A lot of time and ink has been spent discussing the changes brought about by new payments technology developed over the last decade or so, but have alternative payment methods (APM) fundamentally changed the way payments work? Have things like digital wallets, cryptocurrency and buy now pay later really changed how we pay for goods and services?
First let’s define what “alternative payment methods” means. It is generally accepted to refer to any form of payment that isn’t cash or a major credit/debit card scheme. Some of the payment methods covered under this rubric aren’t particularly new. Other methods included in the APM definition are actually quite popular in some markets and not quite as “alternative” as their name would suggest.
Among the older APM are bank transfers, direct debit (like ACH) and money orders. One thing that distinguishes these older APM is that they operate independently of credit card rails. This is not that surprising when you know the history behind these payment methods. For example, money orders were popularized by national postal services in the 19th century, long before credit cards existed. Direct debit dates to the 1960s, which were still in the years when the credit card industry was in its infancy.
More recent APMs are tied directly or indirectly to credit card rails. Prepaid cards are an obvious example.
Single location gift certificates started in the 1970s but took many years to reach widespread acceptance. In the 1980s, single-purpose (also known as closed-loop) cards with acceptance limited to specific merchant locations, were adopted by the U.S. telecom industry. Big retail chains soon followed and in the early 1990s closed-loop cards became the plastic version of paper gift certificates.
Open-loop, i.e. multipurpose, cards owe their adoption in the U.S. to the 1996 federal welfare reform, which mandated that food stamp coupons be replaced with electronic benefits transfer (EBT) cards. These EBT cards needed to be accepted at multiple merchants, which enabled the development of open-loop cards.
The next major jump was from welfare beneficiaries to “unbanked” workers with the creation of payroll cards in the late 1990s. These provided employers a convenient way to pay workers who lacked bank accounts. Open-loop prepaid gift cards finally made their way to the U.S. from Europe in 1999. Today, all major card associations offer multi-purpose prepaid cards that can be used at any merchant that accepts payment cards bearing the brands’ logos.
However, since the turn of the millennium, there have been at least three major payment innovations: digital wallets, cryptocurrency and buy now pay later (BNPL).
A digital wallet provides the user the convenience of storing one or more methods of payment digitally. Instead of carrying cash or cards, the user just stores their payment information on a smart device, like a smartphone, a smartwatch or a tablet.
PayPal’s launch of an electronic money service in 1999 can be considered the advent of popular digital wallets. Other milestones include Alibaba’s 2004 launch of Alipay in China, creating a digital wallet that is now accepted by merchants in over 50 countries and is used by over 1.3 billion users – larger than PayPal. In addition, Google became the first major company to launch a mobile wallet in 2011.
On a high level, the function of digital wallets is straightforward enough. Once a customer has transferred funds into their digital wallet, they are then able to transfer the funds to other digital wallets using simple identity methods such as an email address or phone number rather than through the complex banking system. This can be particularly handy when conducting cross-border transactions. However, the system requires both users to have wallets within the same ecosystem (i.e. payment rail) and still requires funds to be onboarded in and out via the traditional banking system either via ACH or via credit or debit card.
The vast majority of the time, digital wallet users simply transact and then immediately transfer funds out of the system into the banking system or onto cards. Thus, while services like PayPal had the potential to replace credit cards, they simply ended up augmenting the existing system.
Although cryptocurrencies can technically be traced back to the 1980s, the first one to achieve mass popularity was Bitcoin, which was founded in 2008 by Satoshi Nakamoto. Cryptocurrencies based on distributed ledger technology create their own payment rails. But while cryptocurrencies have surged in popularity since 2008, they still are rarely used for actual purchases of goods or services.
For the vast majority of cryptocurrency users, on-ramps and off-ramps from and into fiat currencies are necessary. On-ramps typically make use of the debit/credit card system. Off-ramps typically involve the banking system through wire transfers. In this respect, they haven’t dramatically changed the world financial system.
BNPL is based on the idea of an “installment plan,” where purchases are paid off weekly or monthly. Installment plans developed in the U.S. from around 1840 as makers of furniture, pianos and farm equipment sought to boost sales by making products more attainable with easy financing. BNPL’s twist on the whole notion of installments is to make them available for cheaper everyday purchases, not just expensive equipment and white goods, and to make the installment plan part of online checkout for merchants.
Of the major BNPL players today, Klarna was founded first in 2005. The industry as a whole only really took off over a decade later, with a major push towards mainstream adoption occurring during the eCommerce boom that happened with the COVID-19 crisis.
Some of the BNPL operators, like Klarna, have their own payment rails and charge merchants interchange fees between three percent and six percent of total transaction value for their use.
However, credit and debit cards still figure in the mix. For starters, many BNPL plans offer virtual cards to pay for goods at merchants that haven't onboarded with them yet. These cards ride on Visa and Mastercard's rails.
Second, both Visa and Mastercard have launched BNPL initiatives that enable consumers to pay merchants through installments using their payment rails. These so-called “open loop” models allow consumers to pay through installment anywhere where the card brand is accepted. For example, Visa, in its press release announcing its BNPL initiative, explicitly stated that acquirers on its network can activate the ability to enable installments for any of their retailers that accept Visa.
Last, but most important, for the time being a majority of BNPL purchases are paid with either a debit or a credit card. That means indirectly BNPL operators still rely on credit card payment rails.
At the end of the day, despite the change wrought by newer APM, consumers still rely on their credit and debit cards. Credit and debit card payments accounted for 55 percent of total payments in the U.S., according to the Federal Reserve’s 2020 Diary of Consumer Payment Choice. The next most frequent payment method was cash, with 19 percent of transactions. Alternative payment methods may be the bee’s knees and sometimes more convenient, but it looks like the world of credit and debit cards will be with us for years to come.
For merchants, this means the hassle and expense of dealing with chargebacks is here to stay. That is why you should reach out to a chargeback mitigation solution like Justt, which takes the hassle off your hands and returns money into your pocket before taking a single fee.
