Felix Salmon

The payments impasse

Felix Salmon
Jan 6, 2014 23:16 UTC

I’ll say this for bitcoin: it’s got a whole new class of people, like Matt Levine and Guan Yang, increasingly interested in one of my longstanding obsessions — payments. (You might be surprised to learn how hard it is to get people interested in payments.) Guan’s post, along with the response to it from Simple’s Shamir Karkal, provide a techie’s viewpoint into a question which many non-Americans have when they start living in this country: how on earth can can moving money from one person to another be so difficult, expensive, and time-consuming?

The simple answer, as Karkal hints at, is that we’re suffering from a particularly toxic combination: an outdated payments system combined with a seemingly powerless central bank, which is happy to let the big banks dictate the pace of change (or lack thereof). And as American Banker’s Kevin Wack explained in a great piece last November, the big banks are very good at vetoing even incremental improvements in the US payments infrastructure.

The best place to start, if you want to understand the massive opportunities here, is the public consultation paper on payments which was put out by the Federal Reserve Banks last September. It’s written in reasonably plain English, and makes it clear that the Fed would love to see two key “desired outcomes”:

Desired outcome 2: A ubiquitous electronic solution(s) for making retail payments exists that does not require the sender to know the bank account number of the recipient. Confirmation of good funds will be made at the initiation of the payment. The sender and receiver will receive timely notification that the payment has been made. Funds will be debited from the payer and made available in near real time to the payee.

Desired outcome 4: Consumers and businesses have better choice in making convenient, cost-effective, and timely cross-border payments from and to the United States.

In other words, the Fed absolutely understands what Guan and I have been saying for a while. The big problem, however, arises before we even get to the two big “desired outcomes”. Indeed, it’s so big that the Fed puts it right at the top of the list:

Desired outcome 1: Key improvements for the future state of the payment system have been collectively identified and embraced by payment participants, and material progress has been made in implementing them.

It’s this that isn’t ever going to happen. As the Fed paper drily notes, the results of its analysis of gaps and opportunities in the payments system “are not surprising as they are comparable to the results of a similar gap analysis conducted in 2002”. And the paper itself was released just a month after the big banks which control the existing payments system voted down an attempt to speed it up just a little bit. Probably because they feared that a faster and more efficient payments system would cut into the fees they get from wire transfers, which they charge as much as $50 for despite a cost of only 14 cents.

The Fed is a bit like a hippy parent: it doesn’t want to force anything on its charges, it wants them to change on their own. And so it asked for responses to its paper, which can be found at a dedicated website. If the Fed had any doubt about the banks dragging their feet, then the responses will certainly have put those doubts to rest.

The responses from The Clearing House, Nacha, and the American Bankers Association all basically say exactly the same thing (which is not surprising, given their highly-overlapping memberships). Do we really need instant funds transfer? Can’t we just have instant messaging saying that the funds transfer will happen, instead? How are we going to make money doing this? Do you have any idea how expensive it’s going to be? Don’t you know that we already have a massive regulatory burden? This is no time to ask us to do even more. (Although, by the same token, it wouldn’t be fair to allow non-bank competitors like Ripple to compete against those of us who have many more regulators.) Besides, just thinking about the cybersecurity aspect of the whole thing makes our heads hurt!

The impasse has never been more obvious. The Fed wants changes; it wants those changes to come from the banks; the banks have no interest in implementing such changes. Which means that either the Fed is going to have to get tough, and force the banks to change, or else we’ll have about as much change in the next ten years as we’ve had in the last ten.

What are the chances of the Fed forcing America’s banks to get with the 21st Century? Very slim, I’d say. The banks have been extremely good at squealing very loudly whenever anybody has attempted to implement any new regulation, even regulations designed to safeguard the entire national economy. Improving payments doesn’t protect us against systemic risks: it just makes everybody a little bit better off in a million different ways. And as all politicians know, any policy which benefits everybody a little, but which a small number of key players are vehemently opposed to, will never get off the ground.

Non-bank solutions to this problem, be they based on cybercurrencies or anything else, are never going to cut the mustard: the key element here is ubiquity, which means people shouldn’t have to sign up for yet another service like PayPal or Bitpay or Square. Instead, the entire national (and international) payments architecture needs a massive upgrade.

Realistically, that upgrade can only be overseen by the Federal Reserve — an entity which doesn’t feel empowered to enforce such a thing. Until then, as Guan says, “US Dollars, while a good store of value and unit of account, are also terrible for making payments.”


Here in Germany people have used direct, cost-free bank transfers for decades – slow but fully protected by law – now we have ‘Sofortüberweisung’, aka instant internet transfer, that confirms a payment will be made within seconds – even across EU national borders. German banks have their own problems but letting customers transfer money is not one of them.

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Waiting for bitcoin to get boring

Felix Salmon
Nov 30, 2013 23:16 UTC

Something of a milestone was reached very early in the morning of Friday, November 29, a time when most Americans were either sleeping off their Thanksgiving excesses or out seeking Black Friday bargains. At the end of Wednesday, the price of gold, on Comex, had closed at $1,240 per ounce; that market would not reopen until Friday morning. And then at about 1am Friday, EST, there was a trade on Mt Gox, the largest bitcoin exchange, which valued each coin at $1,242. If only briefly and theoretically, at that point in time a bitcoin was worth more than an ounce of gold.

Bitcoin, by its nature, is a highly volatile asset, which is prone to astonishing run-ups in price. Check out these three one-year charts of the bitcoin price:




The first chart is the year to June 2010; the second is the year to April 2013; and the third is the current chart. Without looking at the y-axis, they’re basically identical.

To put it another way, there is nothing surprising about what bitcoin is doing right now; it has done it many times in the past, and it will probably do it in the future as well. After all, there’s no way to calculate the fundamental value of a bitcoin: indeed, it’s probably easier to justify a price of $1,000 per bitcoin than it was to justify a price of $10. At least now it’s increasingly looking like a Thing, complete with Congressional hearings and front-page-of-the-FT publicity stunts.

The latest bright idea from Alderney — that the tiny island (population: 1,900) should print physical bitcoins backed by electronic bitcoins — is certifiably bonkers. For one thing, the whole point of bitcoin is that it isn’t going to suffer the same fate as all those currencies which the government promised were backed by something else. (The dollar was backed by gold, once; the Argentine peso was backed by the dollar. Neither lasted, and if the burghers of Alderney ever change their mind about the bitcoin backing, or it gets hacked or stolen, the owners of the physical bitcoins are going to have no recourse.)

More weirdly, the Alderney bitcoins are going to have about £500 worth of gold in them, which makes no sense at all. Let’s say that the gold in the coin is worth $800, while the bitcoin backing it is worth $1,000. What, then, would the coin be worth? It can’t be much less than $1,000, at least as long as it can be redeemed for an electronic bitcoin, or a bitcoin’s worth of pounds sterling. But by the same token, it can’t be worth much more than $1,000, because numismatists don’t tend to value gimmicks very highly, so it’s not going to have significant value as a collector’s item. And the most you could sell it for, in terms of its fundamental value, is the value of one bitcoin. Which means that there’s no point whatsoever in pouring £500 worth of gold into it — the gold doesn’t increase the value of the coin at all.

All of which is to say that the FT is splashing all over its front page a crazy bitcoin scheme which is never going to happen. “An independent company will provide the Bitcoins,” explains the newspaper, credulously. “If the price plunged, neither Alderney nor the Royal Mint would lose anything.” But what independent company would ever do such a thing? The company would essentially need to hand over its bitcoins to Alderney, would probably have to help fund the cost of manufacturing the coins out of gold, and would get essentially nothing in return for the huge risk it was taking that all its coins would become worthless.

The news here, then, is not so much that there’s some new cockamamie scheme involving bitcoins — a new such scheme is dreamed up every day. Rather, it’s the way in which the bitcoin bug has infected news editors to the point at which they’ll splash any old vaporware silliness all over their front pages. One of the less reported aspects of the bitcoin story is the way in which editors tend to be much more excited about it than reporters, who are generally more skeptical, and who worry that their own reporting will only serve to inflate the bubble even further.

This is something which should worry the bitcoin faithful, if they really want to see bitcoin become a broadly-used global currency. After all, press coverage of bitocins runs in lockstep with the bitcoin price: it’s times like this, when the price is at its fluffiest, that bitcoin gets written about the most. (If it’s not physical bitcoins, it’s hard drives in landfills.) The largely unspoken assumption behind all such stories: bitcoin is an asset class, and people should get excited about it when (and, implicitly, only when) the price is going up. This is what I think of as the CNBC Premise: when an asset rises in price, that is necessarily a Good Thing, and when it falls in price, that is always a Bad Thing.

The CNBC Premise has never made much sense with respect to currencies, however. And with respect to bitcoin in particular, its most exciting aspect is not its value, but rather its status as an all-but-frictionless international payments mechanism. If you want bitcoin to really take off with respect to payments, you actually don’t want to see crazy price spikes — such things are the best possible way of stopping people from using bitcoins for payments. After all, if your bitcoins are doubling in value every few days, why on earth would you want to spend them?

For me, the most interesting period in the short history of bitcoin was the period from roughly the beginning of May to the end of September, when the volatility in the price of bitcoin was relatively low, even as the price was pretty high* — more than $100 per coin. And more generally, it’s the long flat areas of the three charts above, rather than the attention-grabbing spiky bits, that bitcoin bulls should get excited about. If and when those long flat areas last for years rather than months, bitcoin might start becoming a boring, credible currency. We’ll know that bitcoin has made it to the next level not when editors all want to write about it, but rather when editors don’t want to write about it, because it’s just another way of people paying each other for stuff.

*Update: As Joe Weisenthal points out, stability at a high price is more bullish for the bitcoinverse than stability at a low price, because the higher the market capitalization of bitcoin, the greater the amount of commerce that can be transacted in it.


Great article. Bitcoin should be approached prudently with an eye towards risk management. We comment on this and similar issues on our blog.

http://www.bitmorecoin.com – Quick and easy way to buy Bitcoin in the UK.

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The promise of Ripple

Felix Salmon
Apr 11, 2013 13:27 UTC

This is a chart of the value of bitcoin yesterday, Wednesday. It’s hardly a secret that bitcoins are a highly volatile asset class, so relatively few eyebrows were raised when the price soared from an opening level of $230 all the way to a high of $266. An intraday swing of more than 15% is pretty much par for the bitcoin course, these days. But then came the crash: within a few hours, bitcoins the world over had lost well over half their value, and were trading as low as $107 apiece. That’s not normal — and it just goes to underline how bad bitcoin is at doing everything it’s meant to do.

Bitcoin is clearly not an effective store of wealth — just look at how quickly that wealth can be evaporated. Neither is it a useful payments mechanism, given how fast its value can fluctuate. Currently, it can take an hour for a bitcoin transaction to clear, which means that the value of the transaction when it clears can be radically different from its value at inception. Bitcoin only works for payments if you can be reasonably sure that its value will remain reasonably steady for at least the next hour or so.

At the end of my big piece on bitcoin, I conclude that we need “a universal payments system with no friction or interchange costs”, which can learn from bitcoin’s mistakes. And this morning, the company responsible for one possible such system — OpenCoin, which is responsible for developing Ripple — announced that it has closed its angel funding round, with support from the likes of Andreessen Horowitz, Lightspeed, and Founders Fund.

I’ve been playing around a bit with Ripple, and I think it’s extremely promising. It’s very early days yet, but Ripple already has clear advantages over bitcoin, and if various merchants and developers start to converge on the Ripple ecosystem — which, like bitcoin, is all open-source — then I think it could genuinely become the first real way for anybody in the world to pay anybody else in the world, immediately and about as frictionlessly as possible.

Ripple was founded by geeks, including Prosper founder Chris Larsen and Mt Gox’s Jed McCaleb. As a result, right now it has a bit too much functionality with too little ease of use. It supports an effectively infinite number of different currencies, for instance, including bitcoin; and although it’s easier to use than bitcoin, it’s still not particularly user-friendly. But that will come, with time — and in fact I would be happier if the people developing the easy-to-use front ends for Ripple were not OpenCoin. OpenCoin is a for-profit company, which will make good money if Ripple takes off; I’ll come to that bit in a minute. So it’s very important that a lot of the rest of the Ripple ecosystem not be built by OpenCoin: so long as OpenCoin is the only company to really buy into Ripple, the whole scheme will go nowhere.

Ripple has a lot of resources on its website which explain how it works in various levels of detail; I won’t attempt to duplicate that effort. But the end result feels a bit like bitcoin in many ways. Users are anonymous (or, technically, pseudonymous), for instance: if you want to send me money via Ripple, right now you have to pay racoLWuh2GtC72i1gV7ib14Jqgx3SLmwKc rather than just Felix, or my email address, or my Twitter handle. It’s all open-source, too: OpenCoin has no privileged access to the way in which people pay each other. The fees are de minimis, just enough to prevent DDoS attacks and the like. There’s even a built-in crypto-currency, the Ripple, with a fixed money supply. But the great thing about the Ripple system is that individuals don’t have to pay each other in Ripples. Instead, they can pay each other in pretty much any currency in the world: Ripples, yes, or dollars, or yen, or euros, or even bitcoins.


Here, for instance, is a screenshot of my Ripple wallet: it shows that I own, 3,052 Ripples, 13 dollars, and 0.0284 bitcoins. If I want to send a payment in any one of those three currencies, I can do so pretty much cost-free; if I want to send a payment in some other currency, then the system will select for me the best exchange rate, based on various companies which are offering currency-conversion services on the Ripple platform.

Any time you deal in currencies other than Ripples — which, in practice, is going to be all of the time — you have to go through “gateways” to the Ripple system. Eventually, those gateways could be PayPal, or Citibank, or Western Union, but that might take a while; for the time being, they’re smaller institutions, and you probably don’t want to be moving large amounts of money through them.

Everybody using a Ripple account will have some Ripples in their account, just to get them on the system, and there will always be people making a market, converting Ripples to real currency and back again. The good news, however, is that Ripples are not (fingers crossed) going to become speculative investment vehicles, in the way that bitcoins are. That’s because all the Ripples in existence — 100 billion of them — have already been created, and, to a first approximation, they’re all owned by OpenCoin, which is essentially the central bank of the Ripple economy. OpenCoin is going to be giving away billions of Ripples for free, to anybody opening an account, just to get the system seeded and get people transacting with each other. There’s little reason to hoard a few thousand Ripples if there are 100 billion of them just waiting to flood the market at any time.

It’s in OpenCoin’s interest, then, to carefully calibrate the rate at which it’s introducing Ripples into the active money supply, and to keep the value of a Ripple relatively stable. Right now, there are about 750 Ripples to the dollar, which means that theoretically OpenCoin’s 100 billion Ripples are worth something over $100 million. OpenCoin is going to want to see that number rise, slowly, as Ripple becomes more popular — but it doesn’t want to encourage hoarding: quite the opposite. It wants as many transactions to happen over its network as possible, so that it can really become, in Larsen’s words, “http for money”.

Given the Andreessen Horowitz connection, and a lot of shared interests between the two companies, the first place I’ll be looking for third-party ratification of the Ripple idea is the hot payments startup Stripe. I’ve had long conversations with Stripe CEO Patrick Collison about bitcoin and international payments and frictionlessness, and in theory there’s no reason why he shouldn’t build a pay-with-Ripple option into Stripe alongside its more conventional credit-card and debit-card payments.

As with all such things, there’s a first-mover problem here: there’s no point in building Ripple-based infrastructure if no one is using Ripple, and no one’s going to use Ripple if there isn’t any infrastructure. OpenCoin’s solution to the problem, which I like a lot, is to simply give away billions of Ripples for free, all of which are worth real money, thereby giving people an incentive to use it. I hope it works, and I hope that the number of gateways into the system will soon expand from the current list of relatively obscure sites like Bitstamp. Ripple hasn’t succeeded yet. But at least — unlike bitcoin — it has a genuine hope of doing so.


I am new to all this ripple stuff. Could anyone please send me some ripple ?



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Why online shoppers pay with cash

Felix Salmon
Jul 5, 2012 14:42 UTC

Here’s a reminder, from Stephanie Clifford, of just how two-tier the US economy has become:

Walmart says the majority of in-store purchases are made with cash or debit cards, and that about 15 percent are made with credit cards.

I wrote on Monday about the downside of painless payments, which is that they make it too easy to spend money. And customers at Walmart, it seems, are acutely aware of that particular syndrome.

Megan McArdle moved to a no-debts, no-credit-cards personal-finance system in 2009, where you set up a detailed budget and put cash in different envelopes. “It sounds unbearably tedious,” she wrote. “But it’s actually incredibly freeing. I have never before felt like I had total control over my money”.

This is the downside of any payments revolution: the easier and cheaper it is to spend money, the less control we have over our own spending. Which in turn means that ultra-convenient payments, probably using your phone in some way or another, are realistically going to be a luxury for the middle classes and a cause of stress and danger for families living paycheck-to-paycheck.

Such families, it turns out, are very good — by necessity — at budgeting. Being forced to pay for everything with cash, or with its plastic equivalent, the prepaid debit card, is not an inconvenience so much as a helpful discipline. There are debt instruments out there, for emergencies — but credit cards aren’t used as a payments technology, because they make it far too easy to get into expensive debt without even realizing you’re doing so.

Clifford’s story, about the increasing number of people paying for things online and then picking them up in person, talks a lot about convenience: a Sears spokesman, for instance, is quoted talking about customers’ “need for immediacy”, while a chap from the Container Store conjures up a mom running errands with kids in the car, who just wants to pick stuff up and move on.

But it seems to me that the convenience here runs just as much the other way. Yes, there are people who are shopping online, who want whatever they just bought, and who want it now. These are people who would be shopping online anyway, and who just don’t want to wait to get their goods.

But there are many more people, I think — in number if not in purchasing power — who limit themselves to cash or its functional equivalents, and who welcome the idea of being able to browse and shop online. Shopping at Walmart is never exactly fun, and if you can just punch in an order online — especially if you can simply re-enter your family’s regular weekly shopping list — that saves time in the store and also makes it less likely that you’ll be tempted by some impulse purchase. This kind of customer isn’t using a different fulfillment channel for what would otherwise be a regular online order; instead, they’re basically just using a more convenient way of picking out the stuff they want at a store they’d visit anyway.

At Walmart, clicking the “pay with cash” option doesn’t literally mean you’re going to pay with cash:

In the first weeks of the cash option, Walmart noticed that a different set of customers also found the service appealing. About 40 percent of the customers who paid with cash when ordering online ended up using noncash options, like a credit card or check, when they arrived at the store. They simply had not wanted to provide that financial information online. “There’s still a large segment of people out there afraid of identity theft or just plain putting their credit card online,” Mr. Anderson said.

My gut feeling here is that although fear of identity theft might be part of what’s going on, another part is simply good financial self-discipline. If you want to keep track of where your money is, and if you want to minimize temptation, a “never buy anything online” rule is simple and effective. If you can enter a card number online to pick goods up at a store, then you can enter the same card number online to buy things from just about any website in the world. And many people simply can’t afford to open themselves up to those kind of opportunities.


An insightful article and a whole bunch of very helpful comments. Am I really on the Internet?

I think this exchange of ideas begins to approach the gold standard. Good for Reuters and its readers.

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Adventures with marginal pricing, auto edition

Felix Salmon
Jul 2, 2012 23:23 UTC

Brian Chen has the news today that Uber is rolling out a cheaper version of its service:

Uber’s convenience comes with a cost. People are paying not just for the service, but also the gas used by the big sedans. That’s where hybrid vehicles will help bring down the price: drivers will spend less time and money fueling up…

In San Francisco, for example, the hybrid cars will cost $5 for the base fee, and then $3.25 a mile after that. By contrast, the town cars cost $8 for the base fee and then $4.95 a mile.

A quick back-of-the-envelope calculation shows that this has very little to do with the amount of money that drivers spend fueling up. Compare a Prius (51 miles per gallon) to an Escalade (10 miles per gallon): if gas is $3.78 per gallon, that puts the cost of gas per mile at 7.4 cents for the Prius and 37.8 cents for the Escalade — a difference of 30 cents per mile. Whereas Uber’s price for the Escalade is a premium of $1.70 per mile.

What’s more, since the drivers of these cars can’t pick up hails on the street, they have a lot of downtime waiting for the next gig. As a result, it doesn’t really cost the Escalade driver extra money if she ends up having to refuel once a day rather than once a week. Obviously, the fuel costs are higher — but the opportunity cost of her time is negligible.

Here’s Chen:

The company convinced its car-service partners to buy a total of 50 hybrids just for customers coming through Uber — a sign that drivers are making money with the start-up.

But of course it’s more complicated than that. If drivers were happy with the money they were making with Uber, then they’d stick happily with what they’ve got. In order to be persuaded to switch over, they have to believe that they’ll make more money in a hybrid than they would in a sedan. And that’s despite the fact that “in general”, according to Uber’s Scott Munro, “hybrids will cost 30 to 40 percent less than Uber’s black town cars”.

If that’s the case, then if you compare a sedan driver and a hybrid driver, the hybrid driver will need to be making three trips for every two the sedan driver makes, just to end up with the same amount of money. In order for the hybrid to be more attractive than the sedan, and taking into account the fact that at the margin you’d rather make fewer trips than more trips, a typical driver would realistically be hoping to double the number of fares she was getting before she was happy switching to the cheaper car.

But I suspect that the real relationship here is not between Uber and its drivers, so much as it is between Uber and car-service companies. Any given driver might well prefer to continue driving a sedan, rather than being moved over to a hybrid. But the car-service companies make money on every fare, and so their best interest is served just by increasing the total number of fares, rather than the average income received per driver per day.

As a result, I suspect that this move is going to decrease Uber drivers’ take-home income, on average, rather than increase it. As you might expect, when prices drop. But it will increase income for both the car-service companies and for Uber itself — and it will increase the total number of Uber drivers.

It’s easy to sign up with Uber if you’re a company; much harder if you’re a single driver. The Uber model is that Uber contracts with the owners of capital, who then employ the labor needed to provide the service. And once again, the rich will end up making more, the not-rich will end up making less, and the rich will present the whole thing as a victory for all concerned.

But there’s something else going on here, too, which is the way that companies love to push the idea that we’re paying for extra costs, even when we’re not. Uber sedans are more expensive than Uber hybrids because Uber reckons that’s the way it can best maximize its revenues and profits — not because the sedans are significantly more expensive to drive. Another example of this? Gas stations which offer different prices for cash and credit.

I like this idea, in theory, because gas prices are the most salient prices in America: we’re much more conscious of how much gas costs than we are of how much anything else costs. And if the price for gas on credit is significantly more than the price for cash, then that will help drive home just how big those credit interchange fees are.

Except, gas stations have no particular reason to charge just the interchange fee as a premium. Is the difference 10 cents a gallon? That’s about 3%, which is at the high end of credit interchange fees. After that, it’s all just pure profit for the gas station — and sometimes the difference can be as much as 2 dollars a gallon.

That isn’t a condign surcharge; it’s price gouging. And even a relatively common 20-cent surcharge is basically a convenience or ignorance fee, a way of extracting extra money from people who don’t have the cash or who don’t realize how much extra they’re paying. The rate of paying-with-plastic ranges between 60% and 100%, which means that realistically what we’re talking about here is essentially a bait-and-switch: attract customers with a low headline price, and then charge them a higher one.

Part of modern life is the way in which we naturally gravitate towards easy and automatic ways of paying. If you give Uber your card number once, you never really need to pay at all; you just find the charge on your credit-card statement. It’s certainly convenient — but it also allows Uber to charge quite enormous sums for what they provide. And similarly, at the gas pump, we just want to swipe our cards and get out of there, rather than faffing about with cash. And so there’s an incentive for companies like Uber and gas stations to inexorably increase the implied convenience fee we get charged for using easy payments methods — even if those payments work out cheaper for them. (After all, it would cost Uber a fortune if we paid our drivers in cash and then Uber had to try to reclaim its share from those drivers.)

My radical new universal payments system would help a little bit here, since it would make it impossible for vendors to claim that the more convenient payments method was somehow more expensive for them. But it wouldn’t solve the deeper problem, which is that the more painless payments are, the less we feel the pain. And so merchants will always find ways to charge us more now, if we’re not going to really feel how much we paid until much later. And then, when customers start revolting at the high prices they’re paying, the merchants will act like they’re doing us a favor by offering an inferior and cheaper option.


Well Uber drives Town Cars, not Escalades. And there’s a reason Town Cars (and Crown Victorias) are popular with fleets.. they take a beating, last forever and are actually *cheap* to maintain (cheap, old-fashioned parts, and easy to work on). It’s doubtful that a Prius is much cheaper than a Town Car to maintain if it’s running in commercial service on potholed San Francisco streets. So price discrimination it is… the $3.25 is getting awfully close to the regular taxi rate of $2.75 (+ flag drop, does Uber have that?)

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America needs a modern payments architecture

Felix Salmon
Mar 30, 2012 22:40 UTC

I was sad that I had to miss Bruce Summers’s presentation at the Kansas City Fed’s payment conference this morning; I was a couple of miles down the road, at the Kauffman Foundation. But I did manage to grab five minutes to summarize his argument for the assembled econobloggers: it’s an important one, which deserves a lot more attention than it’s likely to get.

Summers’s paper is here. It’s a dense 32 pages long, which is positively laconic in comparison to his upcoming book, Payment Systems: Design, Governance and Oversight, which features contributions from no fewer than 23 famous-in-the-payments-world grandees. But the message of the paper is a very simple one. America desperately needs immediate funds transfer, or IFT. And we’re not going to get it.

Summers’s new paper is a longer and more detailed version of the paper I blogged back in August. That paper was co-written with Kristin Wells, of the Chicago Fed, and was published under the Chicago Fed’s auspices. At the time, I wrote:

What Summers and Wells don’t say, perhaps because they work for the Federal Reserve, is that it’s downright idiotic that the Fed doesn’t step up to the plate and take on its natural role as guardian of the national payment system. Why doesn’t it? I’m not sure, but I suspect it’s something to do with the fact that the Fed doesn’t really exist as a unified body: there’s just a network of regional federal reserve banks, with a board of governors in Washington.

In the new paper, Summers is speaking for himself, and makes explicit what was only implicit before. The regional Reserve Banks have the ability to implement IFT; the Federal Reserve Board has the authority to implement it. But somehow the two seem incapable of joining forces to actually do it.

IFT — the ability for me to pay you, and for you to receive the funds within minutes, rather than having to wait until the following business day — is already a fact of life in many countries around the world, from India to the UK. Where it doesn’t already exist, you can be pretty sure that someone is working hard on a plan to make it happen. Except in the US, where no one seems to have even started the process yet.

Summers explains that as economic connections between individuals, businesses, and government entities are being multiplied at an astonishing pace, and that the payments system is doing an atrocious job of keeping up. The problem is compounded by the fact that no one has introduced a new universal payments mechanism since the check, which clears slowly — and sometimes doesn’t clear at all — but which is extremely versatile and pretty much universally accepted. He writes:

The U.S. payment system does not currently support immediate completion of payments, and there are no plans for doing so despite long-standing evidence of the need for such a capability and development of these capabilities elsewhere around the globe. While there is innovation in immediate payments, it is limited to small closed systems operated by non-banks, or to small closed systems operated by individual banks or consortia of a handful of banks…

Effectiveness is influenced by speed, versatility, and universal coverage. The effectiveness of a particular method of payment depends on how well it meets the convenience and needs of individual and business consumers in the digital economy. Among the payment attributes that consumers look for, speed in completing transactions, versatility in the use of a given method of payment, and universal connectivity to accounts held in banks are of special importance in the digital economy.

Speed is an especially important consideration for payments in the digital economy. Consumers expect virtually immediate completion of their digital transactions. The idea that money in transit is digital information which can be processed immediately has not been readily accepted by the banking industry. Most bank-sponsored payment schemes depend on clearing and settlement systems that are designed around batch processing and delayed settlement, and these clearing and settlement arrangements are being nurtured as opposed to being re-designed around continuous, real-time processing.

The problem, he explains, is that there’s essentially no one in a position to implement a new architecture along these lines. There’s no real national governance of the payments system in the US; while it has historically been overseen by the Federal Reserve Banks, newer developments like the Durbin amendment capping debit interchange fees gave all the regulatory power to the Federal Reserve Board in Washington. If debit transactions had been governed by the regional banks all along, he writes, “arguably, the Reserve Banks would never have allowed non-par clearing and settlement for inter-bank debit card payments.”

But there’s a strong deregulatory impetus within the Federal Reserve system, and most governors have been quite enthusiastic about the idea of getting the Fed out of the business of clearing and settlement and payments regulation. The banks innovated credit and debit cards, which are very popular, so what’s the need? Summers concludes:

The Federal Reserve Board is not interested in leading or guiding the development of clearing and settlement capabilities for payments in the digital economy. Moreover, the Federal Reserve Board is satisfied to give up the Reserve Banks’ operational leverage as providers of inter-bank clearing and settlement services.

And if the Fed won’t do it, there’s no realistic way that the private sector is going to get its act together and implement something as ambitious as IFT on its own — the collective-action problems make such a cooperative endeavor effectively impossible.

Which means that the only possible way that we’re going to get IFT in this country is if Congress acts, and passes an act mandating that the Fed build an IFT system.

Congress has done this kind of thing before: in 1974, it created the National Commission of Electronic Fund Transfers, which in turn guided the development of the US payments system for decades. It needs to do so again — with the Fed playing a central role in drafting the legislation. In the meantime, says Summers, the least that the Fed can do is to just start taking payments innovation seriously, including non-bank players who are building platforms which might revolutionize the way we all send money to each other.

The Federal Reserve Board should develop a special-purpose bank charter for providers of specialized payment services, allowing in particular for the inclusion of non-banks that are payment system innovators and payment method providers in the nation’s money and banking system for payments.

This kind of invisible plumbing is rarely sexy, and it certainly doesn’t get a lot of votes, but it’s crucially important, and could easily create tens if not hundreds of billions of dollars in value for the economy every year. The fact that the market hasn’t done it is a very clear market failure; and where there’s a very clear market failure, the government — in the form of Congress and the Federal Reserve — should step in.

Should, but won’t. More’s the pity.


I agree with TaxWonk here. Concerning your comment, “And we’re not going to get it”, you’re clueless.

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The stranglehold of payments networks

Felix Salmon
Mar 29, 2012 19:28 UTC

I’m mostly offline today, since I’m attending a payments conference at the Kansas City Fed. (And tomorrow I’m attending an econobloggers’ conference at the Kauffman Foundation: how jealous are you?) There’s a lot to digest here, but one thing already seems clear: if you look at the main players in the payments industry, whether they’re incumbents or new innovators who aspire to disrupting the status quo, everybody seems almost unthinkingly resigned to working on and within the present architecture, where consumers pay with their credit or debit cards, and merchants require some kind of way of accepting those payments.

Exhibit A, in this regard, is “The Credit Card Is The New App Platform“, a piece by Reid Hoffman and his colleagues at Greylock Partners, talking in a very smart way about all the value that can be added to credit cards as we move to a world of mobile apps and payments. The idea, basically, is that right now you have a dumb piece of plastic where all the real value is in that Visa or Mastercard logo; in the future, there’s a lot of opportunity in terms of making that piece of plastic much smarter.

Most of the most exciting innovation in payments, including companies like LevelUp, not to mention the iTunes store, is built on credit or debit card accounts: the first thing you do, when you download one of those apps, is type in your card number, and when you pay, the payment is ultimately made on your card — which means that it necessarily involves making substantial payments to those payments networks. iTunes, the conference was told this morning, has some 150 million card numbers on file, which is one reason why it’s so attractive to people looking to sell content or apps or music. Similarly, one of the great attractions of the Amazon Marketplace, for both buyers and sellers, is that Amazon already has the buyer’s card information on file. Other innovators, like Square and Stripe, are also innovating around credit and debit cards, specifically by making it much easier for the payee to accept those payments.

Visa and Mastercard, of course (and American Express, too) are very happy with this. They can work on innovations themselves, or they can outsource innovation to the likes of Reid Hoffman; either way, they get paid, because they’re the default payments architecture. But what we’re missing here is any kind of threat to their dominance. And that’s a great shame, because these dominant companies have an enormous amount of pricing power. The interchange fees that they charge merchants only ever go up; it took an unbelievably hard-fought act of Congress to bring those fees down just for bank debit cards. (Which is one reason why the number of prepaid debit cards is rising fast: they’re exempt from Durbin rules, and can charge very high interchange fees.)

The keynote speech at the payments conference today came from Joseph Farrell, the director of the bureau of economics at the Federal Trade Commission. He talked at great length about the importance of lowering the transaction cost of payments, and the way that would benefit both consumers and society; he also suggested that this was a key aspect of what the conference was about.

He’s right about the first: transaction costs are too high, and should come down, and there would be large positive externalities were that to happen. He’s wrong about the second, however: there’s actually precious little discussion at the conference about how transaction costs might come down. There’s much more talk about the way in which they go up far too easily: Visa and Mastercard have enormous pricing power, and can raise their prices as much as 30% without noticeably losing any customers at all. Merchants feel forced to accept such cards, no matter what the cost, while the costs to consumers, in the form of higher prices, are extremely well hidden. Visa and Mastercard essentially levy a non-negligible tax on a huge percentage of retail payments, and do so in a largely invisible manner; they then rebate some of that tax revenue back to consumers, bribing those consumers to force the merchants to pay the tax.

At one point last year, I got very excited about a new payments service called clearXchange, which promised the ability for people to pay each other without going through the Visa or Mastercard networks. And because it is backed by giant banks — Wells Fargo, Chase, and Bank of America — it has the potential to be really huge.

The problem is, it doesn’t actually work: it hasn’t taken off, for technical reasons I don’t pretend to understand. All I know is that when I meet executives from those three banks and bring up clearXchange, they tend to change the subject very quickly. It’s certainly not something which they seem to think is going to revolutionize anything, any time soon.

There is some innovation around payments which doesn’t involve Visa and Mastercard in some way. One peer-to-peer payments app I was shown today, which isn’t publicly available yet, is built on the EFT network, the one you use when you withdraw money from an ATM. And another delegate told me that fully 26% of revenue at Starbucks comes from its mobile app, which can be (and often is) funded directly from your bank account, without having to go through Visa or Mastercard.

But that kind of thing is laborious and expensive for startups: one of PayPal’s big competitive advantages, for instance, was the fact that it found a way to link PayPal accounts to individual members’ accounts at thousands of banks around the country. That’s non-trivial, and it’s much easier to deal with just two or three payments networks.

So color me pessimistic, here, at least in the US. There really is a huge public interest in bringing down transaction costs, and moving the locus of payments-related innovation away from the Visa and Mastercard networks, and towards cheaper and more direct bank-account connections. But I see no indication that’s going to happen. In that sense, I have the same view now that I had in 2010, when I said that there wasn’t much prospect of real competition in payments. It would be great were that to happen. But I’m not holding my breath.

As a consequence, the government really has to get involved here, lest the payments networks simply continue to raise their interchange fees and extract ever-higher rents from everybody else. But the obvious entity to do that is the Federal Reserve, and, at least judging by this morning’s remarks from Kansas City Fed president Esther George, that’s not going to happen any time soon. No one really wants new regulation. Which is surely music to the ears of Visa and Mastercard.

Update: One other intriguing idea I was given at the end of the conference: what about using the check-clearing architecture as a payments mechanism? With Check 21, in theory everything could be electronic, you don’t actually need paper checks. (Although some lawyers apparently say you do.) The problem, I think, would be ensuring funds were available. But if you can do that, it could work very well — and much more cheaply than the Visa and Mastercard systems.


I’m a PayAnywhere user. Their device plugs right into your phone and their app has easy to use features. I would definitely recommend it to anyone with a small business or salesmen on the go! http://www.payanywhere.com/home

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Why payments won’t ever be anonymous

Felix Salmon
Dec 16, 2011 16:15 UTC

I spent Wednesday night in Silicon Valley, at a very geeky discussion of Bitcoin, the unregulated digital currency which managed to get a lot of anarcho-utopians very excited. But Bitcoin fever seems to be on the wane right now, and the number of real-world places where Bitcoins can be spent is still, to a first approximation, zero.

One of the subjects we spent a fair amount of time discussing was the question of chargebacks and reversibility of transactions. Bitcoin was designed to be as cashlike as possible: once it’s spent, it’s gone. As one user discovered in spectacular fashion.

There are good reasons for setting payments systems up in a non-reversible way: it makes things much simpler and easier, for starters, and there is real demand out there for a digital equivalent of cash. On top of that, many Americans are unaware of the rights they have when money is spent on their credit or debit card, by themselves or others.

But consumer-advocacy organizations like Consumers Union are very aware of those rights. And as we move, very slowly, into a world of mobile payments, Consumers Union is trying its hardest to ensure that such payments are as reversible as possible.

Most cell phone and tablet users can purchase digital goods and charge them to their monthly bill or prepaid phone account. But they may not get the protections they need to limit their financial liability if something goes wrong with the transaction…

“Consumers using mobile payments should get the same strong protections they currently enjoy when they make purchases with a credit card or debit card,” said Michelle Jun, senior attorney for Consumers Union, the nonprofit advocacy arm of Consumer Reports. “But we found that consumer rights can vary widely between wireless carriers and the protections carriers claim to provide are often nowhere to be found in customer contracts.”

Jeremy Quittner wrote up the Consumers Union findings under the headline “Banks More Consumer Friendly than Carriers for Mobile Payment”:

Banks have been much maligned for nickel-and-diming their customers, but in another area — cardholder fraud protections — they are being praised as consumer champions.

A Consumers Union report released Wednesday shows that protections for purchases that consumers make using their mobile phone numbers are much weaker than those consumers get from standard cardholder agreements regulating their credit or debit card purchases.

I suspect that as the world moves increasingly towards digital and mobile forms of payment, these issues are going to be key in determining how popular those forms of payment become. People are naturally resistant to change, and they still worry much more about spending money online than they do about spending money in much less secure real-world transactions. So long as headlines about digital and mobile payments continue to frame the issue as one of “consumer protection,” the payments industry is going to have to take such things very seriously, even if they run counter to the anarcho-utopian leanings of the geeks developing the underlying technologies.

The tension, of course, comes with regard to anonymity: while cash is perfectly anonymous, other forms of payment are not. And it’s pretty much impossible to create a reversible payments system if the users are completely anonymous.

But that’s OK: if I’m making a payment by swiping my phone, I don’t really feel the need to be anonymous at all. In fact, if the payments system knows not only my identity but also my location when the payment is made, there are lots of ways that it can use that information in ways I could find extremely valuable. We’re seeing this already: various payments companies are putting together systems whereby every time I walk into my local coffee shop, say, I can just pick up my regular order and walk out, and the payment will happen automatically. As will the free coffee I get after paying for ten at a regular price. All I need to do is have my phone in my pocket.

The future of payments, then, is likely to be highly personalized and reversible — exactly the opposite of the anonymous and irreversible protocols built into Bitcoin. And that’s one big reason Bitcoin is not going to be a long-term success.


Pseudo-anonymity is a good thing and will helpout with bitcoin in the long run. Overall it’s good that huge amounts of money can be tracked into the block chain. There are a few bitcoin reviews of some sites that anonymize payments at Bitcoin Branches.


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How to reduce reliance on cash

Felix Salmon
Oct 10, 2011 16:38 UTC

When the financial crisis hit, the smart money went to cash. Literally, in the case of Mohamed El-Erian:

On the Wednesday and Thursday after Lehman filed for Chapter 11, I asked my wife to please go to the ATM and take as much cash as she could. When she asked why, I said it was because I didn’t know whether there was a chance that banks might not open. I remember my wife sort of pausing and saying, “Are you serious?” And I said, “Yes, I am.”

It turns out that this was a worldwide phenomenon. Here’s Ravi Menon, the managing director of the Monetary Authority of Singapore, in a speech last week (HT IK):

Physical cash commands a premium during times of uncertainty. We saw this during the 2008 global financial crisis. Within the first month of the collapse of Lehman Brothers, there was an exceptionally large withdrawal of high denomination notes by banks in Singapore. Typically, 90 per cent or more of the high-denomination notes withdrawn from banks are re- deposited within the month. During the initial months of the 2008 crisis, only 70 per cent of the $100, $1,000 and $10,000 notes withdrawn were returned.

This is understandable. But the fact is that cash is a very expensive payments mechanism:

Handling cash is costly. According to a 2010 study by Retail Banking Research, the cost of distributing, managing, handling, processing and recycling cash in Europe is estimated at €84 billion. This is equal to 0.6 per cent of Europe’s GDP.

For individuals, cash clears at par: if you give me a $100 bill, then I’m $100 richer and you’re $100 poorer. No one’s going to jump in and charge a fee for facilitating the transaction. And if I then deposit the $100 bill into my checking account, once again I see the full amount appear on my statement.

But the fact that most people never get charged for cash transactions is corrosive, in its own way: it helps to impede the inevitable-yet-glacial move away from cash and towards more secure, easier, and cheaper forms of payments.

Which is one reason why Bank of America’s $5 charge for debit transactions is so mindblowingly stupid. The more that people use their debit cards, the less they’ll use cash. And Bank of America spends billions of dollars every year processing heavy, dirty cash flowing in and out of its branches. If banks can persuade people to move to weightless forms of payment like debit, it will save them enormous amounts of money. After all, most of that 0.6%-of-GDP cost of processing cash is borne by retail banks.

And much of the rest is borne by the government. Minting physical currency is expensive! And wasteful! (Menon reveals, in his speech, that those charity-donation buckets in airports are placed there largely at the behest of the monetary authority, to try to stop local coins from leaving the country and having to be re-minted.)

Which means there’s a massive public-interest argument in favor of slowly phasing out cash in favor of other kind of payments. That’s never going to be easy, but it’s going to be pretty much impossible if the alternative payment mechanisms don’t clear at par.

I don’t know what kind of payment mechanism the world will ultimately alight on; I suspect however that it will use NFC technology in cellphones, and that it will be owned and run by a consortium of large retail banks. In the meantime, however, it behooves everybody, from the government to the banks, to do everything they can to wean people slowly off cash. If cash transactions cost the US 0.5% of GDP each year, that’s $70 billion a year at stake — significantly more than all credit and debit interchange fees combined. Don’t any of our greedy banks see the opportunity here?


This argument is ridiculous. I’m perfectly happy with the security, ease, and cost.

It is infinitely faster to pay with cash than a debit or credit card, if you live in the real world where I live.

I’ve carried several hundred dollars all my life, and never been robbed. And so what if I was, I’d lose about $100 out of (I guestimate) $300,000 I’ve carried around in my life. Big deal. Each of my fricking credit card fees are higher than that every year. This guy is a buffoon.

Meanwhile Cheques and electronic transfers are NOT free, otherwise the @#$ banks wouldn’t charge me $1.50 for my 7th cheque each month, and $5-10 plus a 2% spread for a withdrawal in Europe that costs them nearly NOTHING. This guy is a buffoon.

What the heck is the issue with cash?!? What if I want out? Cash gives me the power to opt out of the bank cartel, which is important to me.

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