Post image for Inside the Visa / PayPal Partnership

After a great deal of speculation, Visa and PayPal (or is it PayPal and Visa?) have announced a partnership where the two companies will “collaborate to accelerate the adoption of digital payments.” The announcement, which was actually more detailed than most partnership announcements, speaks of putting the two companies “on a new path” for the benefit of consumers and merchants.

visapaypalIt’s always interesting to look at the motivation behind these sorts of partnerships, drill down into the benefits to each party, and explore the potential ramifications. Let’s walk through the deal points, see what they said, and then offer an interpretation.

Deal Point #1 – Funding Source Steering

Enhanced Consumer Choice and Improved Experience for Visa Cardholders: PayPal will make it easier for new and existing customers to choose to pay with their Visa cards and ensure a more seamless experience: Visa cards will be presented as a clear and equal payment option during enrollment and subsequent payments, with an easy ability for consumers to set as their preferred payment method; Visa digital card images will be incorporated into payment flows; PayPal will not encourage Visa cardholders to link to a bank account via ACH; PayPal will also support and work with issuers to identify consumers who choose to migrate existing ACH payment flows to their Visa cards.

Elimination of ACH steering primarily benefits Visa

Visa benefits from increased purchase volume that will come primarily from Visa cardholders that prefer to use their Visa cards but were too inconvenienced to change the funding source on a transaction-by-transaction basis. Visa purchase volume goes up; ACH purchase volume goes down. PayPal users, who are also Visa cardholders, will enjoy a cleaner user experience with less purchase friction. In spite of its stated strategic importance, Visa will have less urgency to establish Visa Checkout as an alternative to PayPal. This aspect of the partnership also scores points with Visa issuers for having converted non-revenue producing PayPal ACH transactions into revenue producing PayPal debit card transactions.

For PayPal, the company loses the economic advantage of ACH funded transactions for Visa debit card-carrying users in the U.S., but this is offset somewhat by a reduction in ACH NSF reversals. Placing Visa on equal footing with other payment methods will also likely impact the extension of PayPal Credit in the U.S., which is a net win for Visa’s issuing partners. And, while minor in nature, a partnership with Visa also mitigates the competitive threat from Visa Checkout.

Deal Point #2 – Tokenization at POS

PayPal will Join the Visa Digital Enablement Program (VDEP) to Expand Point of Sale Acceptance: PayPal will join VDEP, a commercial framework for Visa partners to access Visa’s token services and other digital capabilities in the United States. This will enhance transaction security and expand acceptance for PayPal’s digital wallet to all physical retail locations where Visa contactless transactions are enabled. Consistent with VDEP, issuers will be able to choose whether to participate and retailers can expect to pay fees that are consistent with other contactless transactions they accept today.

Participation in the Visa tokenization program primarily benefits PayPal

By joining the Visa Digital Enablement Program, PayPal gains access to Visa tokens that can be used at the point of sale anywhere Visa contactless transactions are enabled, presumably through the PayPal app running on Android (with open access to the NFC radio.) Maybe we call this “PayPal Pay”. PayPal would have no economic angle on these transactions, as they would be processed through the merchant’s existing acquirer. The merchant would, in fact, have no relationship with PayPal. This is similar to Apple Pay and Android Pay, where neither company has a contractual relationship with the merchant and earns no revenue from merchants.

PayPal’s motivation here is likely to be increased utility of the PayPal app in the everyday life of the PayPal user, which is a stated corporate goal. Beyond the stated use at the POS, tokenized Visa payment credentials would also likely be used on all Visa-branded funding transactions for PayPal and Venmo. There is a real possibility that, long term, 3D Secure V2.0 (now being finalized by EMVco) might be used to shift some of the fraud liability away from PayPal and its merchants and to Visa issuers.

For Visa, it benefits indirectly by the further propagation of tokenization out into the industry and the accompanying reduction in the data breach footprint. This is also a big selling point for all the Visa issuers.

Deal Point #3 – Instant Withdrawal of Money

Instant Withdrawal of Money: Consumers will be able to instantly withdraw and move money from their PayPal and Venmo accounts to their bank account via their Visa debit cards leveraging Visa Direct – providing an experience that offers speed, security and convenience.

PayPal’s use of Visa Direct is a balanced benefit to both Visa and PayPal

For Visa, further adoption of so-called OCT transactions provides the firm with a leg up on the next generation Faster Payment system from The Clearing House coming to the U.S. in 2017. PayPal’s usage is an endorsement of the OCT technology in the U.S. and may spur others to adopt as well. More importantly, it may provide Visa issuers in the U.S. with an incentive to move to the optional “Fast Funds” model that many have ignored to date. Fast Funds is the model used to immediately post funds received to the recipient’s bank account. PayPal’s support for Visa Direct goes hand-in-hand with elimination of funding source steering for Visa cardholders. For these PayPal users, ACH will no longer be used to fund accounts OR to withdraw funds.

To the extent that Visa issuers participate in Fast Funds, withdrawals from PayPal and Venmo accounts via Visa Direct provide faster settlement to bank accounts and directly benefits PayPal’s customers. This comes at a cost however, as PayPal will now be paying card transaction fees instead of the ACH fees on withdrawals from a PayPal or Venmo account. Presumably, there will be a reduction in exception handling for PayPal as Visa Direct is able to verify the account exists and is open prior to the funds being pushed to the cardholder’s bank account.

Deal Point #4 – Enhanced Data Quality

Enhanced Data Quality: PayPal will ensure that data provided to issuers and their cardholders for Visa-funded transactions will be consistent with the information that is received with traditional Visa card transactions. This will ensure a better consumer experience, reduce cardholder confusion, ensure proper application of rewards, and reduce costly and time-consuming disputes.

Enhanced data quality primarily benefits Visa with no significant downside for PayPal

Visa has long held a stated grievance against PayPal for providing “incomplete” transaction data. Of course, PayPal provides the transaction data that is required by card company rules, but not a lot more. The card networks have changed their requirements over time – they now require PayPal to provide merchant tax IDs for example – but the grievance remains.

In my opinion, this is a bit of a red herring issue as the only real data concern was likely just the incomplete mapping of PayPal sponsored merchants across all of the ISO merchant category codes (MCCs). This incomplete mapping is the result of PayPal asking small merchants to self-map against a predefined subset of MCCs rather than making them work their way through hundreds and hundreds of potential category codes. Instead of knowing that a specific merchant is a “specialty retailer,” Visa will now know that the merchant is actually a “jewelry store.”

Providing enhanced data quality to Visa does not really cost PayPal anything more on a transaction-by-transaction basis, but perhaps they have to invest some money into getting the MCC self-assignment mapping right. Not the biggest deal, but it speaks to how important payment data is today for the increasingly analytics-driven card companies. Providing Visa with this data does not detract from PayPal’s ability to use the same data.

There is a possibility that there is more to this deal point than meets the eye, but it’s hard to know at this point. There are lots of other data elements PayPal could share with Visa, but that would be beyond what is structurally provided to the network on a card transaction.

Deal Point #5 – Economic Incentives

Economic Incentives: The agreement affords PayPal certain economic incentives, including Visa incentives for increased volume, and greater long-term Visa fee certainty.

Economic incentives, of course, primarily benefit PayPal

If successful in implementing the various partnership components, PayPal will financially benefit from “Visa Incentives” meaning that some of the economic downside from other points in the partnership will be mitigated by these incentives. “Greater long-term Visa fee certainty” probably speaks to fixed (if not reduced) network assessments over the length of a long-term contract – and perhaps a promise that Visa will not dream up new fees that are specifically targeted at PayPal. Perhaps this deal point also includes some offsetting compensation for card-not-present transaction interchange on Visa transactions, but we have no way of knowing.

While this might appear as a pure cost to Visa, it indirectly benefits Visa as well, as the volume incentives provide PayPal with clear motivation to minimize their tendency (post-Durbin) to steer qualified Visa debit transactions over PINless debit rails from STAR and NYCE instead of over Visa’s signature network rails. This PINless debit steering technique is used by PayPal to reduce the cost of network assessments on select debit card funding transactions in the U.S. It also will occasionally result in the cardholder being denied debit reward points, through no fault of their own, when the transaction is routed over a non-signature card network. In the end, however, Visa purchase volume goes up; STAR and NYCE purchase volume goes down.

Glenbrook’s Take on the Partnership

At first blush, this partnership is broader and more far reaching than what we were expecting here at Glenbrook. While termed an “extension of their long-standing relationship” this is actually the first time Visa and PayPal have collaborated on anything. Historically, the companies have been arms-length competitors. It’s worth remembering that Visa Checkout is Visa’s third attempt to compete with PayPal in the digital wallet segment of the payments industry. And PayPal uses MasterCard as its network partner on its PayPal Debit MasterCard, PayPal Extras MasterCard, and PayPal Prepaid MasterCard products. So, not historically partners.

The terms of the relationship are specific to the U.S. market. This restriction seems a bit odd given that PayPal and Visa both think and act globally. Maybe Visa doesn’t feel that bank account steering is a major concern outside the U.S.? PayPal doesn’t offer it in many markets. Maybe PayPal doesn’t see Visa having a critical mass of tokenized payment credentials outside the U.S.? Maybe it’s just too early to look at extending the partnership globally?

While we have cast the partnership in terms of what it means to Visa and PayPal individually, some consumers and some merchants will come out ahead of where they were prior to the partnership. From their perspective, most of the benefits will come from the elimination of bank account steering in favor of authenticated debit card transactions.

Consumers in the U.S. carrying Visa cards will enjoy a dramatically streamlined user experience (with less friction) when using PayPal to buy at any of its 14 million merchants. Some merchants that accept PayPal as a form of payment—those that do not qualify for seller protection—should see fewer ACH NSF transaction reversals. To be fair, this is likely a small number of transactions for a small number of merchants. But it may prove meaningful to some.

In the end, though, this partnership isn’t really about consumers and merchants. It’s about generating incremental transaction volume for Visa and its issuers—and unleashing PayPal to compete against Apple, Google, and Samsung at the POS.

For PayPal, what’s particularly intriguing about this tap-and-pay thrust at the point of sale is what it might mean for Venmo users. The same Visa tokens used in the PayPal app could also, potentially, be used in the Venmo app at the POS with the same constraints and same processing model. Embedding tap-and-pay functionality into Venmo would further accelerate the momentum behind Venmo and be the perfect synergistic overlap of social payments and mobile payments for millennials.

Think Venmo Pay!

This post was written by Glenbrook’s Russ Jones.

 

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Post image for Sensibill – Redefining Digital Receipts for FIs

Stretching the retail financial institution’s (FI) mission beyond checking account and debit card management is on that industry’s agenda. It’s what fires the imagination of fintech entrepreneurs too because retail financial services is an industry in need of creative, expansive approaches to accountholder services. Not every idea catches fire but fortunately there are those willing to light a match.

This Payments on Fire podcast looks at Sensibill, a digital receipting and data repository service for FIs. Join Glenbrook’s George Peabody and Sensibill’s CEO and co-founder Corey Gross in this discussion of how an FI can help its accountholders turn digital receipts into data far more useful than what’s on a statement or that piece of paper stuffed into a purse or wallet.

Transcript below the jump.

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Post image for Machine Learning in Fraud Management

Machine learning and the broader category of artificial intelligence are rightly attracting attention and discussion. These are powerful technologies. But, like many new technology conversations, there’s the suggestion that they can address all use cases.

Maybe focusing on a single use case is the better approach right now. Join Glenbrook’s George Peabody and Nuno Sebastiao, Chairman and CEO of fraud management firm Feedzai, in this refreshing discussion about the role of machine learning in fraud management, some of its limitations, and how services like these fit into an enterprise’s fraud and risk management operations.

Read the transcript below the line

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Post image for Biometrics, Big Data, and Tossing the Password

Digital identity is the black hole of the internet. Our online lives simply aren’t protected by a system without strong authentication. Killing the password is Mission One for security professionals because they’re so readily stolen through phishing attacks and malware. Users, warned to make passwords complex and unique, have no hope of remembering them. And a password is simply one factor of secure authentication. Biometrics and data, when used in combination, can relieve password fatigue and, for the relying party, increase security substantially, bringing some light to that dark place on the internet.

We talk with MasterCard’s biometrics and authentication leader, Bob Reany, about where biometrics work and the intersection of device-based tools with what the cloud provides through Big Data, particularly device profiling and behavioral analytics. Your fingerprint’s not just for unlocking the phone anymore.

Transcript below the break

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Post image for The Merchant’s Challenge with Chargebacks

Chargebacks are one of the card system’s great consumer benefits. If fraud happens, the merchant doesn’t deliver on what was promised, or you’re charged six times for something you bought just once, the chargeback mechanism returns your money or restores your credit. What’s not to like? Well, if you’re a merchant, a lot. While there are plenty of legitimate chargebacks, there are also consumers who take advantage of the system through “friendly fraud,” the “I didn’t do it” chargeback category abused by all too many.

Chargebacks are expensive for merchants. There’s a chargeback handling fee from the acquirer. There’s the cost of disputing the chargeback. There’s the cost if, at the network’s discretion, the merchant loses the chargeback. And then there’s the small matter of the cost of the goods or services. Take a listen to this audio primer on chargebacks with Glenbrook’s George Peabody and Chargeback’s CEO Dave Wilkes. Hear how they work, what the trends are, and how Chargeback assists merchants in the chargeback dispute process.

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MobileMoney

Over the past several years, my colleagues and I at Glenbrook have been working on a variety of projects focused on bringing low-cost financial services to the poor in developing countries. While there has been a lot written on how mobile or eMoney payments systems such as M-PESA in Kenya have grown in many developing countries—and how they have brought much-needed electronic payments to the poor and underserved—there’s a critical missing piece that demands attention.

Specifically, few are talking about the criticality of merchant acceptance of eMoney payments.  At Glenbrook, we believe this is a problem, that the lack of widespread acceptance has both inhibited growth in these systems and remains a roadblock to “digital liquidity” in even the more successful of implementations.

Without exception in the developing world, the vast majority of transactions in mobile payment systems are person-to-person (P2P).  That’s fine since poor people, those at the bottom of the pyramid, derive meaningful benefits from the shift of cash to mobile transactions. Those benefits include reducing the theft risk of carrying cash—which can be very dangerous—and the efficiency of being able to send money to someone without losing half a day of work to travel across town. For someone able to afford it, the mobile eMoney service can also provide a safe place to store value but few poor people have the luxury of idle balances in their mobile money accounts.

However, since most merchants don’t accept eMoney as payment, their customers must “cash out” their mobile monies in order to spend, a relatively expensive conversion.  Those cash-out costs work against the goal of providing low-cost payment services to the poor.

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Post image for Shoptalk Conference 2016

This episode of Glenbrook’s Payments on Fire podcast comes from the Shoptalk conference, mid-May 2016. Focused on the entire customer engagement cycle, the attendees are all about influencing consumer behavior, the processes of moving customers through that cycle, about making some portion of enterprise IT work more smoothly, or, yes, even about payments.

Take a listen to my conversations with start-ups Tuku (in-store digital content delivery), Belly (in-store loyalty), Bold Financial Technologies (payout management for Treasury) and established fintech provider ACI Worldwide.

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Post image for A Large Merchant Focuses on its Payments Strategy

Payments industry professionals naturally have a hard focus on the industry’™s own dynamics. So, it’s not uncommon to lose sight of who the customer is and who pays the freight. In retailing, yes, the consumer pays, but payments is a direct cost to the merchant. With all of the changes underway in the U.S. payments landscape, merchants now address payments as a complex, strategic element of their business, both as a way to drive new sales as well as a cost component to be tightly managed.

To learn what’s top of mind for a large scale retailer, take a listen to Dean Sheaffer, SVP of Financial Services at Boscov’€™s Inc., the U.S.’s largest family-owned department store. In this Payments on Fire podcast, Dean addresses payments as a sales tool (Dean and his team have upped usage of the Boscov private label card to 40% of tender!), payments and data security, and the potential of Faster Money.

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Post image for Five Answers – Sort of – to the Big Questions on Blockchain and Bitcoin

I’m back from two days at Consensus 2016 in NYC, and reporting as promised into my investigation of the Five Big Questions.

1. Bitcoin technology: will the problems (versions, processing time, scalability) be  resolved?

Yes. My belief that we are all writing this off too soon in favor of “all things blockchain” was reinforced. Glenn Hutchins of Silver Lake Partners drew a parallel between private blockchains and intranets in the early internet days: important for enterprises but not radical or transformative in and of itself. He headlined his talk “Blockchain good, Bitcoin better”. Balaji Srinivasan of 21 spoke persuasively about how Bitcoin is the mechanism which will “free API’s to be API’s” and interact with other machines (my paraphrasing…)

2. Big banks: will they join hands in a single (or several) new blockchain-based networks? Will there be a new SWIFT? Will it be SWIFT? One of the currently formed consortia? Someone new?

Hard to tell. David Rutter of R3 bragged about 46 large financial institutions, and Chris Larsen of Ripple talked about the opportunity, but I didn’t hear from SWIFT, and there are other players out there…

3. Central banks: will they issue digital versions of fiat? Other digital currency? Support Bitcoin?

Yes. Fabulous panel with David Andolfatto of the St. Louis Fed (I’ve been reading his blogs on “Fedcoin”, MIT Media Lab, others – the energy on the topic is strong and clearly central banks of all kinds and stripes are thinking about it… but perhaps the most fascinating thought is that we could go back 100 years to a pre-central bank world, with central banks, commercial banks and other players issuing their own currencies…

4. Private blockchains: how many are there going to be? Thousands? Millions? Just how different is a private blockchain from a plain old secure database?

Millions. See above re: intranet. Not that different…

5. Interledger – incredibly cool, but how will it play out?

Not clear at all, but multiple private blockchains (or non blockchain ledgers) may need to interconnect. Interledger was referred to but not in detail; other options (Chain, Hyperledger) were more visible but we’re still in theory-land here. I wish there had been more on this.

 

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Post image for Data Analytics, Lending, and the Next 100 Million Borrowers

Extension of credit to people in developing markets has been a long time challenge. Banks, of course, look to repayment history to make such determinations but in much of the world, banking relationships and repayment track records are few. But history has demonstrated that extension of credit in developing markets can be effective and profitable. Just look at the Grameen Bank’€™s high micro-loan repayment rates.

To address this repayment data dearth, Lenddo.com built a lending data set in multiple developing countries, having gone into the lending business just to generate the data it needed to tune its machine learning capability. Lenddo then built its algorithms
that examine some 1,000 characteristics in the data drawn from social, mobile, and other sources. This Payments on Fire podcast with Lenddo.com’€™s founder Jeff Stewart takes a look at lending in developing countries, social and mobile data sources, and examines the algorithmic “black box” that is at the heart of the company’€™s approach to making credit decisions in “thin file” markets.

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Post image for Five Big Questions on Bitcoin and Blockchain

I’m headed to New York next week for the CoinDesk Consensus conference…”Making Blockchain Real”. I’m going because I’m trying to get my head around some big questions. I normally have a sense, even with new things, of the path forward. Not in this case!

Here are the questions I’m thinking about:

  1. Bitcoin technology: will the problems (versions, processing time, scalability) be resolved?
  2. Big banks: will they join hands in a single (or several) new blockchain-based networks? Will there be a new SWIFT? Will it be SWIFT? One of the currently formed consortia? Someone new?
  3. Central banks: will they issue digital versions of fiat? Other digital currency? Support Bitcoin? Support big bank blockchain networks? Is what is happening going to fundamentally change the role of central banks in the economy? Do we go back to pre-central bank economies?
  4. Private blockchains: how many are there going to be? Thousands? Millions? Just how different is a private blockchain from a plain old secure database?
  5. Interledger – incredibly cool, but how will it play out? Is this just a small (albeit important) bit of infrastructure, or does it fundamentally change the way payments systems work? The whole Bitcoin/blockchain conversation over the past few years has made everyone think about what money is – and realize that often (not always!) it is a ledger balance representing a claim on someone (bank, carrier, store…). An electronic transfer is simply an instruction that tells one ledger to go up, and the other down, in a way agreed upon by the ledger owners (and their accountants!) A settlement transaction is another version of the same thing. Can this all be restructured? What about the business rules? Do they need to migrate from their three ring binders into the transfer message itself?

I promise I’ll report back if I discover the answers to any of these questions….

 

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Post image for Coachella Takes Payment Cards – Mostly

I spent the weekend in Indio, California at the Coachella Music and Arts Festival (often referred to as the “Modern Day Woodstock” for you Boomers). Over the few weeks leading up to the event, Square and Apple advertised quite a bit about how every single vendor on the festival grounds would have a new contactless Square reader to accept Apple Pay and payment cards.

In the past at Coachella, paying for a bottle of water or a slice of pizza could only be done with cash. The ATMs at the festival grounds were hard to find, charged high fees, and often broke down. A news release from Square a couple of weeks ago explained that there was going to be no reason to bring any cash to the festival or even a wallet. Hearing such news is a dream come true for festival goers who want to keep track of as few personal belongings as possible.

For the first half of Friday, I was able to easily buy anything I wanted using my chip-enabled credit card and it was a painless process. I simply asked for a bottle of water and the seller took my card and proceeded to insert it into the EMV slot. I chose to abstain from using Apple Pay because smartphone battery life is an extremely precious commodity at the festival—which makes me wonder how those relying on the NFC“Pays”alone got along.

The vendors had their staff swipe or insert the cards, rather than having us do it ourselves, because many people still get confused over when to swipe or dip. With over one hundred thousand people attending this festival, even the smallest hold-up can cost a lot in time and money. Beyond that bottle of water, I also purchased chicken strips and a beer with ease that afternoon.

By early evening on Friday, however, some vendors began stating that the “system was down” and they could no longer accept cards – only cash. I asked a few more of those nearby vendors throughout the day and was met with the same issue. By Saturday and Sunday, I had given up asking altogether and simply came with cash on hand.

Driving home with friends on Monday morning, I asked how they paid for food and beverages throughout the weekend. They all responded that they used their cards whenever they could, but were met with some resistance by certain vendors here and there.

Now, none of my friends are nearly as fascinated by the payments industry as I am, so they were not paying (no pun intended) very close attention. But after digging a little deeper, we realized that we heard “the Square system was down” excuse at only the small tents that exclusively sold bottled water. Those tents get a tremendous amount of traffic, with people of all ages pushing and shoving to get to the front (it is very hot out there!)  I imagine those vendors all agreed to abandon the Square readers in order to boost throughput. I highly doubt that there were actual technical difficulties at just those tents while all the others selling food, beer or merchandise were unaffected. Since these tents sold only one product at one price, it is much faster to collect cash $2 at a time because, let’s be honest, dipping an EMV card can be a tad slow.

All in all, Coachella and Square teamed up to offer a much easier payment experience than in the past. Although I ended up using cash the rest of the weekend at all vendors – water or not – many people throughout the festival grounds were able to buy their meals, merchandise or beer with their cards.

And despite having to carry cash in my pockets, I was still able to enjoy some of the best acts of the weekend—from hard-hitting rapper Ice Cube to soft-spoken singer BORNS to DJ duo Disclosure. Who knows what incredible new artists and different forms of payment acceptance will be there next year!

 

 

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Post image for On Internet Money – Talking Circle.com with Jeremy Allaire

The world of moving money is changing. And faster is the theme. Domestic real time payment systems are showing up across the planet. Today’s discussion is full of bitcoin, open and permissioned blockchain approaches to speed asset exchange. But the competitive balance between proprietary and open systems is in flux.

The view that moving money is or should be an internet-wide capability is a guiding principle for Jeremy Allaire, founder and CEO of Circle. Take a listen to Jeremy on how Circle is connecting US dollars to British pound sterling, his plans for the euro, and how multiple technologies – blockchain and machine learning among them – enable money movement for Circle’s customers.

Read the transcript below.

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Post image for Faster Payments Survey – Your Immediate Reply Requested

It’s been just over two years since we first reached out and asked for your views on the question of faster payments. There have been a number of interesting developments in that period – the launch of FAST in Singapore, the announcement of the New Payments Platform in Australia, development of an instant payment scheme in Europe, a new platform in Kenya as well as multiple initiatives in the United States, among others.

We also have several different adjectives in use to describe how payments should be:  faster, real time, immediate, and instant. By any name, decreasing the end-to-end time to execute a funds transfer has become a top discussion in the industry.

We invite you to take the survey and add your voice to the evolving industry discussion. At Glenbrook, we are keenly following the issue and will host our second Insight Workshop on Faster Payments on May 12. We’ll breakdown the key concepts and look at case studies of how the concepts are being implemented around the world. And we’ll also share our views on how faster payments fits in other industry dynamics underway. The workshop will also be the first opportunity to discuss these survey results in depth.

Click here to take the survey now. Many thanks!

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Post image for What Blocks the Blockchain

Given the high rate of press releases and articles on fintech applications of blockchain technology – and the growing number of financial institutions expressing interest in its potential – I’ve been considering this high signal to noise ratio. A few thoughts:

Hype cycle inflection point

We are, hopefully, cresting the top of the blockchain hype cycle. In recent months, a number of bitcoin technology efforts shifted their focus from bitcoin to blockchain technology as the step most likely to gain positive attention, the theory being that blockchain beauty shines brighter when extracted from bitcoin’s murk. So, in 2016, both hype and serious discussion of blockchain technology are plentiful. Sometimes this serious exploration flirts with flights of fancy.

Welcome to the pilot stage

Almost all of the blockchain initiatives today, especially those looking to automate back office functions, are pilot programs—some just requirements documents, others are early iterations of software running across a handful of devices. This is exactly what we should be doing—but remember how far away from production this stage can be.

Blockchain built for Bitcoin

Glenbrook partner and my colleague Russ Jones said to me “the best blockchain use case I’ve seen so far is bitcoin itself.” Bingo. The blockchain data structure and the cryptography that secures it is optimized for the open, permissionless nature of the bitcoin protocol. I could make the argument that we’re only now seeing interesting bitcoin uses now that third parties are using it within their own operations to effect value transfers.

This is going to take a lot of work

Reading through these articles and press releases, a common theme of technical experimentation emerges. Blockchain experiments are underway, testing the performance and scalability of permissioned blockchains built for specific use cases. There are plenty of applications where bitcoin’s 10 minute transaction confirmation timing is too slow, never mind its current inability to scale up in transaction volume. (We’ve spoken with developers testing blockchain designs capable of processing transactions at Visa-like scale, beyond 20,000 transactions per second.)

That’s as it should be. Every new technology needs to be thoroughly vetted to determine its optimum employment.

But the harder work lies elsewhere, in the domains of governance, rules development, regulatory change, back office optimization, and standards development.

Governance and rules

In our blockchain workshop, we make the point that the bitcoin protocol is rules-based. Its rules are enforced in software rather than by a contract or rule book. New block creation intervals of 10 minutes and the 21M bitcoin maximum are examples of its rules, each choice made and defined by human beings. Subsequent rule changes impact not only the system’s functions but the philosophical and economic lives of those affected.

The current division within the bitcoin development community over expanding the size of each block, in order to accommodate today’s higher transaction rates, is an example of the challenges that governance and rule change represent. Bitcoin adherents have celebrated the protocol’s lack of a central authority as a signal characteristic and advantage. While that may be true at the level of each bitcoin transaction, the keepers of the code are a de facto central authority responsible for rules evolution. Their governance struggles could limit bitcoin’s future. The wide open, largely permissionless internet succeeded because of rules and standards that evolve to address changes in the environment. Bitcoin, or its successors, can be no different.

The same need for rules and clear governance holds true in the domain of permissioned blockchains, where a closed group of parties, such as a collection of financial institutions or asset traders, transact among themselves. While satisfying the needs of a limited set of participants may constrain rules scope and governance complexity, it would be foolish to underestimate the difficulty of getting even a small community to agreement. After all, most are composed of competitors looking for advantage over one another.

Regulation

We’ve all observed how local, state, and national regulations struggle to keep up with technology-driven change. Uber’s multi-jurisdiction confrontations is just one example. As blockchain applications and smart contracts spread into traditional custodian-based businesses such as bank trust departments, law firms, and insurance, expect similar push back from incumbent businesses and the regulators guiding them. Regulations that grow over decades like the U.S. Uniform Commercial Code don’t change overnight.

Back office applications

Many blockchain startups are looking to automate back office functions of enterprise scale business. Most know something about blockchain and very little about the back office functions they propose to support. Complex back office processes make the maths of blockchain protocols look straightforward. Blockchain proponents could well heed Abraham Maslow’s caution:“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.” In the back office, an entire tool chest in the hands of process craftspeople is what’s required.

Standards development

The internet succeeded because smart people came together to write standards for email, FTP, HTTP, DNS and the other tools that form its foundation. That foundation has enabled the innovation we enjoy today largely because it is not proprietary to an individual company or platform. The future foundation of bitcoin and/or its permissionless successors should be built along similar lines. The Linux Foundation’s Hyperledger project is an example.

Be critical

At its simplest, we can think of a blockchain as an unalterable ledger, a permanent database of transaction flows. Just remember, database technology is already highly evolved. While there are plenty of functions that could be served by a blockchain, record keeping functions for example, such uses have to be demonstrably better than current database tools to win.

So when you see the next flurry of blockchain stories, keep in mind that the technology of blockchains could be the least of the challenges.

Let me know your thoughts!

This post was written by Glenbrook’s George Peabody.

 

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