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CHAPTER II - The Weightless Marketplace: New Methods of Payment

The Weightless Marketplace: New Methods of Payment

A second session of the conference focused on the innovations in new methods of payment, especially through mobile phones and the Internet. The idea of a “weightless marketplace” is an apt metaphor because the technical barriers and expenses of market transactions are decreasing radically. As payment systems become easier, cheaper and seemingly invisible, they are reducing the “friction” that has historically been associated with transactions. But it is not entirely clear how the simmering competition among payment systems for e-commerce will shake out, particularly for mobile phone transactions (“m-commerce”).

Jack Stephenson, Managing Director of Mobile, E-Commerce and Payments for JPMorgan Chase, offered a broad overview of the current state of payments systems. Currently, there are five main ways to pay for things: cash; checks and bank notes; credit cards; bank transfer payment systems; and ACH-style wire systems for financial transactions (Automated Clearing House). Two salient features affect the viability and longevity of payment systems, said Stephenson: their ability to meet the needs of both consumers and merchants in what he called “two-sided markets;” and the role of network effects in deterring new entrants into the field.

In terms of two-sided markets, the needs and interests of merchants are often the critical factor in the success of a payment system. For consumers, there are some “basic laws about payments” that affect a system’s success, said Stephenson. It must work quickly and easily among minimally trained people. It has to be widely accepted. It must be trusted by both consumers and merchants. For merchants, the system must work without complications because they do not want to discourage sales through long check-out lines. This means that a minimum-wage clerk with few skills must be able to easily learn how to use the system.

Merchants want any payment system to facilitate sales by lowering the costs of transactions, after all. They are also eager to obtain their money from transactions quickly and with few hassles. There is a great virtue to legacy systems, said Stephenson, because sellers and their customers are comfortable with them, and they have become deeply integrated into the “ingrained business processes” of companies. “Basically, payments systems are like plumbing,” said Stephenson. “It’s an ugly back-end system. You want it to be invisible, frictionless and seamless. You don’t want to have to think about it. That’s the way we prefer payments to work.”

Citing a recent article that he co-authored on the topic, Stephenson said, “While more than 200 new payment systems were launched between 1993 and 2000, only one has emerged as a standout success—PayPal, with some 86 million accounts in more than 55 countries.” He noted that while some new entrants are still in business, more than 190 of them have failed.

Still, payment system innovators persist. Several major factors are driving what Gartner, the consulting firm, calls the “democratization of money.” These include 1) individual access to massive, high-speed flows of information that help people understand and define the value of goods and services quickly; 2) the proliferation ofmobile computing such as smartphones, feature phones, tablets and notebook computers, which enable context-aware computing; 3) the rise of the cloud, which enables individuals to “transact directly with multiple counterparties around the world, without having to use financial intermediaries;” and 4) social commons of highly specialized communities of interest (Craigslist, Facebook, Groupon, Pinterest), all of which are amenable to crowdsourcing of opinion, peer influence and “carrot mob” sales at particular times and places.

To be sure, network effects discourage innovation in this space, much as the dominance of the “Wintel” standard (Windows software/Intel chip) and the Federal Express overnight-delivery model have deterred competition. “It takes a long, long, long time to get enough users onboard to be able to make a system work,” said Stephenson.

“But at some point, you may hit a tipping point when you attract enough people,” as the Diners Club and American Express Cards did in the 1950s and 1960s, he said. These payment systems addressed very specific problems (after hours business entertaining) and they took a long time to build a sufficiently large network of participating merchants and customers. Because such systems tend to achieve a lock-in, said Stephenson, “it’s extraordinarily difficult to break in with a new system, even if you’re providing greater value to the consumer.” Stephenson recalls how when he first started in the business in the early 1980s, there were about 280 different payment networks, 30 ACHs and 180 ATMs (automated teller machines) in the U.S. Now those numbers have been “massively consolidated,” he said.

Credit Cards vs. Mobile Payment Systems

Even though existingpayment systems are deeply entrenched and familiar, there are a number of new types of systems emerging, especially for mobile phones and devices. The big question is whether these upstarts can compete successfully with incumbent payment systems, especially credit cards.

“What’s interesting to me about mobile payment systems is that so many of them are actually working,” said Eric Dunn, Senior Vice President for Payments & Commerce Network Solutions for Intuit Corporation. There are new systems that let people scan checks with their smartphones and send those images to their bank to make deposits. There are bank bill-pay systems that let people pay bills via their phones. Online vendors like Amazon accept mobile phone payments (using credit cards). Mobile peer-to-peer payments, such as PayPal payments, are another option.

Finally, there are new card swipe devices such as Intuit’s GoPayment dongle and the Square, which can be attached to phones to make credit card purchases. Stephenson said that these systems “are basically solving the same problem that PayPal solved—to make it incredibly easy for a person to accept a credit card.”

But even with such innovation, there are complaints about too much friction in the new systems. They can be either technically complicated, not that convenient or costly in terms of transaction fees paid to third parties. “People don’t want to sit and type sixteen-digit credit card numbers over and over and over again with their thumbs,” said Stephenson of JPMorgan Chase. “People don’t want to have 85 different [digital] wallets.” Such impediments will discourage consumers from completing transactions, which shows up in the digital shopping cart “abandonment rate” statistics.

While Apple has seemingly solved the convenience issue through its iPhone and iTunes store, the company charges a hefty surcharge for such transactions. Shane Green, Co-Founder and Chief Executive Officer of Personal, finds it “incredibly easy” to make purchases via these systems, “but I’m paying a 30 percent upcharge every time a I buy something, which I would not necessarily have to pay if I paid directly to the seller. That’s coming out of the prices that sellers are having to pay to Apple; I’m not seeing [those savings] as a consumer.”

Green sees “a lot of artificial” in consumer transactions that is simply about various players “protecting their market turf.” Green believes that a variety of payment startup companies could reduce transaction fees to a tenth of what credit card companies currently charge. But of course, any newcomers must make their alternative systems highly convenient for consumers and merchants alike. “When you solve the convenience problem, as Apple has in its ecosystem, it’s radical how fast the consumer will go towards it,” Green said.

Of course, credit cards are the default standard for easy, ubiquitous, trusted electronic payments. They also let consumers easily consolidate their diverse purchases into a single bill.

But some merchants are not especially happy about the 2 percent transaction fee (“200 basis points”) that they incur, on average, to accept credit cards. (The basis points may vary somewhat depending upon a merchant’s particular agreement with its so-called acquirer.) The issuing banks receive much of the transaction fees because they take the trouble to find the credit card user; underwrite his credit risk; give him a 30-day float on the money used in purchases; and promote higher merchant sales (because consumers are more inclined to buy something with a card versus cash).

To try to reduce the fees paid for credit card usage, a consortium of large national merchants are starting to organize and flex their muscles. Approximately one-third of U.S. retailers, including Walmart, Best Buy, Dunkin Donuts, CVS and 7-Eleven, have started their own network, MCX or Merchant Commerce Exchange. The goal is to develop “a customer-focused, versatile, seamlessly integrated mobile-commerce platform.” MCX is trying to develop a mobile phone, non-card payment system whose fees would be closer to 5 cents per transaction (using MCX) rather than 23 cents (the Durbin-regulated cost of a debit transaction, which in turn is far lower than the cost of a typical credit card transaction).

Vijay Sondhi, Head of Corporate Strategy for Visa Inc., noted that now that one vendor, Amazon, controls 25 percent of e-commerce, and another vendor, Walmart, controls a vast swath of retail sales worldwide, large merchants are trying to use their clout to reduce credit card fees. Sondhi predicts: “As we move to instant payments and 1-Click checkouts, the user’s affinity to a card network or a bank changes. The customer’s affinity with the merchant may increase. People say, ‘I’m an Amazon customer,’ and their relationship with their bank has changed from the pre e-commerce era.” This trend is accelerating among the under-35-year-old segment of consumers, said Sondhi, because of their different view of banks. “So the shift is moving towards more empowered merchants and consumers,” he said, “and it’s going to require the networks and banks to adapt our roles appropriately.”

Credit card companies are in fact attempting to make their cards easier to use with mobile devices. Besides the mobile card-swiping devices mentioned above, Stephenson notes that JPMorgan Chase has invested in a mobile payments platform, GoPago, that enables “go-ahead ordering” and fast, hassle-free transactions: “I can order my breakfast, walk in and a person whom I’ve never met will say, ‘Welcome back, Jack,’ and hand me my order. I will walk out and never take out any cash. To me, that is a really magical, seamless experience. I think that’s what we’re going to see in the future.”

But Esther Dyson, Chairman of EDventure Holdings, cautioned that while such payment schemes may work in the U.S., they may not in places like Russia where people do not trust large, integrated systems. “It’s hard to see this system spreading everywhere,” said Dyson, because of “this trust thing.” “You may worry that you will get billed for a lot of things that you never did—as sometimes happens on credit cards right now when you get billed for $6.79, which is “too little money to get really upset about and too much trouble to spend five hours on the phone resolving,” said Dyson.

Eric Dunn of Intuit offered a hypothesis to explain why there can be so much interest and innovation in mobile payment systems yet so little progress in perfecting friction-free mobile phone transactions. “The high-end market players who own the networks are attempting to define a consumer mobile device + point-of-sale transaction as a card transaction,” said Dunn. “Once that happens, you have a complicated rules environment, the NFC [near-field communication] protocol and secure elements, and so forth. I think this is why we haven’t seen a broad adoption of what transaction people [merchants and consumers] want to do, which is to buy something at a retail outlet.”

Yet even with this inertia favoring the established system, Dunn noted that venture capital money is investing in mobile payment systems because “there’s a belief that if I, as a consumer, have a mobile, broadband-connected supercomputer, and I’m buying something from a merchant who has a broadband-connected supercomputer, it ought to be possible for these two devices to negotiate a simple payment transaction in a way that is more modern, and does not necessarily rely on established card networks, which are expensive in the U.S. compared to elsewhere in the world.”

Dunn’s hypothesis helps explain the current impasse. On the other hand, the situation is quite dynamic as the four factors cited by Gartner—digital information flows, the cloud (including the rise of “personal clouds”), mobile telephony and social commons—continue to develop and cross-synergize each other. This gives many observers confidence that one or more of the networked-based, mobile-friendly schemes now under development could scale rapidly in the near future.

Who “Owns” the Customer?

Walter Isaacson, President and Chief Executive Officer of the Aspen Institute, wondered why is it not possible to develop “an ‘EZ Pass’ that would allow us to make micropayments on the Internet?” People should be able to make relatively small purchases via a Web browser or mobile phone with anonymity, avoiding all personal, credit and administrative data associated with most electronic transactions. “Everything has gotten more friction,” he complained, citing PayPal, Bitcoin and other payment systems. “It just demands so much more of me. I keep looking for ways to simplify this, as Steve Jobs would have said. This kind of system would also transform media because they could sell their newspapers or blogs for 25 cents or a dollar, without having to give up a whole lot to a payment-transaction company….”

The answer to Isaacson’s question seems to be that most payment system companies are quite eager to “own the customer.” They want to establish ongoing relationships that will yield rich personal data about consumers and future purchases. Paul Moreton, Senior Business Director for Digital Commerce at Capital One, noted that there is a struggle among card issuers, merchants and the customers themselves over “who owns the customer.”

In one respect, “no one owns the customer,” said Moreton, because neither the credit card company nor the vendor “owns” a customer who shops at Walmart using a Capital One credit card. But in other respects, most players have a keen interest in “owning” as much of the loyalty, personal data and future purchases of consumers as possible. Not surprising, this “prize” accounts for the aggressive marketing, technology design, lobbying over regulation and other strategic maneuvering to secure market advantages. Innovative new payment systems generally fail to get traction, said Vijay Sondhi of Visa Inc., because of “turf battles over who owns what.”

The persistence of the “own the customer” mentality, said Shane Green, is reinforced by the design of enterprise IT systems. It locks in that approach because there is a whole infrastructure and set of power relationships designed to “control the customer.” “If you look at CRM [Customer Relationship Management] and everything about it,” said Green, “there is all this ‘rocket science’ going against the customer. It’s not focused one bit on empowering the customer in the same way with a set of their own data to use.”

Green believes that “the customer should own the customer”—meaning, individuals should be able to control and use a complete set of their “small data,” which is something they are uniquely advantaged to do as long as they have the right tools and incentives. “I just think this is not a concept that has ever really existed before. So it’s hard for people to get out of the worldview where a company owns the customer, and to enable a new model. But an empowered customer can actually have a much better interaction with the companies that they want to do business with. Data shared by the customer can help personalize and streamline every step of a transaction—turning just about everything into a 1-Click experience. It can be highly advantageous to companies who can’t really compete with Amazon, Apple, Google or Facebook when it comes to removing friction and exploiting user data. By collaborating with their customers in this new way, most any company, but especially data-oriented startups, should be able to provide an experience as good or better than these large digital incumbents.”

One example of customers owning their own data—and deploying it to serve their interests—is the “Blue Button.” This web-based system, implemented by the U.S. Departments of Defense, Health and Human Services and Veterans Affairs, lets individuals access and share their online medical records easily and securely.

As a general proposition, however, empowering individuals to control their own data is not so easy. Many people simply do not know enough about the importance of data to care. Caterina Fake, Founder and Chief Executive Officer of Findery, told of her experience in founding Hunch, which sought to allow consumers to own their own data and help them “personalize their experience everywhere they went.” But with popular images of data analytics as part of a total surveillance and control system, as conjured by the film Minority Report, Fake discovered that people are reluctant to fill out complete profiles or actively manage their digital identities. “We have a very difficult time getting consumers interested in owning their data,” she reported.

Large businesses, for their part, are not necessarily happy to see consumers managing their data. As Green explained, companies often see this idea as depriving them of consumer and market data. He has found it far more disarming to explain that individuals simply want a copy of all of their data, “not that you have to delete yours. I think it is now getting super-easy to go to a company and say, ‘You should be giving copies of data back to consumers. And if you do, not only will you make their lives better and more convenient, they might just reward you by sharing data that you’ve never been able to collect on your own.’”

Zoë Baird Budinger, President of the Markle Foundation, urged that we identify a meaningful role for individuals in controlling their data. We should not regard them as an afterthought “at the end of the system,” she said, but “as an integral part of the system who also reaps benefits from it. We need to pay attention to what individuals get out of the system.”

Shane Green believes that the most effective strategy is to show people some “immediate value” that they might get from their data. “If you ask someone to just put all their data somewhere in the hope that it might be useful to them in the future, it will either terrify them or they won’t find it interesting. You have to find something that they already relate to—something that is a ‘pain point’ for them, like registering for sites, 1-Click checkouts and filling out forms of all kinds.”

Another incentive for people to manage their data, said Peter Vessenes of the Bitcoin Foundation, is the prospect of finding other people who are similar to them. “You want to be able to use your data to find the one other person who has exactly my interests but I didn’t know about.” This is one motivation behind the Personal Genome Project backed by investor Esther Dyson. “My entire genome is up online. My mission is to get people to understand that this stuff isn’t scary; it’s useful. There are a lot of people who are willing to share, especially people who are sick, because they understand it can be helpful. The message about what data is being used for is tremendously important.”

Still, noted Vessenes, “there is a lot of vulnerability” that goes along with such disclosures of data. Extreme care must be taken to protect identity and privacy, he said. Unfortunately, the systems for assuring such protection have not really been perfected.

A deep undercurrent to these discussions is the importance of trust in devising long-term solutions. Trust develops when “people’s understanding of a business and its actual business practices are in close alignment. The more that people participate in managing their digital identities and data, the higher the degree of trust, and the more successful the business will be over time.”

Robert Pepper, Vice President of Global Technology Policy at Cisco, agreed: there must be “an alignment of incentives” so that companies can acquire data they want while enabling consumers to benefit as well. Moreover, the use of personal data should not merely be legal, said Pepper; it shouldn’t “feel creepy.” At present, however, many of the largest data-collecting and analytics companies try to get as close as possible to that line—or as Google Chief Executive Officer Eric Schmidt once told a reporter: “The Google policy on a lot of things is to get right up to the creepy line and not cross it.”

One patch of common ground between businesses and consumers, said Shane Green, is the act of filling out forms: “Companies want their forms filled out completely, accurately and as often as possible, and consumers don’t want to spend time filling out forms; they want it to happen automatically for them.”

Jack Stephenson believes that traditional financial institutions are going to have an advantage in dealing with consumers: “A big piece of these transactions is trust, and the fact that everybody has a card. There is a sort of ubiquity acceptance.” But banks and card-issuers also face a significant impediment: they may not be able to use the data. As one participant noted, the only rights that they have is to use aggregated and anonymized data.

The Future of Bitcoin

Some people believe that the future will belong to an “un-branded,” open source currency. The leading candidate for this is Bitcoin, a form of digital cash invented by an anonymous programmer (or group of programmers) in 2011. The currency, in the form of standard digital “coins” with unique identifying numbers, is released into circulation as individual computers randomly discover key numbers that solve elaborate computational problems. This “mining” of Bitcoins generates a Bitcoin for the lucky “miner.”

About fifty Bitcoins are released into circulation every ten minutes. There are currently about 11 million Bitcoins issued, which is about half of the expected total coinage of 21 million Bitcoins, due to be completed in the year 2040. The market valuation of the existing universe of Bitcoins, in U.S. dollars, is about $1 billion. All transactions made with Bitcoins are recorded as a coin circulates from user to user.

Harkening back to Walter Isaacson’s concern—an EZ Pass system for Internet purchases—Marc Rotenberg, President and Executive Director of the Electronic Privacy Information Center, asked whatever happened to the Internet vision set forth by cryptographer David Chaum—a world of “authentication without identification,” in his memorable phrase? Chaum’s idea was that people could make online purchases and sellers would get paid, but there would be no digital trail to identify buyers or sellers. “Is that dream dead, or is there some future in it?” asked Rotenberg. More to the point, is Bitcoin a practical answer to this vision of authentication without identification?

Peter Vessenes clarified that Bitcoin transactions are “private but not anonymous.” In other words, while Bitcoin transactions do not record details about the buyer, seller and the transaction itself, each Bitcoin contains unique codes identifying the previous parties to a transaction, and how much money was exchanged. With some sleuthing, it is technically possible to track the history of a specific Bitcoin and possibly identify someone.

If Bitcoins are not totally anonymous, they do enable quick, cheap and instantaneous transactions, even for large sums of money, said Vessenes: “On my phone, I have open source software that can send a million dollars anywhere in the world, instantly…. And it works now. It doesn’t need Visa; it doesn’t need a bank. Nobody needs to sign up with any company on either side of the transaction. It’s a money-over-IP [Internet Protocol] protocol, so you don’t need these large, multi-billion-dollar infrastructures any more.” Vessenes hastened to add that “it’s not as if there is no value to be added in the supply chain” by tech innovations that could make Bitcoin transactions easier and more customized. But for now, the basic electronic payment infrastructure is in place.

Vessenes cited three reasons for Bitcoin’s effectiveness and rapid growth. First, the open source protocol behind the currency has confounded regulators, who do not know how to deal with it or control it. “Regulation kills this kind of innovation,” said Vessenes. “Bitcoin’s open source protocol sort of went all the way around that.” Second, Bitcoin provided a way to encourage users to “buy into the system” because the early users would see the value of their Bitcoins appreciate in value over time.

Finally, despite some arcane challenges to acquiring and using Bitcoins, they are eminently easy to use once a person learns how to use the “digital wallet.” “I bought sushi for my team in San Francisco with Bitcoin recently,” said Vessenes. “A 65-year-old Korean woman flipped around her laptop and showed me a QR code. I paid, she saw the Bitcoin come across the network, and she said, ‘You’re good.’ Some people are willing to do a lot of work to use Bitcoin because they don’t have to pay transaction fees or deal with the payment companies. They hate all that stuff.”

Several participants noted that the U.S. Government will ultimately come down on Bitcoin because it facilitates illicit transactions, money-laundering and terrorist activity, not to mention tax evasion. And in fact, federal prosecutors in San Francisco in October 2013 indicted a man said to be the founder of Silk Road, a website that was alleged to do about $1.2 billion in illicit transactions. The FBI seized about 26,000 Bitcoins worth about U.S. $3.6 million. Such episodes underscore why there is regulation of payment services businesses, and why there is a Financial Action Task Force to harmonize the different types of regulation of payment services around the world.

Michael Barrett, a former PayPal executive who is now President of the FIDO Alliance, an open standards consortium that is reimagining authentication for mobile devices and the Internet, pointed out that this is why there is no EZ Pass-style currency for the Internet: it would allow money-laundering. Even if the notional EZ Pass digital wallet could only transmit $25 or $50, criminals would find a way to “chop a million dollars up into smaller units and move it by hand. Regulators have a legitimate interest in this space,” said Barrett, “and to the extent that we try to create mechanisms that don’t give them the ability to have some level of oversight, they will break it [the currency or payment system].”

Vessenes agreed that it’s generally a good thing to stamp out money-laundering, which is bad and evil. On the other hand, there is now technology that can move value to anywhere in the world, at any time, using just 100 bytes of data, he said. In any case, Bitcoin is “way less anonymous than cash” [because of the permanent global ledger of transactions in each Bitcoin].

Rotenberg noted that the 9/11 attacks made it far less attractive to try to invent a payment system that severed the user’s actual identity from the payment to a merchant: “All of the tracking of financial transactions accelerated dramatically after 9/11 because of the perception, rightly or wrongly, that terrorism is enabled through money-laundering and financial transactions that could otherwise be monitored.”

It was pointed out that Bitcoin may resemble Napster in that the incumbent industry—record labels—initially ridiculed Napster as a joke that would be quickly quashed by copyright laws. But in the end, Napster pointed the way to a fundamentally different way of distributing music online, which later manifested itself as iTunes. Today, Bitcoin suggests a different way of making

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