Digital payments can deliver better immediacy and ubiquity than traditional retail payment systems and, therefore, could revolutionize payments, according to a recent Deutsche Bank research paper. The paper, titled “Instant revolution or payments? The quest for real-time payments,” recognizes bitcoin and the blockchain as playing an important role in payment technology as the need for real-time payments expands.
In tackling the complex topic of instant payments, the paper reviews the different definitions of instant payments and establishes what it considers a good working definition. The European Central Bank (ECB), for instance, defines an instant payment as the real-time crediting of accounts, while others define it as a real-time issuance of payment guarantee.
To convey the range of new and traditional services, Deutsche Bank uses a wider definition of instant payments: instant confirmation, instant payment guarantee and/or instant funds posting. Instant payments occur in less than a minute and ideally in a few seconds.
Blockchain technology is one architecture for near real-time payments. The paper reviews recent block chain payment initiatives and notes the factors that will enhance the use of the block chain and some of the challenges it faces.
Blockchain technology offers the ability to pay in near real time. In addition, it allows the payer to pay without the use of an intermediary, as opposed to other electronic payment systems.
Blockchain technology uses aspects of various disciplines, such as peer-to-peer (P2P) networking without central coordination, cryptography and game theory (strategic decision making).
The block chain, however, is not limited to transferring virtual currency. It provides a way to register and transfer a digitally-represented value securely and in a decentralized way. Blockchain-based services are being developed in areas such as land registers and securities transfers. Trust in the distributed ledger is achieved without intermediaries.
Central banks and public authorities presently act as a source of integrity for commercial bank accounts. Central agents for clearing prevent double spending in card payment and bank systems. Blockchain technology, by contrast, achieves this within a decentralized network.
Blockchain technology might revolutionize the financial industry that is characterized by centralized and tiered networks.
However, it is currently unclear if blockchain technology is capable of supporting significant retail payment traffic.
Instant execution processing is possible with the block chain. Where bitcoin transactions normally take up to 10 minutes for validation and one hour to finalize, the Ripple network transfers value within seconds. This is credited to a less time-consuming consensus process in the Ripple network, versus bitcoin’s proof-of-work process.
Scalability is another blockchain issue that could impact the growth of block-chain-based payment systems. Decentralized networks rely on numerous nodes and miners to process transactions and lose the efficiency of central processing.
Some believe that decentralized payment systems will not compete with centralized ones on cost unless they focus on processing fewer miners. This, however, would raise the risk of system-wide fraud. The integrity of payments is based on no single agent(s) controlling the majority of the network’s processing resources.
Future developments will indicate if blockchain technology can process high volumes in a P2P network at a competitive cost and sufficient protection against fraud.
Questions about the legal status of distributed ledger payments also exist. There is uncertainty on how existing laws will be enforced in P2P networks. There are no financial intermediaries that an authority can hold responsible for rules such as tax evasion, anti-money laundering fraud and sanctions to combat terrorism financing.
Bitcoin’s original premise – that P2P independent of intermediaries – is “to some degree being overhauled by real life,” the paper notes. There are now intermediaries like wallets and exchanges in the bitcoin ecosystem. Bitcoin trading is highly centralized in certain exchanges.
The paper reviews recent developments in retail bank payment systems in Europe.
It notes that retail bank payment systems that provide close to instant crediting of accounts have launched in several countries in the last 15 years. The U.K. took the lead in 2008 with “Faster Payments.” Systems have also launched in Sweden (2012), Poland (2012) and Denmark (2014). The paper notes it is hard to judge the market demand for these services.
The ECB has called for building on the SEPA (Single Euro Payments Area) with a pan-European instant payment system. This would prevent the re-fragmenting of euro payments with systems developed for national markets.
In calling for a pan-European system for instant euro payments based on a common scheme, the ECB defined the system as one where funds are credited to the payee’s account in real-time.
In response to ERPB, the European Payments Council (EPC) developed an instant payments scheme based on the SEPA credit transfer. ERPB expects the scheme to be ready to launch by November of 2017.
With the rise of the Internet, consumers are increasingly expecting to be able to buy and pay anywhere at any time. As a result, digitalization is changing how people do business and creating possibilities for payment systems.
E-commerce presently accounts for 14% of the euro market’s retail sales. Online shopping demonstrates that established electronic payment systems were designed for point of sale (POS), bill payments or payroll applications versus online payments.
Credit card payment providers and banks are expanding services to meet the needs of non-traditional payments. Non-bank service providers are developing innovations in this area and are competing with banks by providing value-added services. At the same time, web-based retailers, Internet service providers and telecom companies are entering the fray, offering services that bypass established payment systems.
The growth of mobile payments that offer immediate execution also offers an attractive alternative to cash for consumers.
Existing electronic retail systems include things like card payments, remittances, credit transfers and e-money transactions. These tools can exist across various access channels such as ATMs, plastic cards, the Internet or at physical buildings. The clearing and settlement are done in batches once or several times a day, resulting in a one-day lag between payment initiation and execution.
The ability to pay immediately has emerged as an enhancement in all payment situations. The value added by instant payment, however, is greater in some cases than others.
Mobile payments with the immediate transfer of funds, known as person-to-person, have not succeeded due to lack of speed and a dearth of end-user devices. But the growing adoption of mobile devices in Europe is changing this. Mobile instant payments can provide immediate crediting of funds, thereby improving a merchant’s fund liquidity.
In the e-commerce area, instant payment execution does not address the lack of trust between payers and sellers if the parties are not known to one another. A time lag still exists between the payment and the delivery of goods ordered online. This can be addressed by escrow solutions between parties. The payment service provider does not release the purchase amount until the buyer receives the merchandise.
The paper examines the different organizational and technical structures that can provide real-time services such as closed loop systems, open-loop systems and decentralized networks.
Closed-loop systems are those in which transactions occur between consumers or businesses holding accounts with a specific payment provider. The payment provider handles fund transfers as book-to-book (in-house) transactions. No settlement is needed, facilitating real-time processing.
Card payments include an immediate payment guarantee to the merchant. E-money providers like Paypal are a newer type of closed-loop payment provider. Users convert bank deposits into e-money that the provider issues in real time with other users holding e-money accounts with the provider.
Book-to-book transactions can also be credit transfers if both parties hold accounts with the same credit institution.
An open-loop system refers to systems where users have bank accounts at different institutions. These include credit card and bank payment systems. They are characterized by coordination among providers who adhere to common standards. They allow participants to vie for business by offering competitive terms for payments and value-added services.
In a bank payment system, if a beneficiary and payer have accounts at different banks, an exchange of payment information known as clearing and the transfer of funds known as settlement are required. A central bank usually acts as a settlement agent.
The open-loop systems with added intermediary domain have emerged among online merchants and consumers. Such systems speed payments. The goal is to make payments more convenient by simplifying handling and/or payment integration with customers’ mobile or online purchasing experiences.
Banks can facilitate the integration of their payment services into retail apps or the digital ecosystem by offering application programming interfaces (APIs). At the same time, they face the risk of providing accounts to customers who maintain accounts with other payment service providers.
Services under the intermediary layer of the payment chain are based on four-party payment systems. The real-time services of the new intermediary layer do not permit real-time crediting of payee accounts. Rather, it is the payment guarantee and/or payment information that the service provides in real time.
Non-banks such as digital wallets and payment initiation services provide services in this new intermediary domain, although some banks are offering it as well. The Dutch iDEAL is one such example of an intermediary service based on the open-loop payment system.
The iDEAL service has gained the participation of other banks and service providers to provide online shoppers access to bank accounts and merchants with an immediate payment guarantee. In 2014, iDEAL was used for 54% of all online purchases in the Netherlands.
As for mobile payments, these systems will become an attractive alternative to cash provided they are executed instantaneously. In some cases, instant payment will improve on existing electronic payments and form the basis for further service innovations.
The type of payment service provider determines the type of money to be transferred, be they privately-issued funds, bank deposits or e-money.
The adoption of new payment systems by large numbers of users will be key to the success of these systems.
Instant payment services have to be attractive to numerous users in different use cases, the paper notes. That way, transaction volume will be large enough to match the cost of existing retail payment systems. In developed markets, instant payment tools will need to provide tangible benefits, such as in e-commerce and mobile payments, versus slower but better-established systems including cash.
The service must appeal to both businesses and consumers. For consumers, the tangible benefits include user friendliness and convenience. For merchants, the payment must be frictionless so it does not disrupt the customer’s purchase decision.
Instant payments could add to a merchant’s payment costs since another payment instrument may be needed. But the system could also provide cost savings as there will be opportunities for cross-channel use (POS and the Internet) and the reduction of cost related to cash handling.
In Europe, state-of-the-art technology and wide access to mobile Internet have lowered entry barriers to payment markets. The market has become more diverse in the number of provider and services they offer.
What remains uncertain is whether the current payments market dominated by open-loop networks will prevail or whether more closed-loop providers will gain volume. At the same time, a decentralized system could emerge.
The existing non-bank payment system will not be replaced soon since it provides the bridge needed between different payment service providers, the paper notes.
An instant payment system that can match this nearly universal reach and develop into the different use cases served by traditional instruments could make the existing systems obsolete.
The paper concludes that instant payments will probably not revolutionize the payments market concerning the basic characteristics of electronic payments – account keeping, economies of scale and reach. However, a move to instant payments does offer opportunities for new technologies.
Images from Shutterstock and Deutsche bank.