Digital payments: Revolution, evolution, or both?
There is much discussion among followers of financial technology about the “revolution” in payments — a broad term encompassing all aspects of transferring value from one party to another. Most of the focus is on how Apple Pay and other so-called digital wallets (Google Wallet, Softcard, etc.) are applying near-field communications and enhanced security measures to the use of credit cards via smartphone. Of course, this isn’t the only area where technology is changing value transfer. The Federal Reserve recently announced an initiative, and released a report, about modernizing the U.S. payments infrastructure, and innovative approaches to digital payments are helping those with limited or nonexistent access to formal financial services around the world.
Still, are payments actually being revolutionized, or is this more of an evolution of current models aimed at taking advantage of new technology? The Milken Institute recently visited Silicon Valley to convene experts across the payments space, including market participants, academics, and regulators, to discuss whether we were seeing evolution or revolution. Their answer: “Yes.” To be more specific, they said, in essence, “It depends on what aspect of payments and where.”
There absolutely is a revolution unfolding in providing payment services to the underbanked in the developing world. The private sector, often led by mobile operators, local governments, and in many cases the U.S. government, is using financial technology to change how people store and transfer value. These efforts include encouraging the growth of a digital payments ecosystem (e.g., encouraging merchants to accept them), using digital means to pay recipients directly (providing a safer and more inclusive method in places where access to formal banking is limited), and changing how money is transferred internationally to avoid inefficient and expensive legacy systems.
While some of these innovations are originating in the United States or Western Europe, many are being born in the developing world, where the relative lack of formal financial or established regulatory systems allow market participants and regulators to be flexible. In fact, many regulators are explicitly encouraging innovation, while monitoring it closely, in hopes that financial technology expands access to traditional banking or credit scoring for their populations.
Regarding domestic payments, the consensus was that digital wallets are more evolutionary. They sit on top of existing credit and debit card systems, are subject to current regulatory schemes, and fill a role very similar role to the trusty plastic card. One participant asked whether digital wallets would eventually replace credit cards, given that the latter are cheap, resistant to wear, and never run out of battery life, unlike a smartphone.
Similar views were expressed on modernizing U.S. payments infrastructure. The current system, while not without flaws, is robust, secure, and well understood by its users. It can be improved, but those improvements may well be more iterative than transformative. (The Fed’s report does contemplate certain revolutionary options, like using a public ledger system for bilateral clearance and settlement.) Additionally, and perhaps ironically, the more established regulatory regime in the United States could impose barriers to innovation. As was pointed out at the meeting, multiple federal regulators have jurisdiction over various parts of the payments system, with numerous state and local regulators involved as well. Even if certain regulators are willing to encourage innovation with pilot programs, waivers, or “no-action” letters, such openings can be shut down if other officials are unwilling to go along.
(As one of the most developed, diverse, and mature economies on Earth, the U.S. has naturally built a more expansive regulatory structure than those found in the developing world. To the extent that U.S. regulation is unnecessarily hampering innovation, officials may wish to change their models.)
While some frustration was aired during the roundtable, there was also acknowledgement that regulators and market participants needed to collaborate to strengthen both flexibility and security. Of course, the experts also pointed out that these are still early days. One can imagine a world where a mobile wallet contains your ID, insurance information, and targeted offers in addition to payment details, with all their privacy and regulatory implications.
In assessing where payments are and where they are going, we should remember that enough evolution starts to look fairly revolutionary (after all, it worked for this guy). So even if the steps we observe aren’t turning everything upside down, it doesn’t mean we won’t look back on this time as the start of the revolution.