The Four Horsemen of the Digital Payments Revolution: Real-time Payments
Part 1 of a 4-part series covering four emerging Fintech technologies that will fundamentally change the way we pay. I’ll discuss the state of the technology (both domestically and globally), my outlook on the technology, and where the investment opportunity is.
Introducing the Four Horsemen
Over $100B has been invested in payments startups by VCs over the last five years, with investors attracted by the large market opportunity, high margins, and, ultimately, the outdated legacy payments infrastructure.
The coming innovations in digital payments infrastructure have the potential to disintermediate credit card networks, FX brokers, and banks. Per McKinsey’s most recent Global Payments Report, there’s $2T+ in global payments revenue at stake for disruption.
VC capital and an evolving regulatory environment are driving rapid advancements in real-time payments (RTP), central bank digital currencies (CBDCs), Open Banking, and biometrics. These four technologies are accelerating across the globe, painting a new vision of what payments could be. Say goodbye to expensive credit card networks and slow ACH payments — the new world of payments is instant, low-cost, secure, data-rich, and cross-border.
I dubbed these technologies The Four Horsemen of Digital Payments — the harbingers of the digital payments revolution.
- Real-time payments
- Open Banking
- CBDCs & Stablecoins
- Biometrics
Each week we’ll cover one of the topics above. To start us , we’ll be looking at Real-time payments.
What are Real-time Payments & why they matter?
Real-time payments are payments made directly between two bank accounts. Unlike ACH payments, they are instant and data-rich. Unlike credit cards, they are low cost.
This means that they fulfill use cases that the existing payments are not well suited for.
Real-time payments rails can execute transactions in seconds, 24x7x365. Payments are authenticated immediately, settled immediately, made available in the recipient’s account immediately, and the sender is instantly notified that the funds have been delivered.
This sounds like it should already exist, but it doesn’t. Legacy bank-to-bank systems like ACH are slow and manual. Communication is only in one direction (from sender to recipient), and a very limited set of data is passed along with the transaction. RTP networks have bi-directional communication and can pass along detailed payments metadata via ISO 20022 standards.
Payment takes days on ACH, and the payer can dispute payments after the fact (this is known as chargeback risk). ACH providers charge high “chargeback fees” to cover their loss ratios (ranging from $5 to $25 per transaction). In addition, many ACH payments fail 1–2 days later because of insufficient funds, meaning that the merchant won’t be paid and will have to retry payment on another day. While this works for recurring payments like bills, this makes ACH a bad fit for eCommerce or POS, where the merchant would need to release physical goods before receiving payment.
Because real-time payments are instant and final, these payments are a better fit for eCommerce and POS, at a price point much lower than credit cards. The additional data passed along with real-time payments means they can be more easily integrated into business processes.
Around the World, Around the World
RTP rails are live in 60+ countries, but adoption has varied dramatically by country. Central banks, industry groups (such as The Clearing House in the US and PesaLink in Kenya), and private companies (notably JP Morgan) have been driving real-time payments across the world with varied degrees of success.
Adoption has been supported or inhibited by a number of factors. Slow adoption rates of RTP can be tied to factors such as non-unanimous banking participation, premium pricing (relative to other bank-to-bank rails), and large unbanked populations.
On the other hand, the most successful RTP launches had strong regulatory regimes that mandated compliance from 100% of domestic banks, and, in many cases, built the new RTP rail in partnership with commercial banks and 3rd party tech providers. Open architecture infrastructure allowed further development of digital payment overlay services to be built on the new rail by the central bank, commercial banks and Fintechs alike.
UPI in India and PIX in Brazil are high profile success stories, but Thailand’s PromptPay is a lesser known but equally successful foray in RTP. Other markets well-positioned for accelerated RTP adoption include China, Australia, Indonesia, Malaysia, Turkey and Saudi Arabia.
Another key trend has been cross-border integration of RTP rails. Singapore is leading the way in cross-border RTP. Singapore integrated their PayNow system with Thailand’s PromptPay in 2022, and recently launched their integration with Indian’s UPI system. The Bank of International Settlements (BIS) is working on a multilateral network of RTP systems, codenamed Project Nexus.
I created an index (see below) in order to help compare where certain RTP succeed in driving adoption and where they struggle across markets. With this as a guide, the global RTP landscape can be viewed more clearly.
Check out the Millisits RTP Index for more detail on the methodology.
Party in the USA
Eyes are focused on the US, where the Fed’s real-time FedNow service is slated to launch in July 2023. FedNow isn’t the first RTP network in the US. The Clearing House, a banking association operated by 18 of the world’s largest banks, launched their RTP service (called simply RTP®) in 2017.
Many think the US is poised for RTP breakout in the near term. Zelle, Venmo and CashApp — who provide consumers with instant peer-to-peer payments — cumulatively processed over $1 trillion in 2022. Visa and Mastercard have responded to the threat to their credit card duopoly with Visa Direct and Mastercard Send. JP Morgan is pushing their ‘pay-by-bank’ solution despite the risk to their $5B of credit card revenue.
However, there are two main roadblocks to consumer adoption of RTP — interoperability and consumer preferences.
The Fed and The Clearing House have chosen competition instead of cooperation. Unlike their shared operation of the ACH network, there’s no plans for the RTP networks to be interoperable. This causes challenges for adoption of either platform. Banks, fintechs and tech providers will have to integrate with two separate systems. Even worse, non-ubiquity poses problems for merchants and consumers. Merchants don’t want to integrate new payment solutions without a critical mass of users; consumers don’t want to use payment methods that are not universally accepted.
Overcoming American consumer preferences for credit cards will be a similarly tall order. Consumers are addicted to credit card points. Banks are addicted to credit cards. And some retailers and merchants, especially those in travel and hospitality (airlines, hotels, cruises), have too much credit card loyalty program momentum to walk away (American Airlines made $4.5 billion from their co-branded cards in 2022).
RTP adoption faces an uphill battle in the US. Despite all these developments in real-time payments, less than 1% of payments in the US are instant, according to ACI Worldwide. So why would things be different this time around?
- Interoperability through third parties: The lack of interoperability between FedNow and The Clearing House’s RTP will be papered over by third parties. Payment service providers like Dwolla and treasury management systems like Modern Treasury plan to serve as a switch between the two services. Merchants and consumers won’t know the difference. But they’ll get the user experience they want, which is being able to make/receive a payment between any bank-to-bank pair.
- RTP is a compelling credit card alternative for one-off transactions: Merchants want to move away from credit cards and their high fees (2% of gross revenue, on average), but their current low-cost option is ACH. ACH is a bad fit for one-off payments, because of the chargeback risk. Moving consumers away from their preferred credit cards is difficult, and ACH hasn’t been a compelling enough alternative for merchants to aggressively push consumers to the rail (though some have had success changing consumer behavior — see Target’s foray into ACH). RTP, on the other hand, works well for one-off transactions like you’d see in brick-and-mortar retail or through e-Commerce. It’s worth ripping off the “credit card bandaid”.
- What the banks are saying: At least on paper, banks are planning to move on from their credit cards businesses, pushing bank-to-bank payments. Banks see the risk that low-cost bank-to-bank pose to their credit card revenues, and would rather disrupt themselves than be beaten to the punch by a non-bank player.
Of course, we don’t actually know what the banks will do. Will banks willingly cannibalize the substantial revenues from their credit card businesses? Is the threat of real-time payments real enough for issuing banks to destroy their payments moat? Or will new or existing Fintech players emerge to plug the gap?
The Investment Opportunity
There’s a number of areas where RTP creates potential investment opportunities.
Investing in Payment Services Providers and Payments Infrastructure
RTP creates a lot of value for merchants and destroys a lot of value for banks and credit card networks because it erodes their payments moat. Determining where the value capture happens is the hard part, but there will be some winners offering payment services to merchants. Alternative payment services providers, especially those that own the customer relationship (think issuing banks) or own the merchant relationship (think payment facilitators like Stripe), are potential winners. In the US, a payments switch that provides pivotal interoperability between the two RTP systems is well placed to capture large payment volumes.
- Alternative payment services providers
- US only: Payment switches that interoperability between FedNow and The Clearing House’s RTP
Investing in Value-Added Services for the new RTP rail
Real-time payments happen in real-time. This means that there are a number of business processes that now need to happen in real-time. Alternative payments are increasing pressure on AML functions, and AI/ML solutions are increasingly needed.
We can look to the credit card networks for inspiration, because they provide these value-added services today as part of their card networks (here’s how Visa views value-added services).
- Fraud monitoring & AML
- Credit risk modeling & decisioning
- Digital Identity
- Cybersecurity
- Biometrics
Investing in international money movement
RTP speeds up the cost and payment processing time for the domestic parts of an international transaction. This sets up the potential for instant, cross-border payments (Thunes and Nium are building here). CBDCs and stablecoins are technologies that will compete with RTP networks to be the future of international money movement.
RTP-based networks are likely to win out because of favorable regulatory regimes worldwide, and because the technology will be easier for banks and other financial institutions to adopt.
- Cross-border RTP payment networks
- Global treasury management systems
On Deck
Next week I’ll be covering Open Banking, so follow me on Medium and get notified when the next article goes live!
A special thanks to Teddy Himler and the rest of the Antler team (Fady Abdel-Nour, Eduardo de Haro, Nicho Herold) for their contribution to the article. Thanks are also owed to Kester Keating at Barclays, Andrew Kaing (a fellow GoCardless alum), Gali Heichel from Klarna, and the many others that contributed their time to chatting real-time payments and helping with copywriting!
