This article was taken from the September 2013 issue of Wired magazine. Be the first to read Wired's articles in print before they're posted online, and get your hands on loads of additional content by <span class="s1">subscribing online.
Financial services -- from online payments to transferring money -- are broken. And where a problem exists, so entrepreneurs step in to create efficiencies. Here we meet a new breed of startups taking on the incumbents by rewriting the rules of money on their own terms
Digital currencies will prise open the big banks' grip
In May, with Bitcoin feeling the heat from financial regulators, Liberty Reserve -- the online-payment network and currency service -- was closed down by US government investigators who suggested it played a role in illicit transactions. It appeared as if digital currencies could be under threat. For Andy Schmidt, research director at financial sector consultancy CEB TowerGroup, however, "the fact that regulators are shutting down these exchanges means they're taking digital currency seriously and expect it will continue to spread. And they're right. It has to happen. It's just that Bitcoin needs to grow up."
The fundamentals of banking haven't changed for centuries. "The way banks do business is 300 years old," explains Mark Hale, head of payments at KPMG UK. "Today, money is simply bits and bytes -- and digital currencies recognise that. An accounting-book change in the cloud is a more realistic representation of money today. It's the first proper revolution in payments -- everything else is simply cash on steroids."
Away from Bitcoin, other forms of digital currency are quietly developing. Although Second Life Linden dollars and Facebook Credits are locked in to their respective networks, Facebook's repricing of credits into local currency later this year is aimed at making it easier for goods to sell internationally. In April, there were 800 million active accounts trading China's QQ coins, issued by Tencent Holdings for use on its social-networking sites. In Greece, meanwhile, the citizens of Volos are already trading in TEMs, a digital credit system that uses a pool of transactions to set barter deals. And in the UK, Wigan Council is considering a similar digital-trading systems scheme called VolCom.
In May, Google Ventures and IDG Capital Partners joined a funding round for OpenCoin, the founder of open-source currency platform Ripple, which plans to retain 25 percent of the ripples it has minted to control the currency's value and prevent fluctuations. In the same month, BitPay, a Bitcoin payment processor, announced that it had raised $2 million (£1.4 million) in investment led by Peter Thiel's Founder's Fund. (Thiel, who cofounded PayPal and was an early Facebook investor, also recently invested $6 million [£3.9 million] in TransferWise.) "Peter Thiel says the most disruptive revolutions start with a simple idea where everyone says I believe X, but the founders believe Not X," says Y Combinator partner Garry Tan. "This is one Not X that I think is right. Anything that has the potential to break Visa/Mastercard/American Express's stranglehold on two percent of every consumer transaction is awesome in my book."
Alistair Newton, research vice-president of Gartner's banking team, suggests that social capital, time banks, mobile lending and money clouds might grow from social and gaming networks in the coming years. "The future of payments is about offering a bouquet of currencies at the point of sale," he says. "You'll pay partly in sterling, partly in euros, partly in loyalty points and partly in other currencies."
Biometrics and online reputation are your identity
"The most basic level of trust is your true identity," says Rachel Botsman, author of What's Mine Is Yours: How Collaborative Consumption is Changing the Way We Live. "It's foreseeable that data giving an indicator of character in one marketplace is a baseline of how you will behave in another. The sticky area lies in the shared interests and connections that can be pulled from the social graph."
These interactions have given rise to a reputation economy where our online histories are more powerful than a credit score.
Connect.Me, TrustCloud and Legit are working on systems that correlate this data. But with almost every online entity issuing its own identity credentials in the form of usernames, passwords and cookies, the resulting fragmentation is confusing and susceptible to fraud.
"I think we'll move to a point where information needs to be encrypted in transit and at rest," says Andy Schmidt, research director at financial risk consultancy CEB. "Currently it's mainly banks that underpin identity management and fraud protection for the payments industry. They'll resist that expense if they're expected to do so for the new players."
In Canada, SecureKey lets citizens use their online-banking details to access government services. The Affirm charge card offers a "digital tab", authenticating consumers with Facebook and other social and data signals to assess risk. There's also a push towards biometrics. Finger- and palm-vein recognition has been used for cash withdrawals in Japan for years, and Isbank in Turkey recently installed more than 3,000 biometric scanners in its ATMs.
But Ian Pearson from technology forecast consultancy Futurizon thinks banks can do more. "They're trying to force responsibility for fraud back on to the consumer at a time when we're wary of them," he says. "The best thing they can do to get us on board with their plans is to show we can trust them again."
Meline von Brentano from Palantir, a data company which builds technologies that allow analysts to search databases for patterns and threats, argues that companies must collaborate further. "[The] defence and intelligence communities [have] leveraged technology to share information across the globe," she said. "The financial industry can do this too."
Your borrowing needs will be decided by analytics
Can big data feed the world? Douglas Merrill, founder and CEO of ZestFinance, based in Los Angeles, hopes so. Merrill is pioneering the use of Google's algorithms to lower the cost of credit for subprime borrowers. "In the old days, you'd walk into a bank and the manager might have heard you'd lost your job but he kind of knew you'd be good for the loan," he explains. "That all changed in the 50s and it hasn't changed since -- although the cost of processing a gigabyte of an applicant's variables is now too small to calculate."
ZestFinance analyses 70,000 variables to assess a borrower's risk of defaulting. The more accurately a lender can price a loan, he argues, the cheaper such a loan can be offered to low-risk but low-income borrowers.
MIT professor and entrepreneur Kevin Slavin, whose TED talk " How Algorithms Shape Our World" has received more than two million online views, sounds a note of caution about the relationship between algorithms and money. "If you add computers to biology you get the human genome," he says. "If you add computers to physics you get the Higgs boson. If you add computers to finance you get instability and flash crashes. It takes you 500,000 microseconds to click a mouse, but if you're a Wall Street algorithm and are five microseconds behind, you're a loser."
The result, he warns, is an event like the AP Twitter crash in April where hackers -- reportedly Syrian -- fed reports of explosions at the White House into the Associated Press Twitter feed. High-frequency trading hedge-fund algorithms reacted to the news -- and the Dow Jones fell 143 points. "If that happened at the end of the day and the markets closed in New York, the fear could spread and by the following morning you'd have a genuine panic," Slavin says. "If you're human, you look at that tweet and say 'I don't think so.' Algorithms can't come close to replicating the complexity of decision-making."
Digital wallets will banish cash forever
What's in your wallet? According to figures published last June by the UK Payments Council in conjunction with LINK and The UK Cards Association, if cash isn't king, it's still important. Cash transactions may have declined over the last decade, but in 2012 Britain still made 20.8 billion cash payments, compared to 20.6 billion in 2011. However, the payments industry is still expecting a large-scale shift to use of digital wallets -- bundles of payment providers usually combined on a smartphone .
The major players -- MasterCard, Barclaycard, Visa, Google, Isis and Starbucks -- have mobile-wallet offerings, allowing people to swipe their phones and bill their credit card, bank account or mobile bill. "We hate cash," says Sandra Alzetta, head of mobile at Visa Europe. "It's dirty, smells funny and it's the friend of the gun runner and the drug trafficker." Visa is clear on its chosen alternative -- a near-field-communication (NFC) bouquet of contactless cards. Consumer uptake has, however, been hindered by the confusing range of alternatives. NFC-based mobile wallets require chips and apps on smartphones but can be used for contactless interaction and have Google and Isis backing; cloud-based mobile wallets use an online e-commerce payment system and smartphone app and are backed by PayPal, O2 and US retailer Best Buy; and other methods such as Kalixa's prepaid MasterCard and eWallet allow users to switch between pre-paid card, debit card, online banking and wallet-to-wallet transfers with a single device or card.
Digital wallets are likely to be welcomed on the high street. "Retailers are facing massive pressures from showrooming -- shoppers experiencing items in store then purchasing them at a discount online or elsewhere," explains Gareth Mackown, mobile lead at IBM who works on in-store technology for major retailers. "New payment technologies can help with that -- especially mobile.
Retailers currently know when a customer's visit has ended if they pay on the way out. Increasingly, however, customers are leaving stores simply because the queue at the till is too long. If there are well-matched, geo-targeted, personalised offers, with easy redemption at point-of-sale, it encourages shoppers to stay."
In the US, CardStar returns the advantage to the store with a digital loyalty wallet -- combining loyalty cards, reward cards and club membership cards. In June, Apple applied for patent on a digital wallet with a coupon-based reward system: users might earn credits for watching TV ads, for instance.
But it's slow going. In May, Google announced the end of Checkout, its digital wallet, to be rolled into Google Wallet in November. Google Wallet was described as a " money pit" by Business Week in the same month. "Payments are fundamentally broken," according to Matt Robinson, cofounder of UK payment startup GoCardless. "Collecting money -- as a merchant or a friend -- is a nightmare. We need to simplify that."
Currency rates will become fair and transparent
"You've had that experience when you get your money at the airport and think: 'I haven't got the best deal here,'" says Michael Laven, CEO of The Currency Cloud, a fast-growth London-based startup that undercuts currency-exchange rates offered by banks.
Founded by forex traders and payments specialists, its XBP Connect API shaves up to two-thirds off transaction fees for business clients by buying on the capital markets. The purchase price is disclosed to clients, who are then charged a fixed fee -- between 0.1 and 0.2 percent. (Banks typically charge four percent.) "Big companies get those sorts of rates and fees with the major banks -- we're just extending that to smaller businesses."
The Currency Cloud shows customers the mid-market rate, "the apparent exchange rate that you see when you look it up online but you never get your currency for," says Laven. It shows the customer what it purchased the currency for and the fee it will charge. "We are utterly transparent."
Since its launch in 2012, The Currency Cloud has attracted around £4.3 million in funding from Anthemis Group, Atlas Ventures, Notion Capital and XAnge Private Equity. It only deals with businesses, but consumer currency-exchange services such as Azimo and TransferWise are among its clients aiming to pass savings on to customers. "We're using social to bring costs down," says TransferWise cofounder Taavet Hinrikus. "Every day thousands of people in Paris send money to London and vice versa. We join the dots so that the payments only happen between domestic banks -- the money stays in the country."
Mobile money will transform the way we spend
In 1999 executives at Nokia were predicting that consumers would soon be buying Coca-Cola from vending machines via SMS. That hasn't taken off, but 14 years later, mobile money is beginning to gain traction. Services such as Barclays' Pingit, which allows customers to transfer up to £500 via text message, are building on lessons learned from Kenya's M-Pesa phone-to-phone money transfer system: UK banks are currently building a central database for customers to make bank-to-bank payments using a phone number. Visa, which released digital wallet V.me in November 2012, expects half of all payments to be made through mobile devices by 2020.
At one stage, the banks pinned their hopes on near-field communication (NFC), by which users would tap their phone to pay.
But growth has been slow. "We've been waiting for NFC technology for ten years," argues Wendy Dobson, head of innovation at DataCash. "Each time another iPhone comes out without NFC, it locks away another million consumers who aren't going to be using it any time soon. With Transport for London now enabling NFC Oyster-card payments, it will be interesting to see if consumers will start demanding tech companies include NFC. I suspect it's good news for Android phones."
Alastair Lukies, CEO of Monitise, agrees -- with caveats. He predicts that mobile banking will grow from ten percent penetration to 50 percent within three years, with peer-to-peer mobile payments and m-commerce following. Lukies feels that the industry has only recently realised that it faces a threat. "Everyone's beginning to accept that ten percent of a big market is better than 100 percent of nothing," he explains. "The threat is two kids in a California basement ready to disrupt the ecosystem."
Retailers, meanwhile, have found ways to circumvent NFC. "Starbucks's mobile-payment proposal is effortless," argues Ed Chandler, CEO of Kalixa Group. "You can pay through the app; you earn gold stars, which you watch tumbling down the screen; it includes a store finder and offers free e-books and iTunes downloads when you're in-store. It's just using the existing iOS tech."
Starbucks has partnered with Square, Jack Dorsey's San Francisco startup that lets anyone accept credit cards using an app on a smartphone or a tablet. Analysts have speculated that Square will process roughly $5 billion (£3.22 billion) in the tie-in's first year.
Sweden's iZettle is offering a similar service in the UK, with a 2.75 percent transaction fee. PayPal is following suit -- it launched its Cash For Registers programme in the US last June, offering free card processing for businesses trading in cash registers for its PayPal Here app. "PayPal handled $14 billion (£9 billion) in mobile payments last year, and expects this to rise to $20 billion (£13 billion) in 2013," says Cameron McLean, PayPal UK's managing director. He points to its Pizza Express joint-venture whereby customers can pay for their meal using their smartphones while in the restaurant.
At the end of last year, Luxembourg-based venture fund Anthemis invested in Moven -- formerly Movenbank -- which combines mobile banking with financial advice. "You swipe your phone in-store when making payment and Moven can keep tabs on your spending, your earnings, even -- if you link it to Facebook -- your social life," says Anthemis founder Sean Park. "Very few people have a good fix on their bank balance as they shop. Moven can tell you if you can afford that pair of shoes and tell you how many lattes you've bought over the past month. It will encourage better financial wellness."
The online payment sector is preparing for revolution
Software developer Patrick McKenzie started his first business after a discussion with his father, who thought it would cost his son thousands to set up a company. McKenzie said that he could do it in a week with only $60 (£40). On 1 July, 2006, he launched his company Kalzumeus Software and chose PayPal to process online payments. The experience, however, was frustrating. "PayPal aggressively puts itself between you and your customer. You have to leave my website to make a PayPal payment. That is no longer as appealing as it used to be," says McKenzie, who is based in San Francisco. He describes PayPal's API as "absolutely maddening", and claims that it takes, on average, two weeks of a developer's time to integrate. Last year, he tried Stripe, an online-payment service which lets developers create their own payment process. "The way Stripe does things is different. Customers can complete transactions without leaving the site." McKenzie hypothesised that because Stripe offered a seamless and quicker experience, it would make him more money. "I ran an A/B test: adding a Stripe-based checkout was worth a 40 percent increase in sales," he says. "Stripe is what PayPal would be if PayPal was written in 2013."
McKenzie's experience reflects a general dissatisfaction with PayPal: in an interview with tech website PandoDaily in July 2012, PayPal cofounder Elon Musk -- who left the company in 2002 following its purchase by eBay -- said: "If PayPal doesn't do something it will be screwed. If you look at the product plan that I wrote in 2000, there's hardly any difference."
Stripe is a fast-growing alternative: the Palo Alto-based startup processes billions of dollars a year for thousands of clients including Walmart, Foursquare, Shopify and Reddit. The platform is available in the US, Canada and, since March, the UK. "The internet made it possible to start a business anywhere and have customers all over the world," says John Collison, president of Stripe. "What's hardest is charging people and getting paid and having someone in another country pay you. We decided to fix that.
We want to be the underlying payment infrastructure for the web."
Collison, who founded Stripe with his brother Patrick, is from Limerick, Ireland. In 2006, aged 17, Patrick left to attend MIT. (John, who is two years younger, left in 2009 to study physics at Harvard.) Patrick dropped out to join Y Combinator with his company, Auctomator, which he sold in 2010 for $5 million (£3.2 million). They came up with Stripe in 2011. It allows web developers to take payments without having to set up their own merchant account and payment gateways without having to store consumers' credit-card details. It charges 2.9 percent of every transaction plus 30 cents, without monthly fees.
Last September, Stripe raised $20 million (£13 million): among its investors were PayPal cofounders Peter Thiel, Max Levchin and Musk. "I was surprised at how excited they were," says Patrick. "They want PayPal's mission -- to revolutionise payments online -- to succeed more than they want PayPal to succeed."
Although PayPal remains dominant, competitors include Google Checkout and Braintree Payments, a Chicago-based startup that processes more than $8 billion (£5.2 billion) a year. "The focus is not the competition," says Patrick. "It's on making the internet economy bigger."
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