PayPal’s Bitcoin strategy is about much more than bitcoin

Given that the people who are great supporters of bitcoin often talk about its key characteristic being that it is person-to-person, uncensorable value transfer you do have to wonder who will be using the new PayPal service that will allow them to pay merchants using the cryptocurrency. My good friend Ron Shevlin drew on a survey of 3,000 US consumers conducted by Cornerstone Advisors and FICO which found that around two-thirds of US smartphone users have the PayPal app installed (as I do), a seventh of all PayPal users already own some form of cryptocurrency and of those PayPal users, half of them used Bitcoin to buy products or services in the past year. So does this mean that the mass market use of cryptocurrency for payments is just around the corner?

I think not. The overwhelming majority of all cryptocurrency transactions are purely speculative and the people who think that bitcoin is a good investment* are never going to use it for payments. Bitcoin was originally billed as an elecronic cash system but most bitcoins aren’t used as currency in transactions for goods and services. Surveys have shown that the majority of bitcoin are held for speculative purposes and while some retailers accept Bitcoin, they see cryptocurrency purchases having a higher drop-out rate than cards and cash payments.

Paypalpassword

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

So this can’t be much of a payments play. Think about it. If you think that the bitcoin is going to the moon (and will be worth $1 million each within five years, as this former Goldman Sachs hedge fund person has just predicted) then why would you waste even a tiny fraction of a bitcoin buying the pizza or a Pez dispenser? No, the people who will use their PayPal wallet to exchange bank dollars for PayPal bitcoin are simply investing. If they choose to pay a merchant using bitcoin from their wallet, PayPal gives the merchant dollars anyway. Neither the consumer nor the merchant ever has any actual bitcoins in their possession.

When people do use bitcoin to buy things it tends to be things they can't buy using PayPal anyway. Click To Tweet

The amount of cryptocurrency spent on “dark markets” rose two-thirds to reach a new high in the final quarter of 2019, according to Chainalysis and the New York Times says that this data is likely to understate the number transactions for illegal purposes because the company cannot identify all activities relating to drugs, ransomware, tax evasion and money laundering. If I use bitcoin to buy illegal drugs, example, because of its “anonymity” and uncensorability, then I am hardly likely to start buying drugs using PayPal. The example of adult services makes this point rather well. Adult performers who are engaged in a perfectly legal business complain that PayPal refuses to allow payments to them and so they are forced to use third-parties who, according to the New York Times, take anywhere from a third to four-fifths of performers earnings in fees. Those people still won’t be able to use PayPal, whether in dollar or bitcoin, so the new service won’t make any difference to them.

PayPal’s Big Picture

Well, since the people who run PayPal are much richer and much smarter than I am, I am forced to conclude that they must have a plan that goes beyond earning some spreads from buying and selling cryptocurrency for retail speculators. I have no knowledge what PayPal are doing or why, but I do have some experience looking at strategies for financial institutions exploiting new technology, so I think I can make some informed guesses.

First of all, PayPal’s move is to be admired purely in marketing terms. The announcement put five percent on their stock price and garnered gazillions of column inches, links and commentary such as this. Even if they never turn a profit on bitcoin itself, their investment in software and licences has already paid off. I worked on a project for a global financial services financial services organisation a couple of years ago and I can remember the calculations around brand and exposure. To old-timers like me, PayPal is the grandparent of fintech, an upstart storming the walls of the entrenched incumbent financial services giants. But to youngsters, such as the son who I just asked about the company, PayPal are part of the establishment, no different to Wells Fargo or Barclaycard. A bit of cryptocurrency glitter does not hurt the brand, even if it is cosmetic.

Secondly, the technologies of cryptocurrency (shared ledgers, cryptographic proofs and so on) are going to be the foundations of a longer term shift to the trading of digital bearer instruments that are exchanged without clearing or settlement networks so building up institutional expertise is valuable. It’s reasonable to imagine that these instruments might well be implemented as tokens traded across decentralised networks, so exploring the trade-offs around infrastructures and interfaces is a good investment of time and effort.

Thirdly, and much more importantly though, I suspect that PayPal are making two much more strategic and long-term plays around the wallet and its contents. They are no doubt looking enviously across the water to the Asian “super apps” and thinking about the impending Alipay IPO. Turning PayPal from being a repository of balances to fund payments into a financial hub managing a number of different assets for a broad range of consumers is attractive to them. In their scenario planning, PayPal undoubtably started to think about the opportunities that will arise from the trading and management of digital assets (in the form of tokens) in the not-too-distant future. By gaining expertise in decentralised alternatives to commercial bank money and the regulation that does with them, PayPal is being very smart.

I don’t think PayPal’s experiment with bitcoin is really much about bitcoin at all. I think this is a measured and intelligent step towards the transactional environments of the future where digital assets compete with digital fiat across a payments landscape that is utterly different to that of today. As Ajit Tripathi pointed out, crypto-believers might feel they have occupied Wall Street but the reverse is true. Banks (and their regulators) have won and some of these interesting new digital assets are on their way to becoming part of the financial mainstream.

There is one particular category of digital asset that is inevitable: Central Bank Digital Currency (CBDC). In the run-up to the biggest IPO in history, Jack Ma talked about how digital currencies may play an important role in building the type of a financial system that will be needed for the coming generation and said that digital currency could “create value and we should think about how to establish a new type of financial system through digital currency”. Just as the Chinese government have begun to distribute their digital currency through third parties, including commercial banks and apps, so PayPal might reasonably expect to be an invaluable partner to the US government when it finally gets its act together to deliver some sort of digital dollar. If PayPal were to pivot away from the traditional infrastructure of banks and accounts, payments cards and interchange towards an infrastructure of wallets exchanging digital dollars (or perhaps, as Meltem Demirors speculates from a very well-informed perspective, their own alternative to Facebook’s Libra private currency) that would be a significant shift in the dynamics of the payments sector.

* I am not saying that I do or do not think cryptocurrency is a good investment. I am not making any comments that might be misconstrued as financial advice. Please note that any comments I make about cryptocurrencies as an asset class are for entertainment purposes only.

[This is an edited version of a piece that first appeared on Forbes.com, 25th October 2020.]

Today we celebrate Saint Valentine, the patron saint of customer verification methods

It’s one of my favourite days of the year today! I am a payments romantic, so you will undoubtedly know why! Today across the civilised world, we celebrate Saint Valentine, the patron saint of customer verification methods (CVMs). We buy flowers and eat chocolates on this day every year cto commemorate the introduction of chip and PIN. Yes, chip and PIN was launched in the UK on 14th February 2006. 

Yes, it’s lovely St. Valentine’s Day. Was it really thirteen years ago? The beautiful day, the day unromantically dubbed “chip and PIN day”, when we stopped pretending that anyone was looking at cardholders’ signatures on the backs of cards and instead mechanised the “computer says no” alternative. It really was! Thirteen years!

We English, we love out heritage. We still write our laws on vellum, we still say “what an interesting idea” when somebody says something that is transparently insane and, for now at least, we still use cards to buy things in shops. We cling to tradition. And chip and PIN is a tradition. Or at least it was.

I’m sorry to say that in Merrie England, chip and PIN is on the wane. The majority of card transactions are contactless and, according to Worldpay (who should know), they have been for a few months now. Fraud is manageable because most transactions are authorised online now and would be whether we had chip and PIN or not. The offline PIN and “floor limit” world has gone. The world’s first optimised-for-offline payment system was launched after the world had already got online. This is why you see  Brian Rommele writing that “by the time the UK implemented chip & PIN, the base concept and much of the technology was already almost 40 years old”.

Early chip and PIN focus group.

It is time to remind people what Saint Valentine stood for and reiterate why we are using chip and PIN at all. In ancient times, when European retailers could not go online to verify PINs due to the anticompetitive pricing of the monopoly public telephone providers, it made sense to verify the PIN locally (ie, offline). But this is 2019. We have smart phones and laser beams and holiday snaps of Ultima Thule. We can probably think about verifying PINs online again, or even replacing PINs with fingerprints or DNA or whatever.

Smart phone in particular mean change and, as I have bored people on Twitter senseless by repeatedly tagging “#appandpay rather than #tapandpay”, this will take us forward to a new retail payment environment in which the retail payment experience will converge across channels to the app. As payments shift in-app so the whole dynamic of the industry will change. Introducing a new payment mechanism faces the well-known “two-sided market” problem: retailers won’t implement the new payment mechanism until lots of consumers use it, consumers won’t use it until they see lots of retailers accepting it. This gives EMV a huge lock-in, since the cost of adding new terminals is too great to justify speculative investment.

When you go in-app, however, the economics change vastly. For Tesco to accept DavePay in store is a big investment in terminals, staff training, management and so on. But for the Tesco app to accept DavePay is… nothing, really. Just a bit of software. However traditional we might be, the marginal cost of adding new payment mechanisms is falling (particularly direct-to-account mechanisms because of open banking) and our industry needs to think about what that means.

I’m not saying that cards and PINs are going to go away any time soon, but what I am saying is that it’s time to start thinking about what might come next. Right now, that looks like smartphones with biometric authentication, but who knows what technologies are lurking around to corner to link identification and continuous passive authentication to create an ambient payments environment in which cards (and for the matter, terminals) are present only in a very limited number of use cases.

We need to go cashless, not drift into cashlessness

Having just been to China for Money2020 and having experienced at first hand the operation of a cashless society, I’ve even thinking (again) about the design of cash-replacement payment systems for a range of perspectives, using China as a case study. The first point to make is that people in China are well aware of what happens to when society switches from anonymous cash to not-anonymous (I can’t think of a suitable antonym) electronic payments. As observed in the Financial Times, “that scale of data accumulation is beyond our imagination”. The Chinese woman making this comment (while observing that despite her concerns about privacy, mobile payments are too convenient to opt out of) goes on to say (somewhat poetically, in my opinion) that she cannot tell whether her compatriots are “constructing a futurist society or a cage for ourselves”

Not everyone in China is part of this revolution, of course. The World Bank Global Findex database, which measures financial inclusion, estimates that as of lat year some some 200 million Chinese rural citizens remain unbanked, or outside of the formal financial system. As in Sweden, the shift toward cashless is raising issues around exclusion and marginalisation.

There are, for example, supermarkets with different lanes for cash or cashless payments that act as physical manifestation of social stratification between, as Foreign Policy notes, the young and the old and between the urban middle class and those left behind (between, as David Goodhart would put it, the “anywhere” and the “somewheres”). I’ve written before that we will see the same in the UK as cash vanishes from middle class life to become the preserve of the rich and the poor who will use it for tax evasion and budgeting respectively. A “Which” survey found that over 75% of low-income households rely on cash, as well as over 80% of elderly households. The shift to cashless society must be planned to help these groups so that they share in the benefits of cashlessness.

Woking going cashless

Cash is vanishing even in Woking.

I think we should start to plan for this now. In China, as in Sweden (where the New York Times observes that “cash is disappearing in the country faster than anyone thought it would“), we are beginning to see what happens to societies that slide into cashlessness. I am against this. That is, I am in favour of cashlessness, but I am in favour of it as a policy decision by society that is implemented to meet society’s goals. I couldn’t disagree more with the Wall Street Journal’s view that the move to cashless society “should be left to technological advancement”. No, it should not. This is a matter of great importance and with significant implications for society. The strategy should therefore be set by society, not by technologists.

Now, clearly, technological advances deliver new possibilities to policymakers and it is good for technologists to explore these possibilities. But, as they say, just because something can be done does not mean it should be done. We need a proper debate and a regulatory envelope set out to move forward. I wonder if we might seize the opportunity and set down a technological marker for post-Brexit Britain by declaring that cash will be irrelevant in the UK in a a decade. That is, anyone who needs to pay for anything will be able to do so electronically and that anyone who does not want to pay electronically will be presented with a method for paying in cash, albeit one that they have to pay for like (like cheques).

This must mean that in parallel we must set a national goal to provide a free at the point of use electronic payments infrastructure for everyone. Otherwise we’ll end up where they are in America, where jurisdictions are trying to ban cashlessness (and thus keep the cost of the payment system high, especially for the poor) in the name of social justice. In New York, Congressman Ritchie Torres has put forward proposals to force businesses to accept cash and called them a a “new frontier” of anti-discrimination law that is needed to prevent a “gentrification of the marketplace”. Similarly, as the Washington Post reports, lawmakers in the nation’s capital have introduced a similar bill. A council member there said that by refusing cash businesses are “effectively telling lower-income and younger patrons that they are not welcome”. Maybe, but if so it’s only because those demographics don’t spend enough to provide the margin needed to cover the cost of cash.

It’s time to start thinking about what the requirements for that infrastructure are and consulting consumer organisations, businesses and government departments on their needs. We need to make a cashless Britain, not simply allow a cashless Britain.