Don't mess with credit: Why the future of payments is already in your pocket.

By Farhad Manjoo , written on February 18, 2012

From The News Desk

Everywhere you look, someone is working on a new way to let you pay for stuff. It’s obvious why: Paying for stuff is the most fundamental activity in commerce, something you do many times a day, wherever you are, even at home, even in secret. Thus anyone who hits on a creative new way to get people to part with their money stands to gain a slice of an unbelievably huge market.

And, of course, we all want new ways to pay for things. Cash is stupid and in the process of being deprecated. Credit cards work well except when they don’t: In places with low connectivity, when you want to trade money with friends, when you don’t want to go through the process and expense of setting up a merchant account, and when you’d prefer to carry a phone instead of a wallet. That’s why some of the oldest and many of the newest names in tech—from PayPal to Square to Google Wallet to Clover to Chirpify—are all clamoring to forever alter the once-simple act of paying.

The trouble is, none of these firms is revolutionizing payments, not really. That’s because the payment revolution already arrived decades ago, and it’s here to stay. Despite their limitations, credit cards are the real breakthrough in payments—the fastest, most versatile and most secure payment method ever invented. Nearly every start-up working in payments is simply creating a new front end for your credit card. That’s not a small thing; we need new ways to use our credit cards. But we shouldn’t forget the true winners in this new marketplace—whatever innovations we see in payments over the next few years, there’s a very good chance that most of the rewards will flow to Visa and MasterCard.

This becomes obvious the first time you you try to use any of these modern ways of paying. What’s Square? A credit card reader. What’s Card Case, Square’s fantastic mobile wallet app? It’s a way for you to pay for stuff from Square merchants using your phone—but only after you’ve entered in a credit card number. (No wonder Visa is an investor in Square.) What’s Google Wallet? It’s just an NFC-enabled mobile MasterCard—in other words, a way to use your credit card without swiping. What’s PayPal and Google Checkout? An online proxy for your financial information; both allow you to use either a bank or credit card account, but because credit cards offer lots more fraud protection, many PayPal and Checkout members prefer to pay using credit. It’s the same story for Facebook Credits, Apple’s iTunes accounts, and Amazon Payments—they all seem new and shiny, and we all marvel at the possibility that they could become the next wave in paying for stuff, but none of them could work without credit cards.

To be sure, there are some truly novel payment methods that are doing away with credit cards entirely. One is Dwolla, a promising start-up that’s trying to create an electronic equivalent of cash. Unlike PayPal, Dwolla doesn’t accept credit cards; to set up an account, you link Dwolla to your bank account, and then transfer your money into it. Dwolla is winning converts—and raising a lot of money—because it has figured out how to make bank-linked payments both secure and cheap. PayPal charges sellers as much as 2.9 percent of their sales in merchant fees. Dwolla, by contrast, charges sellers only 25 cents for any sale of $10 or more; for receipts under $10, you don’t pay any fee.

The trouble with an entirely bank-driven system like Dwolla, though, is that it requires critical mass to work. You can’t send a Dwolla payment unless the other guy uses Dwolla too. And if you’re a business, you’re not going to go through the trouble of setting up a Dwolla account unless you’re sure that a substantial number of your customers are going to use it. Because we’re talking about people’s money—their bank accounts!—it’s going to take a long time before we get a critical mass of people joining that kind of system, however forcefully Dwolla talks up the security of its network. PayPal, after all, is 14 years old, and in that time it’s managed to sign up 106 million registered accounts around the world. That sounds like a lot—but if you compare it to the billions of people who pay for stuff, it’s nothing. It’s a nice business, but it’s not revolutionizing payments, not by a long shot.

Critical mass is exactly what credit card companies have going for them. Since the 1970s, they’ve managed to make plastic cards the de facto alternative to cash—the thing almost everyone accepts as the default method to pay for things. (In some places—like airline cabins—credit cards are now the only way to pay.) And although their security leaves a lot to be desired—ever wonder what that sketchy waiter did with your card?—credit cards have managed to get us hooked with ironclad guarantees against misuse. You don’t care what that waiter does with your card, because even if he copies your number and runs up a bill at a Russian casino, you’ll get alerted to the misuse and you’ll never have to pay a dime for it.

Over the years many pundits (including me!) have speculated how Apple, Amazon, Facebook and other giants could destroy the credit card industry simply by pushing their users to tie their payment systems to bank accounts instead of cards. But what many of these pundits don’t realize is that setting up a secure payment system is a huge, expensive headache. Does Apple really want to deal with chargebacks, purchase monitoring, fraud, and theft? I doubt it. And what would be the point?

For most customers, there’s already a perfect way to pay. Why fix it?