Alternative Payments are eating up card supremacy
Cards have been the default payment method for a long time. This is not true anymore with the rise of Alternative Payments that are devouring market share from traditional card payment methods.
Alternative payments such as digital wallets, account-to-account (A2A) payments with open banking and BNPL are becoming some of the preferred payment methods for consumers. Furthermore, crypto, stablecoins and CBDCs are coming to the game.
Why is this shift happening?
Consumers want to choose a payment method that’s right for them, and what’s right might differ with each transaction. Habits have also shifted massively during the pandemic.
Merchants are increasingly in tension with existing payments rails, especially card networks Visa and Mastercard, over transaction fees. Also, adding new payment methods can be a leading factor in purchase conversion.
Payment processors and service providers are jumping on the opportunity to get an early mover advantage and win clients.
But all these new options bring fragmentation, also because of strong geographical differences.
How can a smooth, omnichannel experience be offered among all these different options?
How to guarantee fraud prevention, cybersecurity and privacy?
There is a need for a new type of financial infrastructure, with payments at the heart of the system to be able to support this.
Subscribe to Dealroom’s Fintech newsletter, for weekly insights on finance-focused
startups and investment:
Explore the rise of Alternative Payments 👇
Increasing tension with existing payments rails
Visa and Mastercard are a duopoly in the card payments space. Card fees totalled $61.6 billion in 2020, up 137% over the past decade.
But retailers and marketplaces are increasingly putting pressure to reduce these fees.
For instance, Amazon and Visa recently agreed to end their global dispute over credit card fees. Amazon had imposed surcharges on Visa credit card transactions in Australia and Singapore and an announced ban for Visa credit cards in the UK.
US retailers are asking regulators to examine Visa and Mastercard fees for irregularities and market manipulation.
In addition to direct fee costs, cards also suffer high indirect costs due to fraud. A recent regulation introduced in Europe is Strong Customer Authentication (SCA), which requires customers to take extra verification steps when paying with cards. In detail, it requires a Two Factor Authentication (2FA). This might cause a decline in conversion rates and a degraded customer payment experience since 2FA is not a native feature of cards payments, compared for instance with Open banking payments.
Europe is also increasingly seeing this dependency on US providers for the payment infrastructure as troublesome. To achieve ‘payments sovereignty’, the Commission and the ECB have pressured European banks to create a new European card network, to compete with Visa and Mastercard. The project called “European Payments Initiative” (EPI) has failed with more than half of its 31 members abandoning the effort last week. The project is now expected to ditch plans for a card scheme and will instead focus on a digital wallet.
The need for alternatives is, therefore, stronger than ever, so let’s get deeper into every one of these alternatives.
Digital wallets have already crossed into the mainstream
Digital wallets have already become the main payment method for both online and PoS transactions globally, mainly spearheaded by China and emerging markets.
In Europe, digital wallets account for 27% of online payments compared to a combined 39% for debit and credit cards and for just 8% of the PoS transactions. A further boost is also expected to come from the impending launch of the official European Digital Identity Wallet.
Leading wallets in Europe include global players such as Paypal, Google Pay, Apple Pay, Samsung Pay and local players such as Swish in Sweden. But not all wallets are the same.
In general, digital wallets (or ewallets), store and encrypt identification and payment information. In this way, consumers can pay using their wallets without re-entering any detail and merchants can have lower fraud risk and high conversion thanks to payment ease.
Paypal is the most used wallet in the Western world and allows to add bank accounts, credit or debit cards and choose the desired payment method in each transaction or by default. It can also be used to receive money on its own balance.
Google Pay and Apple Pay are instead just digital versions of the customer debit and credit cards so that they do not need to re-enter details and have the card with them.
Overall, digital wallets are aggregators, they still sit over existing payment networks, mostly card payment rails and have therefore equal or higher fees for merchants. Thir huge potential is in becoming super apps.
The main question is, will we have one universal wallet or many wallets for different functions?
Account-to-account (A2A) payments jumping to the next level with Open Banking
Account-to-Account (A2A) payments move money directly from one account to another without the need for additional intermediaries or payment instruments, such as cards.
A2A payments have been around for years, with use cases such as regular bill payments and direct debits, but now Open Banking is taking them to the next level, from an ‘alternative’ payment method to a mainstream one.
The need for A2A payments is crystal clear. Cards and wallets, for instance, are both intermediaries taking high transaction fees, especially in larger transactions. Choosing which payment method to accept is always a trade-off for merchants between reach, conversion and cost. Cards and wallets have become the dominant form of payment because of network effects (largest reach) and better conversion rates.
A2A payments are processed over national clearing systems, which do not require intermediaries and can reduce friction and have better efficiency at a fraction of the cost.
A type of A2A online payment, Online Banking Electronic Payments have been very successful at a country level, for instance, iDEAL has a 71% market share for online payments in the Netherlands.
But these systems are limited to a single country since they rely on national rails.
Open banking is a game-changer for A2A payments. Open banking APIs overcome the fragmentation of the clearing rails and allow the embedding of A2A payments at the point of purchase.
A critical requirement is the quality and availability of these APIs, which have greatly improved, with the top 10 EU countries having rates ranging from 97.61% to 91.12%.
In regards to customer payment experience and conversation rates, the way payments are initiated is a critical component in A2A payments. If consent is given, the payment can be initiated on the customer’s behalf through APIs without the need to fill in other details or take further actions. With customers taking more confidence in this payment method the purchase experience is set to improve massively.
Another advantage of A2A payments is data availability. Open banking allows assessing the customer’s credit and insights into spending. This improves use cases ranging from fraud detection to loyalty rewarding.
Summing up, A2A payments with open banking boasts great reach (need just for a bank account), great and fastly improving conversion rates, very low transaction costs and wider data availability.
VCs have already jumped on the opportunity, with more than $1.5B invested globally in Open banking startups last year, up 4.3x from 2020. Incumbents are also making sure not to miss the wave and are on an acquisition spree. Visa acquired Swedish Tink for €1.8B last June, Mastercard acquired US-based Finicity for $800M in 2020 and Danish aiia last September and even Apple has just acquired UK-based Credit Kudos for $150B.
The question is then, how fast will A2A payments grow and when will they cross to mainstream?
Buy Now Pay Later (BNPL) is ramping up market share
BNPL is now revolutionizing the customer journey by seamlessly integrating sale financing into e-commerce (and point of sale) as a checkout option.
Merchants have rushed to adopt BNPL payments as a way to boost sales and improve conversion at checkout, even if BNPL fees are much higher than any other payment method even in its more mature market, Australia.
Globally, BNPL is poised to grow from 3% to 5% of all online sales by 2026, with Europe growing even more from 8% to 12%. In many European countries, BNPL is posed to grow more than 100% in that timeframe.
However, important questions remain concerning regulatory aspects and challenging profitability for BNPL operators, as articulated in our “Is BNPl already over?”.
For a detailed analysis of BNPL companies globally see this post.
Crypto and stablecoins
By 2030, 60% of global consumers will have made a transaction using an asset class other than fiat currency. Crypto-backed card growth is outpacing that of conventional cards, with dollar spending rising eight times between 2020 and 2021 to more than $7.5 billion.
Crypto payments are the most requested feature by Airbnb users and more and more companies are racing to offer them such as Paypal, Square, Nuvei and Stripe.
However, offering crypto payments is not that easy, due to the regulatory framework (crypto custody, blockchain AML) and due to fiat-crypto on-ramp/off-ramp. In addition to this, cryptocurrencies are highly volatile creating a barrier to usage for payments. Stablecoin are seen as a more suited option for most C2B, B2C and B2B payments.
Traditional card networks, like Visa and Mastercard, are striving to ensure their role as payments rails, claiming their blockchains will be ready to support transactions whether for stablecoins or CBDCs. Visa just announced it is working on an interoperability platform for CBDCs and stablecoins, which would allow it to seamlessly make a cross border payment where the recipient receives a different CBDC or permissioned stablecoin. Mastercard instead released last year a virtual sandbox tool for central banks to test CBDCs settlement using Mastercard infrastructure.
Get to know more in our stablecoin deep dive.
Central Bank Digital Currencies (CBDCs) could reshape the financial system
Central bank digital currencies (CBDCs) are essentially the digital version of cash. Like cash, they are issued by and have their value guaranteed by central banks.
Around 100 countries are exploring CBDCs at one level or another. Some researching, some testing, and a few already distributing CBDC to the public. No major country has launched a CBDC on full scale yet. China has the most advanced CBDC initiative in the world. Looking at Europe, Sweden is moving the fastest.
However, there is no universal case for CBDCs because each economy is different.
In emerging economies, CBDCs can leapfrog financial inclusion, while in advanced ones they can restructure the financial system, improving its efficiency and resilience. However, CBDCs also raise serious privacy concerns (depending on the implementation chosen).
From the payment perspective, CBDCs can help solve many of today’s payment issues like long transaction times and high fees. People will be able to exchange currency with each other digitally in real-time using mobile phones, computers, smartwatches, bar code scanning, and so on.
CBDCs can potentially cut out the middlemen in financial transactions, primarily banks, and allows transactions to travel directly from person to person or customer to vendor. However, especially in advanced economies, this is unlikely to happen and a tier 2 system including banks that act as distributors for the CBDC. In China, these services will be licensed to four state banks and three telecommunications companies.
Given the advantages of low costs, faster transactions, and offline capabilities CBDCs offer, consumers could choose CBDCs over existing digital payment options like credit and debit cards and mobile wallets.
A fragmented and complex payment world
In the latest years, we have seen the world moving away from cash toward digital payments, mainly through cards and digital wallets. Now we are moving towards a fragmented and complex payment world in which several types of money (fiat-backed, crypto, stablecoins, tokens, CBDCs, rewards, etc) and several payment methods (cards, digital wallets, A2A/open banking, etc) will coexist.
How do we manage all these options in a coherent, omnichannel and convenient way?
As Miguel Olguin from Truelayer put it “we’re just at the beginning of the wild west of payments for a few years. After a while, options will consolidate to a much more manageable number …. in the meantime, it’s the responsibility of providers to educate merchants and consumers alike on the benefits/risks of their offering.”
Let’s ask some experts
Next week I will have the pleasure to moderate a panel on the future of payments at Innovate Finance 2022 in London. The amazing speakers will be:
- Jane Loginova, Senior Vice President, Chief Strategy Officer at BPC and Founder and CEO at Radar Payments
- Kat Cloud, UK Policy Lead, Plaid
- Jack Wilson, Head of Public Policy, TrueLayer
- Martin Hargreaves, Chief Product Officer, Quant
- Rónán Gallagher, Head of Omnichannel Product, Trust Payments
What should I ask them?
Subscribe to Dealroom’s Fintech newsletter, for weekly insights on finance-focused
startups and investment:
The Global Payments Report – Worldpay from FIS
The resurrection of Account to Account Payments – Martijn Mulders
What If Central Banks Issued Digital Currency? – Harvard Business Review