Credit cards, as we know them today, started in the late 1950’s. In the early 1970’s, the credit card companies computerized much of the workflow. Since then, the process of using a credit card to make purchases has remained more-or-less the same. But their world is changing. A group of tech-focused businesses called fintechs are rethinking the payment processing workflow. And the changes they make will affect the future of payment processing.
This post is the last intro post in our series on payment processing. Here, we’ll explore what the payment processing industry can evolve into. We want to focus on two specific sectors: Buy Now Pay Later (BNPL) and cryptocurrency. These two spaces aren’t the only areas of fintech growth. But, we think they are the two most significant areas where the future of payment processing would affect small businesses.
Let’s start with why we think the payment processing industry is ripe for change.
Signs an Industry is Ready for Disruption
If you’re into watching tech startups, then you know that one of the forever buzzwords is disruption. But what does disruption really mean?
Technically, it just means that the tech company is going to change some established way of doing things. But, an industry that’s ripe for disruption will show a few more signs.
First, the industry has only a few big players. These big players tend to dictate how the industry does business—i.e. the standard contract terms, how and when their suppliers and contractors are paid, and how the product or service gets to the end user.
The industry is also often highly regulated. The complex laws create a barrier to entry for newcomers. Often, because of lack of competition, the industry can pass down all their costs to the end user. And the end user has no choice but to pay these costs if they want the goods or services. As a result, the existing players make a lot of money, the industry can often be inefficient in many ways, but the big players have no incentive to change the way they do things.
Payment processing is such an industry. There are only a handful of card brands in the US and around the world. Most, if not all, of the cost of doing business is passed down to the merchant. Because payment processing is a type of financial services, it’s subject to a lot of legal regulations. The industry is making money for its participants, so it has little to no incentive to change.
Until the fintechs came along.
Some Fintechs Only Change a Portion of the Payment Processing Industry
The word fintech actually covers a lot of ground. Any tech startup related to banking or financial services is a fintech. Only a small fraction of fintechs are in the payments sector.
In our series on payment processing, we’ve already covered some of these fintechs. All the third party processors we highlighted—PayPal, Square, Stripe—are fintechs. The wire transfer companies Wise and OFX are also fintechs. The merchant account providers still use the old payment processing method, but they’re adopting new ideas influenced by the fintechs too.
Looking at the payment processing workflow, you’ll see that fintechs like PayPal, Stripe, and Square have only changed a portion of the workflow. They’ve taken the traditional direct processors and their ISOs out of it. Then, they replaced the idea of a one-merchant-to-one-merchant-account with a risk pool, so that many merchants are using one merchant account.
As to the wire transfer companies like Wise and OFX, they’ve also changed the traditional way to make wire transfers. In fact, they’ve reverted to an older, simpler way of moving money—by using an internal ledger entry.
What we present below are radical, outside-the-box ways of how some fintechs are changing how money is moved from one entity to another. They erase the payment processing workflow altogether. And that’s why we think these fintechs can make a significant impact to the future of payment processing.
Let’s start with BNPL.
BNPL and a New Way for Customers to Pay
BNPL is basically a quick, short-term loan from the BNPL company directly to consumers. Because this is a direct loan, the loan application, approval, and repayment process is completely different from the credit card processing workflow.
Typically, the consumer applies for a short term loan with the BNPL company for a specific purchase. Once the BNPL company approves the loan, the consumer has four payments to pay off the loan. They pay the first payment at checkout. Then, the BNPL company pays the merchant the entire purchase amount.
The consumer either pays the BNPL company the rest of the payments in a short timeframe like 6 weeks, without interest. Or they can pick a longer repayment period but must pay interest for the loan. If the consumer fails to repay the loan, the merchant gets to keep their money—the issue is between the consumer and the BNPL company.
For a merchant to actively offer BNPL to its customers, they have to join a BNPL company’s merchant network. However, most BNPL companies also let their users buy from out-of-network merchants. In this case, the user pays the merchant with a debit card issued by the BNPL company. The payment is completed just like any debit card payment.
In-network merchant transaction fees can be around 6%-4.5% + $0.30 per transaction. This is higher than most credit card transaction fees.
Some of the biggest BNPL companies right now include:
- Affirm
- Klarna
- Afterpay
- PayPal Pay Later
- Apple Pay Later
We explain how these companies work and go into each of their pricing in our more detailed article:
Should Small Businesses Offer Buy Now Pay Later (BNPL)?
How Cryptocurrency Can Change the Future of Payment Processing
Cryptocurrency (crypto) is a controversial topic. Some people think it’s the way of the future. Others think it’s worthless. What is certain is that most people don’t actually understand what crypto is.
Most crypto enthusiasts think of crypto as an investment. They buy it and then hold it, hoping its value will go up. Then they sell it to someone else who will again hold it and wait for its value to go up. But if crypto is supposed to be money, you have to be able to use it to buy things.
Crypto Avoids the Payment Processing Workflow
When a merchant takes crypto as payment for goods or services, the money transfer doesn’t involve banks at all. To transfer money like the US dollar (called fiat money) from one person to another, you can either physically hand over cash or you can send the money from your bank to the other person’s bank. But crypto has no physical form like cash, and it isn’t stored in banks.
Instead, crypto coins are stored on the blockchain. More specifically, the proof that you own crypto is memorialized on the blockchain. Only you can transfer your crypto to someone else. The transfer happens on the blockchain, with the help of folks called miners.
And, because you don’t need a bank to hold your crypto, payments for goods or services don’t follow the payment processing workflow. Instead, they happen on the blockchain.
To understand how cryptocurrency and the blockchain work, here’s our simple explanatory article. You pretty much have to understand both crypto and the blockchain to understand the rest of this article. So, we highly recommend you at least skim the article. We promise we’ve made it as easy to understand as we can.
What is Crypto and the Blockchain?
How Merchants Can Take Cryptocurrency as Payment
Crypto can be transferred only at a crypto exchange. They can only be kept in a crypto wallet. For a merchant to take crypto, you’ll have to have access to a crypto wallet connected to a crypto exchange.
You and your customer can always convert the price of your goods or services from fiat money to crypto. Then, you can transfer the money manually, from their crypto wallet to your business’s crypto wallet.
But, in the past few years, the process has become easier. Quite a few crypto wallets like Coinbase and PayPal can be integrated with online shopping platforms like WooCommerce and Shopify. Then, your customers who wish to pay with crypto can pick this payment choice at checkout. The rest of the process can be handled through a crypto gateway. The process ends when the crypto is transferred to your crypto wallet and you release the goods or provide the services.
Here’s our detailed article on how a small business can take cryptocurrency as payment:
How to Accept Crypto Payments, for Small Businesses
Whether BNPL and Cryptocurrency Will Affect the Future of Payment Processing Depend on Merchant Adoption
As a merchant, you get to decide whether you want to take BNPL or crypto payments. For these new payment methods to be worth your trouble, there must be some sort of benefit over existing payment solutions.
After analyzing how BNPL companies charge merchants and looking at the nature of cryptocurrency, we don’t think there’s much of an advantage for small businesses to take BNPL or crypto payments. At least, not right now.
BNPL Doesn’t Offer a Clear Advantage Over Existing Payment Methods
To take BNPL payments, some BNPL companies require merchants to join their network, but others do not. Often, and ironically, those merchants who are in the network pay more to process a BNPL payment than those merchants who are not in the network.
BNPL fees for in-network merchants can be as high as about 6% + $0.30. But some BNPL companies let their users pay out-of-network merchants with a debit card. So, out-of-network merchants end up paying much less.
This fact alone means it makes little sense for a small business to join a BNPL company’s network. Yes, some BNPL companies offer targeted advertising opportunities to merchants in their network, but there isn’t a lot of data on how effective such advertising can be.
We can think of one advantage BNPL might have over credit and debit card payments: reduced chargeback rates. Once the customer buys through BNPL, the BNPL company pays you. Any default or disputes with the payment is between the BNPL company and the consumer.
So, yes, there might be some small advantages for a merchant to offer BNPL as an additional way to pay. But because BNPL transaction fees can be higher than credit card processing fees, there is currently no compelling reason for you to join a BNPL company’s merchant network. Consumers who are BNPL enthusiasts will likely be able to pay you with an ordinary debit card anyway.
There is No Reason to Take Payments in Cryptocurrency Over Taking Payments in Fiat Money
As to cryptocurrency, in all honesty, we don’t see a reason to use it. Both you and your customer will have to pay fees to complete the transaction. So, it can turn out to be more expensive to pay with cryptocurrency than with fiat money.
To transfer cryptocurrency from one person to another, it’s the sender who pays the transaction fee. So, for your customer to pay you in crypto, they pay a fee on top of what you charge for goods or services. In contrast, if your customer uses a payment card, you pay the transaction fee.
We see no reason why a sane person would choose to pay more for something when they don’t have to. That’s why, we think that even if you offer crypto as a payment option, you might not get many takers.
To simplify taking crypto payments, many merchants use a crypto gateway. Gateways cost money, so, in addition to the transfer fee paid by your customer, you’ll also have to pay a fee to take crypto payments. And, if you ever want to convert your crypto to fiat money, you’ll have to pay an additional transaction fee.
It is true that there is no such thing as a chargeback when you transact in crypto payments. So, if you run a high-risk business, taking crypto might make sense.
Other than this, we don’t see any advantages of taking crypto over fiat money. There’s nothing wrong with using fiat money, and if it ain’t broke, don’t fix it.
BNPL and Cryptocurrency are Intriguing Ideas but New and Shiny Aren’t Always Better
At the end of the day, both BNPL and cryptocurrency are very intriguing ideas. Intriguing ideas, however, do not always make practical solutions to real-world problems.
Right now, neither BNPL nor crypto offer compelling advantages over existing ways for merchants to take payments. The current BNPL pricing model doesn’t make a lot of sense for small businesses. And, with crypto, most small businesses have no issue working with fiat money, so they have no reason to switch to another currency.
Of course, this is not to say that BNPL and crypto can never affect the future of payment processing. It’s just that, right now, they haven’t given small businesses reasons to use them. Which is a shame. Because either crypto or BNPL has the potential to wipe out the credit card processing industry entirely.
But, if you’re a big supporter of BNPL or crypto, offering them to your customers as a way to pay certainly won’t hurt. We just don’t think you need to be in a hurry to add them to your business’s payment options.
Next Up: How to Run a Creator Business
If you’ve been reading our blog from the start, then you know that a lot of our articles deal with how to set up and run a business that sells goods or services. But there is another group of small businesspeople that sell neither. Instead, they deal in intellectual property (IP).
These are the creators.
The word creator is a relatively new industry term. It not only includes traditional artists but also YouTubers, bloggers, and influencers. As far as we can tell, anyone who makes online content is a creator.
And online content is IP. IP is a very different critter than physical property. Some aspects of how IP works and how it can be used to make money aren’t very intuitive. So, we think it’ll be helpful to give a general introduction to IP law. Then, we’ll go over some places where creators can show their content. Finally, we’ll discuss various ways creators can make money—including how IP licensing and product endorsement work.
We start the new series with an overview of IP law:
How to Run a Creator Business: IP Basics
Questions? Comments?
