Exploring the Wallet-as-a-Bank Model

Cash App, by Square, made headlines in 2020 as a leading digital wallet in the U.S. As a digital wallet, Square allows users to send & receive payments. Similar to a wallet in your pocket, a digital wallet is a place where you can store money for quick use and retrieval.

There are many digital wallets where payments can occur. But Square functions well beyond this.

Square is not just a digital wallet; it’s becoming a wallet as a bank (WaaB). It’s not just for sending and receiving money. Users utilize Cash App similar to a bank account. You can sign up for a direct deposit. You can buy, sell and send bitcoin and stocks. You can even get your stimulus check in 2020.

So, what’s really going on here? Through Cash App, Square offers a growing suite of financial services, akin to a bank. At its core, a bank takes in consumer money and then provides loans to consumers. It’s quite uncommon for banks to be used for payments. However, payment applications have been effective at doing the same thing banks are doing — gathering assets. Switching costs for banks are quite high, as most consumers rarely close their accounts. Therefore, banks are able to retain assets and create a large network.

Similarly, payment applications require a network effect as users join the platform and start sending payments to their friends and family. In a manner similar to banks, payments become a low friction way to also amass deposits and earn yield. Once a network effect is established, banking services like direct deposits and lending are a much easier jump for both the provider and the consumer. Since its initial launch as a payments application, Square expanded to offer more bank-like services such as debit cards, direct deposits, and even recently received conditional approval for an Industrial Loan Company bank charter.

Of course, this trend originates well before Square. AliPay began as an escrow system but quickly shifted to a payment model for Asian merchants. Today, AliPay offers wealth management services, micro-financing, insurance, and credit. There are an estimated 700M monthly active users of the AliPay app, and financial services via AliPay are increasingly ubiquitous. In fact, Ant Group suggests that 60% of its users are “living their lives” via the AliPay wallet. Their digital wallet is the primary banking relationship for most users.

Why Digital Wallets?

A recent study by McKinsey found that 3 out of 4 Americans use some form of digital wallets. Why are tech companies expanding their digital wallet services? And why are so many people using them?

For Digital Wallet Providers
There are two main reasons for tech companies to pursue digital wallet models. First, the data is valuable. Financial data provides the greatest insight into consumer behavior, which can support a number of other products and services that cross-sell on any one platform. For example, payment data can be used to underwrite small business loans in lieu of a FICO score. By gathering and processing payments data, wallets evaluate a payment track record for a particular business. Using data science, Square and other technology companies can onboard users first, and verify later. They can also create flexible loan payment models based on user needs. A strong data-driven approach is a critical advantage for technology companies moving into financial services.

Second, are the revenue growth opportunities. As tech looks for new sources of growth, payments and financial services, until recently, remained largely untapped for tech. Research suggests that digital wallet adoption is occurring 2x faster than social media did in the early 2000s, representing an $800B market opportunity in the U.S. by 2024 (Ark Invest). Additionally, digital wallet providers may have lower customer acquisition costs (CAC). Retail banks pay anywhere from $350 to $1500 to acquire customers whereas Square’s Cash App acquired new users in 2018 for less than $20 (Ark Invest). Although these accounts may have a lower lifetime value (the avg. Square users tend to make less than $50K), the lower CAC suggests these wallets can be profitable with this user base. Digital wallets as a customer acquisition channel can also lead to conversion for higher-margin products and services in the future.

For Users
In a world of smartphones and ecommerce, digital wallets offer two major benefits to users: accessibility and convenience.

Digital wallets are uniquely accessible. While many banks have limited app functionality, digital wallets are accessible via a mobile phone with little to no fees at entry. This accessibility is important for historically underserved demographics. There’s an estimated 55 million Americans who are unbanked or underbanked, with little to no access to banking services. Research suggests that Square’s Cash App has proven to be an effective solution for these underserved populations. Comparing Square’s Cash app adoption with unbanked rates across the U.S. suggests they have greater adoption with these demographics. Given the lower barriers to entry, accessibility is important.

Image from Ark Invest

The second reason for consumer adoption is the mobile-first user experience ensured by tech companies. Big tech is, once again, making it incredibly easy for consumers to use their tools. They offer consumer services like analytics tools and reporting with a great UI. They partner with consumer apps like Starbucks and Uber, integrating more seamlessly with day to day activities. The user experience offered by tech has become a hallmark of the industry. Because big tech has ensured this smooth user experience, adopting digital wallets also becomes the path of least resistance.

In short, there are strong network effects from users dipping into their digital wallets every day, and tech companies have ensured an easy transition to this model with their UX capabilities and expanded capabilities. A market like payments has strong network effects and services a consumer who demands accessibility and a great UX. From both the wallet provider and user perspective, a wallet-as-a-bank environment makes a lot of sense. But the trend isn’t isolated to fintech companies.

Enter the Crypto Wallet-as-a-Bank Model

With crypto, if you want to hold or use an asset you need a digital wallet. As the crypto asset ecosystem grows, many digital crypto wallets are naturally taking a wallet-as-a-bank approach. It’s possible that the strongest WaaB growth trends will come from the crypto sector.

With few traditional banks or tech companies providing these services, many crypto financial service companies are doing it themselves. Banking services for crypto includes buying and selling of digital assets, savings accounts denominated in crypto assets, interest-bearing accounts, and even loans collateralized with crypto assets. To name a few:

  • Coinbase wallet allows users to send and receive crypto assets as well as dollars, earn interest on USDC, the CENTRE stablecoin, and invest in a myriad of products
  • Dharma’s peer-to-peer payments application allows for payments via your twitter handle, savings on your cash deposits, and swapping for nearly any token
  • BlockFi, a popular lending platform, is launching a credit card as well as interest earning-savings accounts.

These products’ digital wallets are rushing to build out a suite of banking services for its users, alongside the growing trend in fintech. Many exchanges are building a full suite of banking services, in absence of their ability to partner with traditional banks.

Why might crypto-wallet infrastructure and digital assets be integrated more broadly? It’s clear that digital wallets are beneficial to both the consumer and the provider. The primary benefits of crypto-asset digital wallets come down to their global usability and programmability.

Global Usability
The beauty of crypto wallets is their global nature. With only an internet connection, anyone can spin up a crypto wallet directly from their phone or computer. This could open up banking and remittance services to the world’s population who may not be able to access their existing financial infrastructure. Crypto assets have the potential to bypass the existing payment processing infrastructure and send assets with little friction and fees. Today, most of the digital wallet monopolies are geographically segmented (AliPay / WeChat — China, Vodafone — India) but in the future, payments via stablecoins could allow these companies to expand their reach across borders. Although local regulation and jurisdictions may prevail, rebuilding infrastructure with stablecoin rails may result in a cheaper and faster system.

Open blockchains enable programmability in a manner that is incapable of the existing financial system. Programmability is defined as the ability to execute code in an automated manner, often with multiple actions or interdependent relationships (like IFTTT). Once a programmable crypto asset is created, these assets become openly accessible and interoperable with other crypto smart contracts. This, in turn, opens up the potential for new assets, markets, and ownership models that were previously unreachable due to costs, systems of trust, or accessibility.

As an example, we consider the concept of “Flash Lending.” Flash Lending allows users to borrow funds immediately and take advantage of arbitrage opportunities on exchanges. The entire transaction — taking out a loan, conducting a trade on an exchange, and paying back the loan occurs in mere seconds. When payment occurs in the same transaction — it effectively means the loan was outstanding for zero time with no counterparty risk. These programmable actions allow for cross-platform usage in a manner that is typically not cost-effective or technically feasible in today’s systems.

With digital wallets built on crypto infrastructure, the types of financial assets and products that can be offered is fundamentally different than what the traditional financial system offers today.

Will crypto WaaB be the model for the future?
In 2018, Square added functionality for users to buy bitcoin via Cash app. Now users can send bitcoin to an external address. The move was largely unprecedented by any fintech company, and bitcoin purchases netted $17M in profits for Square in Q2 2020 with over $200M in sales. Cash App also doubled down on its support for bitcoin, hiring developers to build bitcoin-first products. It’s no longer a question of dollars or bitcoin — in Cash App you can do both. While it may not be easy to send dollars back to a friend in India, with Cash App you can send bitcoin to a friend in India’s bitcoin wallet, seamlessly. In their march to becoming a wallet-as-a-bank, Square might be the first company to simultaneously bridge the gap between crypto-assets and fiat systems and is wildly more successful as a result. I would surmise, crypto’s WaaB model may serve as a wedge towards broader market adoption.

Many thanks to Ellen Fishbein, Spencer Bogart and Max Friedrich for the discussions & feedback on drafts