It has been a decade since I first embarked on my journey down the payments rabbit hole. Since then, the predicted disruption of payments as we know it has proven to be more of an evolution than a revolution. With that in mind, even though there have been massive shifts in the payments space, the most exciting times are yet to come. Here are seven trends that will shape the next phase of payments evolution.
Ecommerce has held the center stage as one of the strongest trends driving the future of payments for a while now and does not show any signs of being less important in the time to come. Even though eCommerce has grown both rapidly and steadily over the years in every single region of the world, there is still a major gap between eCommerce leaders like China and South Korea and the rest of the world. While the estimated average online share of commerce in European countries is around 15 percent for 2021, more than half of retail commerce in China is online.
The growth in eCommerce is not expected to slow down, as almost every merchant is has adopted some kind of online presence since the initial outbreak of COVID. According to digital payments company Square, the share of businesses accepting online payments increased by 13.2% from February to July 2020.
For the payment industry, this means that reducing friction and thus increasing conversion rates should still be a top priority to leverage the continued growth in eCommerce. When it comes to online payment simplicity the gold standard is the one-click buy button. Payment providers that manage to provide retailers and eCommerce software platforms with easy-to-implement and developer-friendly APIs for embedded payment solutions will have a significant competitive advantage.
Buy Now Pay Later
Deferred payments or buy now pay later has seen a meteoric adoption across almost all regions alongside the growth in eCommerce. According to Adobe, buy now, pay late” experienced 215% year-over-year growth in the first two months of 2021.
In its simplest form, consumers are granted a mini-loan at the point of sale, where you may choose between a variety of repayment terms. One of the potential challenges with this scenario is that each solution has its own set of rules on fees, number of installments, duration of schedules, interest rates, and credit reporting.
As Buy now Pay later options are designed to increase conversion rates in online checkout, such solutions are sometimes interest-free for consumers (at least for a given period), while recuperating those revenues through a significantly higher merchant fee than credit cards. For reference, a typical credit card interchange fee is often somewhere between 1% to 3%. The buy-now-pay-later companies usually take about 5% or 6% from the retailers.
For incumbents, this has several implications. McKinsey’s Consumer Lending Pools data estimate that in the US market alone, fintechs have diverted somewhere between $8 to $10 billion in annual revenues away from banks, and if the size of yesterday’s acquisitions tells us anything, we have only seen the start of this development. Buy now pay later providers are targeting a sweet spot in the payment value chain where they can disrupt both consumer and commercial banking.
Revenues at risk consist of revolving interest rates from credit cards and consumer loans as well as interchange fees on the consumer end on one side of the transaction. On the other side of the transaction, buy now pay later is disrupting card acquirers and providers of transaction banking products towards small, medium, and large enterprise clients.
While buy now pay later still represent only a small portion of the total payment market, it is predicted that the global size of buy now pay later payments will reach a total spend close to 700 billion USD by 2025, doubling the total spend of just north of 350 billion USD in 2019.
To really understand the potential implications for banks, it is important to look beyond short-term revenues at risk and view payments as more than just stand-alone transactions or one-off financing offerings. The leading providers of buy now pay later are engaging in establishing a digital ecosystem, where the point of sale is the gateway to both user acquisition and long-term customer relationships through their entire purchase journey, from prepurchase to post-purchase. Klarna’s recent acquisition of APPRL, a platform that helps content creators and retailers cooperate shows how Klarna is building a digital ecosystem centered around eCommerce transactions.
In the time to come, we should expect to see buy now pay later transition from the checkout process at online retailers and become an integrated offering from digital wallets such as the announced Apple Pay Later, PayPal’s, Pay in Four, and the upcoming integration of Afterpay in the Cash app. For incumbent banks and credit institutions, this is bad news, as banks are not in the driver’s seat in the digital wallet department.
For incumbents, it is imperative to rethink how credit is offered. The lines across traditional credit products are already blurring, as banks offer loans against open credit card lines and fintechs offer installment-based credit cards or debit cards with pay later features. Loan origination, therefore, needs to be agnostic of the product through which credit is being delivered.
Digital wallets have been a hot topic ever since Google announced their initial plans for Google wallet ten years ago. While it has been a slow train coming, digital wallet adoption is surging, and the banks are not in the driver’s seat.
Consumers’ use of digital and mobile wallets has tripled in the past three years and has only been accelerated by the pandemic. The number of unique digital wallet users are expected to exceed 4.4 billion globally by 2025, up from 2.6 billion in 2020, according to a recent study from Juniper Research.
In The European market alone, the top European digital payment and money transfer apps gained 29 million downloads in Q1 2021, a 29 percent year-over-year increase in mobile wallet downloads (excluding Apple as an integrated OEM wallet).
In addition to adoption, frequent usage is also increasing. An estimated 13 percent of the world’s population made purchases using digital and mobile wallets in 2020, and these wallets will be used to pay for more than 52 percent of eCommerce transactions by 2023. The total amount spent through digital wallets is also expected to nearly double to $10 trillion annually by 2025 from $5.5 trillion over the time period.
Fueled by the decline in cash usage, China and Asia-Pacific are leading in mobile wallet adoption, whit Alipay and Wechat pay as the dominant platforms.
When looking at the mobile wallet space, it is worthwhile acknowledging that there are regional differences ranging from technologies deployed, to the source of money, where digital wallets in western countries often rely on traditional card schemes, Asia and emerging markets is relying on stored-value wallets.
The mobile payment space consists today of numerous players, but few potential winners. Will there be a winner-takes-it-all scenario where a select few financial super-apps dominate in their respective regions of the world, or will consumers continue to use different wallets for various purposes?
Of all the forces predicted to challenge and disrupt banking and financial services, open banking has proven to have a staying power that stretches beyond the initial hype. The remaining question is whether this paradigm holds up when it comes to producing tangible results.
In its simplest form, open banking is about the exchange of data and services through standardized technical interfaces, so-called APIs. These three letters describe the way different IT systems interact based on standardized formats. This is an acronym that has long been reserved for the IT department, but the commercial use of APIs will create new opportunities for those who dare to explore and think outside existing organizational boundaries.
Even though the term open banking has been versed enough to become a household term in the financial industry, the true potential of open banking is still up for debate. This is largely due to the fact that in order to master open banking, it requires knowledge and expertise in a number of disciplines to fully understand the scope of opportunities as well as potential limitations. As a result, some of the initial promises made by open banking are falsified, while future opportunities are still open to those who dare to venture further along the open banking path.
One of the markets that have been at the forefront of open banking in the UK market, and according to Experian, the number of people in the UK choosing to share their data through open banking has tripled since the start of the pandemic, and more than half of regularly used finance apps have some kind of open banking integrations, proving that open banking solutions have made its way into the mainstream.
VISAs acquisition of Swedish open banking provider Tink is another example of the future potential of open banking to disrupt traditional card schemes in favor of direct account access. Through Tink, banks can access aggregated financial data, initiate payments, verify account ownership and build personal-finance management tools.
Given that Visa already tried to acquire plaid in the US market, it should not have come as a surprise that VISA was looking for a way to get hold of a stake in the open banking game.
Cash is no longer king
While cash is the exception rather than the norm in the Nordics, the decline of cash in traditional cash-loving countries such as Austria and Germany, marks a major shift in user habits and creates a window of opportunity for the payment industry.
The use of cash was already on the decline prior to COVID, the way we pay has undoubtedly been affected by the current crisis. According to Nets, contactless adoption rates in the Nordics are increasing at a never-before-seen rate. Mobile payments in physical retail have proven to be a slow train coming so far, but the option to authenticate a payment on your own phone rather than handling a potential germy PIN-pad may be the spark that accelerates mobile payments. Combined with the rise in eCommerce, mobile wallet dominance over digital payments is likely to solidify even further.
Just as different customer segments show different behavioral changes amidst the crisis, an analysis by EY predicts that few consumers expect to go back to their old behaviors any time soon when we look past the immediate effects of the pandemic. As with many of the shocks we encounter in life, people are in a mood to pause and reflect, and those reflections will shape our future behavioral patterns.
Regulatory and infrastructural changes
There are few things that stir up the status quo in the financial services industry such as regulatory changes. Ranging from EMV for security and fraud protection, IFR for interchange fee cap on domestic and intra-EEA consumer transactions at 0.2% for debit and 0.3% for credit, and PSD2 for increased competition through a leveled playing field.
While the intentions were good, the effects are somewhat absent. A study by CMSPI and Zephyre found that, on average, European merchants were paying more to accept each card transaction than they had prior to regulation. As regulations targeted card transactions, online payments have over time shifted towards a different mix in payment methods, where higher-cost methods such as buy now pay later show strong growth.
PSD2 has also proven to disappoint when it comes to the original intentions and acts as a perfect example of the incompatibility between regulations and digital. While the RTS should define the standard for API implementation, details were still left up for interpretation. As a result, PSD” does not allow open banking and embedded finance to be as innovative as they could be through the PDS2-mandated APIs.
Not only are the PSD2 APIs far from standardized in their current implementations, but they are also often experienced as downright unreliable and unpredictable. This makes it impossible to use PSD2 as a foundation for new and innovative payment services, where availability is crucial. In addition, the requirement for re-authentication every 90 days, even though the intentions were good in terms of security and fraud protection offsets the customer experience and may act as an inhibitor for user retention.
The European Central Bank (ECB) launched a pan-European service for settling electronic payments instantly. TARGET instant payment settlement (TIPS) uses central bank money to settle payments individually in less than 10 seconds. The initiative has been sparked by the growing popularity of digital, contactless payment services offered by big tech firms such as Apple, Google, Amazon, and Alibaba in China.
P27 is another cross-border payment initiative between major Nordic banks with a vision to create, within the Nordics, the worlds’ first solution for domestic and cross-border payments in multiple currencies. In a press release, Henrik Bergman, deputy director for financial infrastructure at the Swedish Bankers’ Association states that the collaboration reflects an effort to stay ahead of global technology giants like Apple and Samsung as customers no longer rely exclusively on their banks for financial services.
In the mobile payment space, leading mobile payment systems have joined forces in the European Mobile Payment Systems Association (EMPSA) with the ambition to achieve interoperability across borders by providing roaming solutions among participating payment systems.
With this in mind, it is highly plausible that we will experience new regulations that aim to level the playing field in the payments space, first by targeting the buy now pay later space. It is up to the regulators what’s next to come, but in terms of strategic planning, fortune favors the prepared mind.
Even though bitcoin has failed to reach mainstream adoption, it may still be too early to write off digital currencies as a factor in the future of payments. Where bitcoin in my opinion has proven to be somewhat useless as a mainstream medium of exchange, it has proven an incredible staying power as a store of value and an asset class.
Where bitcoin may have its weaknesses as a medium of exchange, other application areas and are emerging, such as social tokens, where specialized cryptocurrencies that are tied to a brand, platform, creators, or influencer have entered the payment scene in 2021.
IN the wake of both the decline of physical cash and the attention around digital currencies, several governments around the world are either considering or actively pursuing the possibility to issue Central Bank Digital Currencies (CBDC). According to Atlantic Council, 81 countries, are exploring a digital currency, and five countries have already launched one. Leading the pack is China, with the digital yuan, which has already been trialed in over $5 billion worth of transactions.
Unlike decentralized cryptocurrencies like bitcoin, CBDCs are issued by governments and are basically digital versions of an existing national currency. However, there are many unresolved issues related to CBDC, such as whether CBDC may challenge traditional bank accounts as the primary store of value, thus affect the banks’ balance sheets. a possible CBDC solution must also follow several architectural design principles regarding scalability, interoperability, accessibility, security, and flexibility. The solution must be able to scale in terms of both user and usage growth. The solution must be independent of devices and operating systems, as well as to adapt to changes in this landscape to be accessible for everyone. With the cost, complexity, and potential consequences of a central bank digital currency, a key question is whether a CBDC ever will reach widespread enough adoption to pay off.
It is still too much uncertain to take an absolute stance on how this will play out. For players in the payments space, this is an area that should be on the watchlist. For digital wallet providers, it is particularly important to stay on top of the development of digital currencies to make informed decisions in the time to come.
In conclusion, these trends will affect the payment ecosystem in many ways. Changes in regulations and infrastructure will define the playing field for the players present, and different business models will have different contributions to value creation. But at the end of the day, the decisive factor for payment evolution is user adoption and usage.