Fast, Cheap,


STACI WARDEN is CEO of the Algorand Foundation and a senior advisor to the Milken Institute.

Published Jaunary 23, 2024


For you, intrepid American shopper, the credit card system is a technological marvel. From the time you tap your card until the time you see that life-affirming “approved” message a mere three seconds later, your card’s legitimacy, your financial wherewithal, your recent transaction history and your identification as a non-money launderer or terrorist have all been checked. The merchant’s status has been similarly verified, and you can believe that your bank has put a hold on your funds before your purchase has traversed two feet of checkout-counter space and dropped into your bag.

You may not even have the green squirreled away to cover the transaction. If not, you will avail yourself of the 30-day interest-free revolving line of credit that comes with the plastic. Even better, you will be rewarded over time for your hard work shopping – with airline tickets, hotel stays, electronic gadgets and even cash. Shopper, you are not alone! U.S. consumers bought almost $10 trillion worth of goods and services in 2021, in 157 billion card payments. Every second, 10,000 credit card transactions are made globally, two-thirds of them in the United States. Each tap and swipe adds up, and total U.S. credit card debt now stands at $1 trillion, or almost 5 percent of GDP. Meanwhile, those who can’t (or don’t want to) take on credit card debt have loaded another halftrillion dollars onto prepaid debit cards, which are particularly popular among millennials.

We’re Number One (Not)

Though it may come as a surprise to the average red-blooded, credit-card loving American, the U.S. now lags behind a large number of countries in digital payments. China and India, in particular, but also Brazil, the UK, Sweden, Singapore and the EU, among many others. All have partially or completely leapfrogged the U.S. in terms of payment systems that can get money into the hands of people, in large quantities or small, as soon as they have earned it. China has even rolled out a large pilot for a central bank digital currency (CBDC), raising deep fears in some circles about the future hegemony of the dollar as the world’s uber-currency – the currency held as liquid reserves by central banks as well as international businesses.

Why the lag? One reason is that the U.S. payment system works well for most people most of the time, making it more difficult to summon the political will to invest in wholesale improvements. But the U.S. faces a myriad of overlapping challenges with – and missed opportunities from – its fragmented and entrenched legacy payment environments. Among them: the relatively high cost of most payment transactions, slow clearing and settlement times that have cascading deleterious effects on the less well-off, and the persistent exclusion of some seven million households from the financial system.

In any event, this is no time to be bogged down by inertia. We are still in the early innings of a global payments revolution, and U.S. policymakers would do well to become attuned to the potential societal benefits – everything from opportunities to expand the reach of digital into micropayments to geopolitical macroeconomic influence – that this payments revolution could bring. The challenge is to catch up to the formidable advances made elsewhere, particularly in the realm of direct payments, and to try for some leapfrogging of its own.

The U.S. need neither fear nor necessarily embrace a central bank digital currency, though. Rather, the path forward will likely be a combination of public infrastructure improvements and private sector innovation, true to the American ethos. As such, the Fed would do well to push forward aggressively on public direct payments initiatives now underway, which have been too slowly and timidly implemented – but also to be open to outside-the-box private-sector enterprise, particularly by developing fit-for-purpose regulatory frameworks around these ideas.

Warden Stacy Future of Payment Systems 2
The Credit Card Revolution

Bank of America kicked off the global credit card revolution in the late 1950s by “air dropping” 60,000 pre-approved BankAmericard offers to consumers in Fresno, California. The pitch to shoppers was that they could, with just a piece of plastic, buy stuff on credit and be billed only at the end of the month. For the 300 merchants who quickly got on board (despite the 6 percent transaction fee), the motivation to participate was the expectation that making it easier for shoppers to pay would surely make it more enticing for shoppers to shop.

Scale came quickly on the back of two important early decisions. First, to get around state-centric commerce laws in the mid- 1960s, Bank of America decided to license its brand to participating banks nationally, which would then be responsible for issuing cards. Second, it standardized the fee it would pay the banks for coming onboard. Today, these interchange fees paid to card-issuing banks are governed by detailed rules, and payment rates are non-negotiable. This early decision prevented a race to the bottom on fees, and the possible dominance of one banking group.

It was an auspicious start. But a huge wave of fraudulent transactions in the early days nearly took down the whole enterprise. And it became increasingly clear over the years that, with fraud still over 1 percent of sales in 1973, payment authorization needed to take place in real time.

The turning point came in the 1970s at Dorothea Parry’s kitchen table one evening, when she explained to her IBM engineer husband that the machine-readable magnetized tape he was trying to affix to identity cards for the CIA would stick a whole lot better to the plastic if he would iron it, and thus melt it on, rather than trying to glue it. With the magnetic strip now properly affixed, the name of the card holder, the card number, the authorization code and the expiration date of the card could be instantly captured electronically.

Visa mandated the use of these magnetic strips on all cards by 1980 and then embarked on an all-out marketing blitz to get machines that could read them into the hands of merchants. With time, the cost of these point-ofsale (POS) devices came down, and the magnetic strip was replaced (first in Europe and now, increasingly, in the U.S.) by yet-moresecure digital-chip-and-PIN technology.

Square proved a gamechanger for small businesses, which were happy to pay more for the back- office help – especially as many of them couldn’t get merchant accounts at all at these banks.

Fast-forward to 2009 when a tech startup called Square unveiled a small device that could “listen to” the magnetic tape on the back of a card through a smartphone’s audio port, and thus turn any smartphone into a mobile POS device. Square’s diminutive slice of white plastic led to a payments revolution in farmer’s markets, craft fairs and other small-merchant forums. Square treated them all as sub-merchants under its own account with the merchant bank, setting them up quickly without hassle and then interfacing with the credit card schemes on their behalf.

Square proved a gamechanger for small businesses, which were happy to pay more for the back-office help – especially as many of them couldn’t get merchant accounts at all at these banks. In Ireland at about the same time, the Collison brothers, then just in their early 20s, did the same favor for online merchants with Stripe. Starting with the idea that payments integration can be done with just “seven lines of code,” Stripe provided easy application programming interfaces for websites to access payment systems. And, like Square, the company handled all the servicing and more. Indeed, with Stripe, almost anyone can set up an online business and start taking credit card payments.

Though consumers typically don’t notice, credit card payment infrastructures are expensive, in part because there are so many parties involved in the process. Processing credit card payments is thus a very big business. In the U.S., the total cost of processing card payments in 2022 was a whopping $160 billion. Visa now has a market cap greater than the top-ten banks in Europe combined, while Square and Stripe are valued at $27 billion and $50 billion, respectively. Note that they have all made their money on the backs of merchants, who pay for this infrastructure with every transaction. And pay, they do. For every dollar you spend with a credit card, the merchant receives on average about 97 cents – and sometimes as little as 94 cents, depending on the industry they are in and how you pay (e.g., in person versus over the phone). You can be sure, shopper, that merchants pass these costs on to you wherever and whenever they can.

Waiting to Get Paid

While card transactions are authorized immediately, the money doesn’t get to the merchant in anything like real time. Settlement instructions are sent by the merchant’s bank to the customer’s bank only at end of the day (to allow for error corrections and the addition of things like tips). Issuing banks then send payment instructions to the Fed in huge batches. The Fed clears them on a “net” basis (that is, after canceling out the credits and debits that banks have with one another) and then parses them out to the merchants’ banks for settlement (payment).

It can then be several more days before the money actually hits the account of the merchant, depending on the merchant category, size and the number of intermediaries. This, of course, has direct implications for how quickly a merchant can turn over inventory and manage its own accounts, especially if it is small.

Batch payments are slow almost by definition. In the case of credit cards, millions of individual payments are aggregated and sent to the Fed by an end-of-day cutoff window so they can be collected together and then netted, which also takes time. Other kinds of batch payments are made through the Automated Clearing House, a not-for-profit consortium of the largest banks, also during designated time windows. These are the mainstay of B2B (business to business) payments, and 82 percent of transactions in the U.S. are processed this way, for a total of $62 trillion in transaction value in 2020. ACH payments are also how you likely make your automatic utility payments and other kinds of standing transactions – and, equally to the point, how most salaries and Social Security payments are delivered.

Warden Stacy Future of Payment Systems 3

In 2018, U.S. companies and individuals also spent $26 trillion by writing 16 billion checks. As many as one in three business transactions are still made this way, and 80 percent of firms say they pay at least some bills using checks. Our national preference for checks is widely mocked internationally – and checks are, of course, stone-age artifacts compared to the faster, less costly digital payments systems multiplying around the world. But the lowly check has its defenders. It was actually the first form of long-distance interoperable payment, as it was (and still is) accepted almost everywhere across the country. Furthermore – and most beneficial for recipients – checks, unlike credit cards, are paid out 100 cents on the dollar, with none of the processing fees taken out. Still, though…

Last, but certainly not least, payments are slow in the United States because the payments industry takes weekends and holidays off. The Fed defends this 19th-century custom as time to correct any clearing errors, but weekends and holidays can add two to three days to the delay on all of the above. In many advanced countries, these bankers’ hours are a thing of the past: their payment systems run 24/7, 365 days a year.

If you have an income high enough to maintain a sufficient balance in your checking account to buffer the ebb and flow of payments that must come from it, you might not be aware of any delays at all unless and until you have to make an emergency payment. But for people living closer to the edge, turtletime- as-usual too often undermines their ability to manage household finances. Even the standard three-day ACH salary delay can have a cascading effect for those living paycheck to paycheck, most notably in the form of reliance on outrageously expensive payday lenders and/or bank overdrafts that come with hefty fees.

In fact, several fintech models today are based entirely on (with apologies to the payments industry in advance) “putting lipstick on the payments pig” by shielding customers from the delays built into the traditional payment “rails” – the infrastructure that moves money from payor to payee. As just one example, neobanks spotted an opportunity to poach traditional bank customers by offering same-day salary delivery. What these companies do, in effect, is pay workers up front on the date that payrolls are submitted for processing, and then bear the three-day credit risk against the ACH payment not settling. This is considered to be a smart tool for customer acquisition because the risks are modest, particularly if the payroll run is from a large, reputable company.

The Rise of Real-Time Payments

Given the delays inherent in batch processing, the rise of real-time payments in the U.S. (and globally) has been nothing short of a revolution. The OG in this story is PayPal, a direct payments platform that grew out of the eBay online auction marketplace in the late 1980s. Its irresistible value proposition was to solve for the risk of non-delivery of goods by momand- pop shops on eBay that had no easily verifiable customer service history. (Recall, this was the very dawn of the World Wide Web.)

PayPal stepped into the middle of the transaction as a kind of escrow service, collecting customer funds up front, but not sending those funds to merchants until the goods were delivered. Over time, though, with customer and merchant accounts on one platform, it became easy to orchestrate immediate payments among them.

In the modern-day version of PayPal and the myriad other direct payment apps that have followed, each user loads a digital wallet with money, typically through an electronic bank transfer. The balances of all users on the platform are held in one omnibus trust account that the app, in turn, maintains at a traditional financial institution. Because from the point of view of the app this is one account comprised of many customer subaccounts, “moving” money back and forth among customers is simply a matter of making accounting entries to update its omnibus ledger. For this reason, payments are instant and typically very low cost as long as both parties use the app. In terms of the mechanics behind them, the other important thing to understand about direct payments is that they are “push” payments. While credit card rails and most ACH payments “pull” money from an account when authorized, in the case of peer-to-peer payments, you push the payment out of your account to the account of whomever you send it to.

Warden Stacy Future of Payment Systems 4

This turns out to be a very important operational distinction, in part because it is what enables the easily accessible, user-friendly interface of direct payments. On a direct payment platform, you can be identified, and thus get paid, by providing only your email address or phone number. Nobody can ever use this information to take money out of your account because that’s not how the system works. The only risk to you is that you send an irreversible payment by mistake – and that’s a risk that these platforms bet you’ll be comfortable taking.

The poster children for real-time payments today are the Chinese super-apps, Alipay and WeChat Pay. Alipay found its raison d’être in the same way PayPal did, by providing escrow services and the credit-scoring of merchants based on their online behavior – in this case on the humungous Alibaba e-commerce platform. In addition, though, it rolled out a groundbreaking innovation to make it easier for merchants to accept payments: the QR code.

The QR (quick response) code turned the buyer-merchant relationship on its head by switching the onus of being online from the merchant (who went from needing an online POS device to needing only a sheet of paper with a QR code on it) to the buyer (who went from needing a plastic card in a wallet to an app on a smart phone).

Alipay and WeChat Pay transformed China from a primarily cash-based economy to a primarily digital one in a mere five years, and they now boast about a billion monthly active users combined (which is, as a reminder, about three times the population of the United States). In fact, the ubiquity of the Chinese super-apps has made it almost impossible to live in a Chinese city without them. With only cash, you’d find it extremely challenging to hail a cab, buy food or make a wide range of everyday purchases. Today, both super-apps offer 90-day installations for tourists, so they won’t starve or get stranded on street corners in Shanghai!

Today’s most advanced national payments schemes mandate an open banking environment that enables third-party apps to initiate payment instructions on behalf of banks. And this opens up a whole new world of embedded payment services for individuals and businesses alike.
Tearing Down the Walls

The problem with direct payments apps, though, is that whereas debit and credit cards are accepted anywhere, these platforms are closed systems and onboarding is like entering a walled garden. Some, like those in China, are so omnipresent that the world beyond the garden is too distant to inconvenience most users. But in the U.S., it is not common for stores, say, to accept Venmo or Cash App. In this case, offramping back to your bank account to make non-app payments takes 2-3 days, as you are back in the world of batch processing. Making a direct payment from the app to your bank account, while possible today, will cost you an additional fee.

To have the immediacy of direct payments with the ubiquity and interoperability of credit cards means moving back to a bankbased system, where payments can be made directly from bank account to bank account in real time. In 2008, the UK was the first major country to implement this kind of a national payments scheme, which is called the Faster Payments Service. This was followed in the EU by the Payment Services Directive 2, and now over 50 other countries have followed suit to one degree or another.

These systems are typically organized, at least in part, by the central banks. But they can be privately operated, and in most cases encourage innovation on top of established standards for smooth user experience and customer protection, etc. Today’s most advanced national payments schemes go one important step further, though, by mandating an open banking environment that enables third-party apps to initiate payment instructions on behalf of banks. And this opens up a whole new world of embedded payment services for individuals and businesses alike.

These days the runner-up prize in national payment platforms goes to Brazil and its PIX network. Before PIX, it took debit card payments two days to clear and credit card payments a whopping 30 days to clear. It is hardly surprising that less than two years after the introduction of a well-designed system costing one-third as much per transaction, 70 million Brazilians are now making digital payments and PIX is handling four billion transactions per month.

The grand prize, though, goes to India for its now-famous “India Stack” and Unified Payments Interface, on the back of the rollout of its nationwide Aadhaar digital ID system. Third-party providers of all kinds (from Uber to Google to online retailers) can now plug into the UPI to give banks payment instructions on behalf of their customers directly from their own apps. And while the UK system took seven years of anemic growth and several revisions before it began to catch on, the seven-year-old UPI already processes ten billion transactions per month.

It is in this area in particular that the United States stands out as the global laggard. The Fed invited me to participate in its newly formed Faster Payments Task Force back in 2014. And the path is only just now being made available, starting with smaller-value payments and with banks signing up on a volunteer- only basis. ACH introduced its own direct payment system in 2017. But in the second quarter of this year, it still only handled 60 million transactions – for the quarter.

Warden Stacy Future of Payment Systems 5
Fast, But Not So Fast

Of course, the easiest way to make a direct payment – one that transfers and self-settles instantly – is to pay with cash. Cash is what is called a “bearer instrument,” which means, as any child with older siblings can attest, that possession is ten-tenths of the law. It is also a direct liability of the Federal Reserve (as opposed to a liability of the banking system). If these properties of cash could be digitized as a CBDC, forward-thinking central banks have reasoned, this could become the solution to interoperable real-time payments.

The biggest advantage to CBDCs is that they would put the government in a direct monetary relationship with the public, allowing it to better roll out targeted fiscal transfers Instead of the debacle that was the distribution of Covid-19 relief funds in the United States, for example, with a CBDC the government could have instantly distributed relief payments in a targeted way to those deemed needy.

In addition, retail holdings of CBDCs could add another tool in the monetary policy toolkit. As Bank for International Settlements president Agustín Carstens recently put it, with CBDCs “the central bank will have absolute control on the rules and regulations that will determine the use of that expression of central bank liability. And also, we will have the technology to enforce that.” Translation: central banks could set the interest rate on savings as a negative number.

Retail CBDCs, though, are both politically fraught and difficult to imagine putting into practice. It is safe to say that central banks are taking a cautious approach. This, not least because they could put central banks on an internal collision course with their financial stability mandate. The three-day rush to the exit at Silicon Valley Bank last March taught regulators that depositors don’t line up outside banks anymore. They use their mobile phones to wire their money from bed before they even brush their teeth in the morning. And because CBDCs would be backed by the full faith and credit of the government, periods of broader financial system stress, or even the rumor of stress, could potentially lead to an immediate run from the banking system as a whole. Why take chances, after all? For this reason, most studies contemplate limiting the amount of CBDCs that individuals could hold.

For their part, many people view CBDCs with trepidation due to fears of Big Brother. Carstens may have been speaking only in theory, but it is a short fearful step to imagine that a government could enable CBDC usage at, say, a grocery store but not at a liquor store. And while on a macro policy level, there may be an argument for a more efficient demand stimulus, as an individual, you don’t have to be a hardcore libertarian to be troubled by the notion of government taxing you for saving your own money.

The other, broadly concurrent movement to rethink instant payments from the ground up has been the cryptocurrency/blockchain phenomenon of the last decade. Here, though, the animating force has been to create a universally open-access, permissionless, and wholly decentralized financial system.

China was the first major country to roll out a large CBDC pilot, and you can believe that this brought urgent whispers to the hallowed corridors of Western central banks that China might match its astonishing success in retail digital payments with a similar dominance of e-currency – and with that, the potential displacement of the U.S. dollar as the global reserve currency. U.S. policymakers have also given some voice to these fears, but the primary impact has been to engender an acrimonious political debate about the merits of creating a CBDC here in the United States.

In any event, the idea appears to be a complete political nonstarter, particularly with Republicans. Florida governor and presidential wannabe Ron DeSantis recently announced, for example, that a U.S. dollar CBDC would be banned in the state of Florida. That would probably not be his call, but you get the idea.

The other, broadly concurrent movement to rethink instant payments from the ground up has been the cryptocurrency/blockchain phenomenon of the last decade. Here, though, the animating force has been to create a universally open-access, permissionless, and wholly decentralized financial system. More specific to payments, the idea is that dollar-backed “stablecoins” show promise as direct payment vehicles as they continue to mature. Three particularly interesting opportunities that stablecoins appear uniquely able to deliver in the payments space are:

1. Micropayments that allow the monetization of very small services (e.g., webpage views)

2. The potential for time-based continuous payments, such as for car insurance that only kicks in when the vehicle is on the road, or earned wage access where you’ll be paid as you log the hours, as opposed to only every two weeks

3. Programmable money

The ability to embed rules into the payment instruction – even a payment’s own settlement instructions – could be especially transformative by enabling “trustless” transactions in, say, financing exports or other domains that currently rely on escrow services. Interest in each of these cases continues to grow despite the broader issues of trust and stability in the crypto landscape. Stablecoins globally now boast a $124 billion market capitalization.

A full discussion of the opportunity from (and cautionary aspects of) blockchain-facilitated stablecoins is beyond the scope of this article. But suffice it to say that, here again, important progress is being made in Europe (with the recent publication of the Markets in Crypto-Assets [MiCA] regulation) to put in place a regulatory regime that tries to balance innovation with investor protection and financial stability considerations. The UAE, Singapore and Hong Kong (among others) are working on this as well. But for the most part, U.S. legislators and regulators have shown no interest in creating clear regulatory guidelines to guide the growth and maturation of this industry.

Warden Stacy Future of Payment Systems 6
Play to Your Strengths

Starting with a clean slate and the goal of a cheap, fast, ubiquitous payments regime, it is unlikely that even the maddest scientist would design anything like the Frankenstein that is our current payments landscape. And though its myriad flaws have been costly, particularly for smaller and more marginalized households and businesses, the U.S. lags behind most other rich countries in addressing payments issues head on.

Private sector innovators will no doubt continue to focus on ways to grease the wheels of the existing payment infrastructure. But substantive change awaits a fresh start. From a public policy perspective, there are three paths to improving payments in this country, none of which is mutually exclusive: improvements in and expansion of bank-centric real-time payments platforms, CBDCs and blockchainbased stablecoins.

Fortunately, CBDCs – the most operationally difficult as well as most politically challenging – are also probably the least necessary. In fact, in the few instances of CBDC pilots globally, when the citizenry has been able to vote with their feet, they have run for the exits. Most notably, there has been almost no uptake in China. It may be that the now widely implemented Chinese social credit system, potentially translated into some kind of permission (or not) to make payments, gives them pause. But other pilots have fallen into the same black hole. In any case, it’s not clear that there’s much to be gained from retail CBDC over a well-functioning national direct payment system.

So, while there may be macroeconomic or political reasons to worry about challenges to U.S. dollar hegemony in coming decades, the Chinese CBDC experiment is probably not one of them. In fact, U.S. policymakers might take some solace from the fact that, despite a complete lack of regulatory clarity around crypto in general and stablecoins in particular, the $124 billion in stablecoin issuance worldwide is overwhelmingly dollar-backed. Currencies reflect values, and the world seems to continue to appreciate the dollar, whether digital or in cash, fiat or fiat-backed, as the embodiment of a relatively liberal, open and rule-based monetary system.

A benign regulatory environment that encouraged private-sector-led innovation launched U.S. credit cards, the forebearer of the first global revolution in digital payments. Unfortunately, though, the U.S. has now fallen well behind in the second revolution. As such, it compromises the welfare of its citizens and risks exclusion of U.S. input from frameworks for international payments that may soon be based on the coordination of national direct payment regimes.

Instead of extending the contentious (often far off the point) debates about implementing a CBDC, U.S. policymakers would do better to play to our national strengths. As part of this strategy, they should join the scores of other countries that have mandated open banking frameworks that enable third-partyinitiated payments, put in place sensible regulation to encourage innovation in blockchainbased stablecoins, and aggressively work to improve the Fed’s real-time payments system for both large and small banks. Also, make it work weekends.

main topic: Finance: Banking