America used to be behind on digital payments. Not any more

JUST OVER a decade ago Patrick and John Collison founded Stripe, a company in Silicon Valley that helped other tech startups accept online payments. It has since outgrown them all. On March 14th the firm said it had closed a fundraising round valuing it at $95bn—three times its valuation 11 months ago and enough to make it America’s biggest-ever unlisted firm. Stripe is not the only company cashing in on the check-out business, as the payments revolution finally takes off in America.

It has been a while coming. In 2018 Ant Financial, China’s payments giant, raised private funds at a valuation of $150bn. It was common then to hear Chinese executives say that America, land of the posted cheque and the hand-signed credit-card receipt, was years behind, held back by a cosy club of banks and credit-card firms.

Now investors have decided the moment has come. Take PayPal, a digital-payments firm set up in 1999 to allow users of Palm Pilots, a forebear of smartphones, to “beam” each other money. It was later bought by eBay, an online marketplace, which spun it out in 2015 for $45bn. Today it is worth $275bn, more than Citigroup or Wells Fargo. It is also more valuable than Ant, which has fallen out of favour with regulators in China and has been forced to cancel its initial public offering.

Enthusiasm for digital-payments companies has been whetted by the pandemic. The share price of PayPal has jumped 186% in the past 12 months while shares in Square, an American rival, have more than quintupled and those of Adyen, based in Amsterdam, have nearly tripled. The digital boom is luring credit-card colossi and tech titans, such as Visa and Google, to online payments.

The digital-payments industry is rather like a transport system. “Acquirers” connect the shop’s app or website to the infrastructure and check details, including a buyer’s identity or available funds, to authorise travel. The money then moves along the customer’s chosen type of “rail”: credit-card, bank-to-bank or mobile-wallet systems, run by distinct firms. Then come the refreshment trolleys—service providers, like buy-now-pay-later firms, that purport to make the journey more pleasant. Everyone takes a cut on the way.

Part of the digital firms’ ascent reflects the fact that they have achieved scale. PayPal combines an online wallet used by 350m consumers with a gateway accepted by 30m merchants. That generates large network effects, which the firm has sought to encourage further by crafting tie-ups with other firms, like Mercado Libre, a Latin American marketplace, and UnionPay, a Chinese credit-card scheme. The company expects its users to double by 2025. Square, which has targeted independent merchants and consumers under-served by conventional banks, operates a similar model (the chairman of The Economist’s parent company is a director of Square).

By contrast Adyen and Stripe are pure online acquirers with no consumer brand. But their tech nous makes it fast and easy for businesses to set up online-payment platforms. (Stripe has long served smaller firms and Adyen big ones, but they are converging.) Because verifying a customer’s identify and probity is hard, especially when transactions are cross-border, about 10-15% of online transactions are usually declined. But the digital firms can reduce rejection rates by four to five percentage points. In return they charge a decent fee: Stripe typically takes 2.7-2.9% of each transaction, or 1.9% in Europe. Now they can spread their costs over hundreds of billions of dollars of transfers, the fee they earn on every extra payment is nearly all profit, which they can reinvest.

Three trends are helping to propel the digital firms further. One is the growth of e-commerce, which has been turbo-charged by the pandemic. The second trend is the dash away from cash in favour of digital payments, which covid-19 has probably accelerated by three to five years.

A final factor comes from increasing market share within online payments. Over half of digital-transaction volumes worldwide are still acquired by the captive, sluggish arms of banks, says Lisa Ellis of MoffettNathanson, a research firm. Since most lack global aspirations and e-commerce expertise, market share is bound to migrate to the online giants.

Such trends also boost Visa and Mastercard, the dominant card networks. Yet they run only one type of rail, whereas the four payment champions are mostly agnostic about which way the money travels. And the established card firms are under attack from antitrust watchdogs who worry that they make it difficult for merchants to process transactions through cheaper alternatives. On March 19th shares in Visa fell on reports that the Department of Justice was investigating it.

A bigger threat to the fintech quartet could come from giants in adjacent sectors. Big-tech firms are starting to beef up their own payment apps. Large retailers like Walmart and Target are building their own acquirers and wallets, through which they could give rewards to loyal customers.

In order to pre-empt the threat of competition, the digital-payments firms are expanding their offerings. PayPal has launched buy-now-pay-later, cryptocurrency-trading and credit-card services. On March 8th it said it would buy Curv, a digital-asset-security firm; it bought Honey, a coupon service, last year. It says it wants to become a “super-app” for financial services, and in February told investors it expected to more than double its revenue to $50bn by 2025. Square’s peer-to-peer payment business, Cash App, has evolved into a digital bank enabling users to buy bitcoin, trade stocks, receive paycheques and use a debit card. It now has 36m users, up from 7m in late 2017, and brings in 45% of Square’s gross profit. Stripe has started offering working capital and accounts to merchants, in partnership with banks.

With digital payments set to continue to surge, the fantastic four have three or four years of clear runway before running head-on into each other, predicts Darrin Peller of Wolfe Research, an equity-research firm. By then, however, they will probably have become entirely different firms, with their own range of banking or software products. That should give them even more room to roam, as well as access to far bigger revenue pools. It may have taken a while for digital payments to hit the big time in America and the West. But better late than never. ■

A version of this article was published online on March 20th 2021