The way we pay
The way we pay is changing dramatically and quickly. The question is if we even understand the transactions we initiate and what will come next. One thing seems clear; cash is soon gone – even if it means no more bills burning holes in our pockets. Dan Ouchterlony, Head of Personal Finance, tells a story of an area where innovation really is happening.
1994 was a long, hot summer. Together with my father I had spent the better part of a week with my shoes planted in melting roofing tar, renovating the family’s lake house. Riding shotgun back into town on the Friday night I was inspecting my black, sticky shoe soles when dad reached for his wallet and uttered the magic words: Here’s your pay. Here is your pay – It was simpler back then.
Flash forward to today: I am shopping for food with my two-year old. She loves riding in the mall’s custom-built grocery cart and she loves helping her dad to pay. Well, actually, she loves inserting the card, punching in the pin code and pressing the big green ok button on the store’s card terminal. Little does she know that we, in fact, did not just pay. We authorized a complex multi-step process involving a handful different parties: She 1/ authorized my credit card issuer’s bank to transfer money to the store’s 2/ acquiring bank using the terms of the 3/ card association VISA and in the process she put 4/ me in temporary debt and extended 5/ the store a line of credit. Phew!
The payments industry has skillfully made something complex simple for the user. In fact this knack for simplification is at the core of what drives innovation for the simple reason that lowering friction, and obscuring the value of money, increases usage. Our irrationality in spending behaviour has long been the target of innovation.
With equal skill the industry has been obfuscating and convoluting the cost of the transaction. As a user you never really know how much you pay to pay. Sure, there is a yearly fee in some cases. But what about currency exchange spread, late fees, interchange fees, and overdraft? What does paying for things really cost?
Innovation on multiple levels
Daddy got ten cents on the dollar, sang Barbra Streisand. In the payments case it is about a quarter of a cent per dollar. That might not sound too bad, but the amount of dollars being paid is colossal. According to Boston Consulting Group more than 400 trillion dollars in digital payments are being handled yearly – that is around five times the global GDP! In a classic case of a small slice of a big pie, one trillion dollars are being captured and shaved off yearly.
With a trillion dollar prize it is no surprise that the payments space is seeing immense start-up and venture capital action. Innovation is really happening on multiple levels at once. Most of the action is not revolutionizing the payments infrastructure as such, but rather bringing existing payment technologies into new devices and situations. One example is Apple Pay, which in short is a very clever and user friendly way to use your existing credit card. Nothing more, nothing less, at least from a payments perspective.
If using the smartwatch as the key to digital transactions does not seem innovative enough, how about paying with chat messages? Some speculate that chat or text messages will be the user’s preferred control panel for everything. Snapcash, a partnership between youth-favourite chat app Snapchat and payments startup Square, lets users store their card details and subsequently send each other money with the flick of a finger. Chinese behemoth WeChat has also implemented a similar extension and made quite the buzz in 2013 when scattering 300 vending machines in the Beijing subway, allowing WeChatters to quench their thirst in-between messages using the app. This trend of online-offline convergence of payment is accelerating with offline experiences such as restaurants, kiosks etc. coming online through e.g. chat payments.
Some initiatives go further down into the stack and drive innovation in payments on a more fundamental level. One example is the Swedish, Sequoia-backed company Klarna. Using a familiar payment vehicle, the invoice, and some very clever technology to boot, Klarna’s proprietary credit scoring engine is handing out micro credit in real time. No need for a pre-approved credit line from your bank – just enter a few personal details and press the button! The beauty and simplicity is inseparable from magic, luring over 35 million users and 50,000 e-commerce companies to date. In fact, the process is so frictionless that many users do not realize they have taken a loan – until interest fees and late fees are unshrouded. As part of the business model, Klarna operates their own debt collection firm and have been criticized for being far too aggressive.
Bitcoin can change the game
One particular niche under attack is international payments, or remittances. Why? Among other things: Currency exchange spread. It is rather hard to tell unless you do your due diligence, but banks and payment companies do a surprisingly bad job of buying and selling currencies on your behalf. Purposefully? The high fees are a moral crime, according to top VC Marc Andreessen. This very high margin business for banks and money transfer specialists like Western Union is under pressure from well-funded start-ups like CurrencyFair, TransferWise and WorldRemit. What could banks do to protect themselves? According to Currency Cloud CEO Mike Laven, not that much: “Banks have built up a series of legacy systems over the years so they actually have to charge higher fees. It’s not that they’re bad people. Banks just have a higher cost base.” And a very high profitability.
From time to time a new technology comes along that catalyzes profound change and innovation. Examples are the wheel, the combustion engine, and the Internet Protocol. And now the Blockchain, which is the underlying technological invention that powers the more widely recognized cryptocurrency bitcoin. According to ex-Googler Paul Buchheit, famous for creating Gmail and coining the Google motto “don’t be evil”, bitcoin may be the TCP/IP of money. What on earth does that mean? To begin with it means bitcoin is at an extremely early phase of its development. And it means bitcoin has the potential to drastically change how we interact with money.
In the case of TCP/IP who would have thought that doing email in 1995 would be the first step on a path that would have you never again going to a record store in 2015? And the technology TCP/IP was invented by Serf and Kahn some 20 years before, in 1974. In 1994 the Electronic Frontier Foundation released a statement claiming the “World’s first electronic cash payment over computer networks”. Today, 20 years later, a set of very clever technologists and venture capitalists 17 are investing your pensions and savings in the Blockchain and bitcoin, hoping that what we see today is equivalent to email in 1995 – in terms of potential.
The concept of bitcoin not only promises to change the way we pay and interact with money, but also change the fundamental concept of what we pay – currency. How? Today, the concept of currency, fiat, is based on that we trust tax-funded and weapon-protected states (governments) to back up their currencies, e.g. the US dollar or the euro. These currencies are traded in the trillions of dollars daily on exchanges, reacting to ongoing events such as the Grexit or interest rate decisions by the Fed. With bitcoin we do not need intermediaries and governments and can instead trust each other and trust technology.
By leveraging very complex mathematics and calculations owning a certain set of numbers is the equivalent to owning a crisp dollar bill. This has the potential to radically speed up innovation by making handling of currency decentralized i.e. easier, faster and simpler. And also riskier. To date bitcoin is far from mass adoption, in part due to multiple high-profile fraud cases such as the spectacular downfall of Japanese bitcoin exchange Mt. Gox. The Kings of old understood that vibrant marketplaces and bazaars required careful nurture and protection from highwaymen and pirates – market making, or market design in the words of 2012 Nobel laureate Alvin Roth.
The key barrier to wider adoption, however, is the relatively high level of friction for the end user. Most people do not really care about the underlying technological revolution. They do care, however, about the several unfamiliar steps to get started, the fairly high level of computer skills needed for keeping the money safe, and the emotional friction due to the severe volatility of the exchange rate of bitcoin to e.g. US dollars. Not knowing whether your bitcoin would buy you 20, 240 or 60 Bic Macs over a two year period makes bitcoin seem more like a very risky investment than a store of value.
The role of bank is shapeshifting
The way we pay is fundamentally and irrevocably changing. Digital money will flow like water, silently and smoothly, overseen by our personal assistants and connected devices. In the background furious cryptographic computation, biometric identification and instant communication ensure the safety and validity of all transactions. And as transaction leave the realm of the physical the ancient role of the banks is also shapeshifting from giant steel vaults – keeping our valuables safeguarded under lock and key – into the more elusive duty of keeping our personal data secure and uncorrupted. Even the Internet itself is transforming into a network of money, where generations of digital natives will be triggering payments as casually as they shoot off chat messages.
With this fundamental change our emotional relationship to money and payments will also evolve. To use the language of today’s youth: the amount of f-cks given by my daughter will be zero when her car negotiates and pays for parking by itself with the garage’s AI. Her smartwatch will silently and biometrically verify her presence picking up the groceries, authorizing the transfer of funds. Instead of keeping mental tabs on any and every transaction she will trust the discrete but precise summaries and warnings in her notification flow.
Summarize ebbs and flows
A newly established coffee shop’s mediocre latte at an outrageous 63 per cent above market price will be flagged down and posted on social media. Who pulled that kind of stunt any more!? At the end of the day or week her personal financial management app will intelligently summarize the ebbs and flows of money, highlighting anything out of the ordinary and recommending the best course of action. She will never have to learn the many social and societal rituals of payment of the card-bill-and-coin generation, such as hiding pin codes, rummaging through purses, or standing in front of the candy machine with the wrong sort of coin in your hand. How will she tip the bartender, just to impress her friends or her date?
Entering the bar that same Friday night I could feel the small wad of bills from my dad burning a hole in my pocket: Self-confidence, a sense of accomplishment, and the promise of a good night out with friends. Paying the bartender for the first of what would become many rounds that night I proudly blurted out: keep the change! Not because the service was fantastic, but because I could.