlap between the unbanked and WalMart customers.  It’s a natural business opportunity for Wal-Mart, and potentially immensely disruptive to banks.

Here is a short description of the service:

Using the retailer’s stores to promote and support the card, American Express is seeking to reach low-income customers with the service, which allows for cheque deposits and payments by smartphone and has no minimum balance or monthly fees.

The service, called Bluebird, is Walmart’s latest foray into financial services. As the retailer competes against encroaching
online rivals, the move could also help ensure customers keep visiting its stores, which will serve as Bluebird branches.

Dan Schulman, an American Express executive, said: “In an era where it is increasingly ‘expensive to be poor’, we have worked with Walmart to create a . . . product that rights many of the wrongs that plague the market today.” He said it was aimed at the “wide swath of consumers who are either unbanked, underbanked or unhappily banked”.

Better Than A PowerPoint

This is Jack Dorsey today in the WSJ:

We definitely have a lot of plans and we stick to them and hold ourselves accountable to them. But the way we funded ourselves is not [showing investors] a 40-page business plan. It was by asking, “Do you have a credit card? I’d like to show you the new product.” Once they are hooked, say, “Here’s how we will scale. Here’s how we will build it.”

Death or New Life For Cash?

Look, as I have blogged before, I think there probably is a massive disruption opportunity available with mobile payment systems or mobile wallets, but I don’t think anyone has articulated well-enough the customer benefit.  That articulation will really drive the scale and scope of the disruption of cash payments.  For example, why is paying with a phone app better than paying with your credit card?  If it’s just because it’s cool or more satisfying, is that good enough to drive a massive change in behavior?

While this recent Fortune survey of payment efforts — ambitiously titled the Death of Cash — is interesting, it doesn’t really convince me that the customer benefit has been convincingly articulated yet by any of the efforts (although Square’s efforts on articulating the benefits for small merchants and signing them up are impressive).

I think, the more important news of today actually raises the possibility the opposite might happen — cash may have new life.  Technology is cool, but the core issue with many merchants is that they don’t like paying credit card fees that cut 2-3% or more off their sales on credit card transactions.  Credit card association rules kept retailers from charging a surcharge to credit card customers over a cash purchase, but a forthcoming settlement between the retailers and credit card associations/banks, may eliminate that restriction.   In many states, the retailers could then charge surcharges for credit card usage, and indications (perhaps posturing) are that retailers will do so.

This sets up an experiment, with many interesting questions. Do customers still appreciate the convenience of card use to pay the surcharges?  Is the magic of mobile payment systems trumped by lower prices for cash?  Do consumers switch back to cash?  Do credit cards start slashing their fees to merchants to prevent customers from changing behavior?  Do retailers support alternative payment system outside the credit card models which take lower cuts of sales?

In my mind, assuming the settlement happens, these may be the real questions that will drive whether cash is really dead over the next couple of years.

My Personal CFO Is On The Phone

For the couple of years in which it has been discussed, I’ve been stumped at why I need my mobile phone to be a wallet.

Sure, I can understand it from the provider perspective. If a company puts itself between me and my spending, there is a tremendous opportunity.  If I am Google, I can deliver ads on a timely basis based on that information and placement.  If I am a wireless company who owns that wallet, I can dip my paws in another revenue stream.  If I am a bank or credit card company, I can continue to maintain my incumbent position as the money intermediary by blocking Google from taking that position.

But from a customer perspective, I have failed to see the benefit to me.   What does it matter whether I carry a credit card in my wallet (which I need for other reasons) or whether that information is stored on my phone?

And without that benefit, there isn’t a business, no matter how many providers want it.

But here’s a customer benefit.  What’s powerful about the smartphone generally is the concept of having a lot of computing power in your hand on the go.  In the case of payments, the payoff is putting a computer between the individual and every payment he makes.  The reason is simple.  Company have CFOs who oversee financial decisions, with the mandate to prevent stupid financial decisions.  Individuals don’t and consequently make dumb financial decisions.  Indeed, the profits of the retail banking industry have been built on this premise, as described in this description of the retail banking industry in the Economist:

It will be harder to pretend that banking is free when in fact it relies on customers giving banks virtually interest-free loans in the form of deposits; harder to profit from the disorganisation or sloth of customers who slip into unauthorised overdrafts or roll over balances on high-interest credit cards while leaving cash in low-yielding savings accounts.

Much of retail finance has been built on customer ignorance and making non-optimal choices.  A gatekeeper that makes more logical decisions completely upends this banking paradigm.  As the Economist says:

If this was just a more convenient way of paying, the banks would probably shrug. But it also promises to overturn your existing financial relationships. Instead of reaching for the first card that happens to be in your wallet to pay for a $2 cup of coffee (and risk being charged a $35 penalty by your bank for exceeding your overdraft limit), your phone will choose the best method of payment. Credit cards with the highest rates of interest, or the meanest rewards schemes, will be shunted to the back of this smart wallet. Repayments will automatically be channelled to pay off the most expensive loans first. Penalty fees for inadvertent overdrafts will become things of the past.

So, the opportunity for customers is inserting a microchip as personal CFO between our instincts/carelessness and our spending to help avoid silly financial moves.  The problem is that many of the contenders have no interest in this outcome, further disrupting the huge profits available from customers making non-optimal decisions.

Of course, in order for this vision to come through, what matters is that the architect of the mobile wallet has the incentive to enable better financial decisions.  That is where the opportunity lies for greenfield entrepreneurs, without a stake in the existing system.

NYC’s Coming Square Fares

As kids, we learn that bad people use the cover of darkness to do bad things. Shining a light and illuminating the situation often takes care of the problem.

With its opacity and fat margins, the payments space represents a huge pinata of opportunity for entrepreneurs. Along those lines, I blogged, recently, about Dwolla, which appears to be a full-fledged attack on the current payment system.  Even staying within the current system, transparency and simplicity offer major opportunities to bring benefits to customers.  Some interesting news concerning Square today exemplifies this value.

Several years ago, credit card acceptance became mandatory in New York cabs. Reports say that this has driven both usage and tips higher.  But the 5% fee on credit card fares has infuriated drivers.  3.5% goes to the credit card processor.  And the garages and fleets that hold the medallions and lease out the cabs to drivers have taken a 1.5% cut for nebulous “overhead.”  The medallion holders have piggy-backed on and exploited the opacity around payments to grab their own cut.

Enter the experiment with Square, under which 50 cabs will be equipped with Square-equipped tablets if approved later this week.  Not only should it remove any justification for the 1.5% grab from the driver’s take, it presumably will lower the processing fee since even Square’s standard rate of 2.75% is lower than the incumbent processors.  This is great for the driver, putting a little more into his pocket.

And, as more than just an additional benefit, thankfully, it will return a little sanity back into the cab for both driver and rider by shutting off the ridiculous and useless television screen and replacing it with a tablet that should offer something more useful to riders.

Welcome to the Big Apple, Square!

Starting Over

The second startup theme sparked by Dwolla.

I love the exercise of performing the thought experiment of how to design a system or process today to optimize performance without dealing with the constraints and artifacts of actual history.  This is from the TechCrunch piece on Dwolla:

It’s an all-new payment option.  The idea behind the company is to rethink what a payments network would look like if it was built today using web technologies. By eliminating the legacy issues, fraud and overhead, it can lower costs for end users and merchants alike.

Explains founder Ben Milne, “Dwolla’s network isn’t just about mobile wallets and sending money to your friends with Facebook, it’s about creating an entirely new network architecture to disrupt the $332 trillion electronic payments landscape.”

So, for example, one could ask, in addition to how payment networks would be designed in the digital age, how would digital books or music look like if designed today without the burdens of a history of a physical past.

The delivery of many services is susceptible to such a thought exercise.  Services are often about the transfer of information.  The digital age is about the frictionless transfer of information, so if you somehow imagine how that would work starting from scratch — putting aside the current dominating institutions, the gray hair/experience factor, sticky relationships, closed systems — you would be onto something in finding an area to disrupt.