Faster payments and electronic transfers is a hot sector of Fintech. For quite some time, traditional banks sat on the sidelines watching Fintechs push into their business. Today, they are stepping things up but questions remain as to whether or not old finance has the agility and ability to innovate to keep pace.
Earlier this month, The US Federal Reserve announced “FedNow” a new service to “help ensure that real-time payments are available to everyone.”
Federal Reserve Member Lael Brainard, explained FedNow as follows:
“The Federal Reserve will develop the FedNow Service, a real-time payment and settlement service for the future. Everyone deserves the same ability to make and receive payments immediately and securely, and every bank deserves the same opportunity to offer that service to its community. FedNow will permit banks of every size in every community across the country to provide real-time payments to their customers.”
The move by the Fed has been broadly welcomed but FedNow could still take years to be live and in the wild. Meanwhile, other services including crypto payments are attempting to streamline transfers.
Recently, Crowdfund Insider discussed the payments ecosystem with Derek Chau, a Partner at the VC firm Acorn Pacific Ventures. Acorn is an early-stage venture capital firm with a focus on global technology strategies in North America and Asia.
Acorn is actually a network of funds founded as one of the first Chinese Americans funds in Silicon Valley. The VC was initial formed via funding by some “very successful Chinese American entrepreneurs.”
Our discussion on payments and transfers is shared below.
The technology to provide faster, near-immediate payments and transfers have been around for quite some time. Why has it taken so long to accomplish in the US?
Derek Chau: Like the adoption of most new disruptive technologies, the actual technology feasibility exists several years (and sometimes decades) before we see mass adoption by consumers and businesses. In the case of the payments space, the pace of change has obviously been slower than many other new technologies/behaviors. It seems like things are finally reaching a “tipping point” now, but at the same time, the volume of payments that are made via check/wire payments/ACH still astounds me.
The adoption of digital payments / P2P payments is still heavily skewed towards younger demographic cohorts. While that is changing now, I believe that B2B payments will lag behind the consumer space. It takes even more time for behavior change in B2B payments as there are a number of entrenched players servicing cash management and payments for businesses.
Also, I think that many businesses perceive traditional payment methods as “safer” as they have experience with those methods and understand the fraud rates associated with them. Businesses are still made up of people, and it takes time for people to become mentally comfortable with new methods.
Recently, the Federal Reserve announced “Fed Now” their faster payments initiative. This was the result of an ongoing discussion within the industry plus some coaxing from Congress. What are your thoughts on this?
Derek Chau: I don’t know much about the FedNow initiative, but it is super important that the Fed plays some role in helping to push the ball forward. The interbank system still relies upon the CHIPS and Fedwire system primarily, and we are talking about a few trillion dollars clearing interbank daily. I hope the FedNow initiative also addresses interbank transfers as both of these systems are quite old, and without innovation in this sector, it will be difficult to realize efficiencies in the P2P and B2B and other categories.
Is part of the problem due to the reticence of established players, such as banks, to innovate, adapt, and undercut their own margins?
Derek Chau: Yes, I believe that certainly is part of the problem.
Everyone is aware that the US interchange fees for card payments are very high compared to other countries. So yes, banks and payment processors have a big incentive to protect their margins. But the other part of the problem is that banks have very large and complex IT systems. Their IT infrastructure is very hard to change because it is a complex web of interlinked systems (“big ball of knotted string” so to speak) and has to deal with state/federal regulations, privacy, fraud, etc.
The Zelle consortium is an interesting case study in that the large banks are defending their ecosystems proactively and aren’t really trying to monetize; Zelle seems to be more of a defensive play. I would definitely give the banks some credit for the initiative in that consortium, but there are still many difficult problems in the P2P space to solve given the fragmentation between the different P2P platforms.
Are Fintechs in a better position to provide a faster, less expensive payment ecosystem?
Derek Chau: Yes, I believe so. And that’s why we are observing so much VC investment in the space at the moment. Given that startups are leaner, don’t have legacy IT systems, and are more incentivized to disrupt the space, I do think Fintech startups will lead the way here.
One possible outcome is that the ecosystem becomes similar to the pharmaceutical/biotech space whereby startups primarily fuel the innovation in new drug development and then via licensing / partnerships / M&A, the large established pharmaceutical companies bring the drugs to market after the initial drug discovery.
In the payments space, the banks and other established financial enterprises would have a comparative advantage in dealing with the regulatory rules, privacy, and large scale distribution of new systems. The Venmo-Braintree-Paypal acquisition is an example of this. But it is still to be determined how things will continue to evolve.
What about blockchain/DLT technology? Is this part of the path forward?
Derek Chau: I purposely don’t spend much time in the blockchain/DLT space as it related to Fintech. While there are a lot of interesting ideas and innovation, I have found it difficult to sift through things given the noise in the ecosystem. It seems that many Fintech startups just added a blockchain/crypto element to their strategy as an afterthought, somewhat the same way that many software companies added an artificial intelligence/machine learning strategy a couple of years ago.
Having said that, I do think there are a lot of interesting applications for blockchain in specific applications like trade finance, cross border payments, fraud, and KYC. The Visa B2B Connect initiative is a good example of where they are using pieces of DLT. Blockchain will face the same problem of interoperability as many other systems, though as I think there will be a lot of fragmentation in the space for some time given the different platforms and public vs. private blockchains.
Haven’t the Chinese already schooled the US in how payments should be done?
Derek Chau: Yes, China has definitely been innovative on this front. They had the advantage of a mobile-first mentality/technology infrastructure, which played a big role. Also, China didn’t have the same problem of legacy technology and user behavior, so that was also a significant advantage. We were able to learn a lot from China, but things have not evolved in the same way in the B2B and cross-border payments space.
There remains a number of greenfield opportunities in those spaces. I’m especially curious how cross-border payments will innovate over the next few years. It is a more difficult problem given issues with currency exchange, capital controls, compliance, fraud, and interoperability across different financial systems. It’s interesting to see a large financial institution like Visa with their Visa B2B Connect initiative and their attempt to innovate in the space. I am definitely keeping an eye on that initiative.
What are your thoughts on Facebook’s Libra? What about other cryptos in the payment/transfer sector?
Derek Chau: Again, I don’t spend as much time in this space, so I can’t provide much genuine insight here.