Digital Wallets Are King in the U.S.—But Can FedNow Step It Up?

Cesar Boralli

Associate Managing Director – Fintech and Banking Lead

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Last November, the top U.S. consumer financial watchdog suggested¹ regulating tech giants’ digital payments and wallets handling more than 5 million transactions per year because, despite rivaling traditional payment methods in scale and scope, they lack consumer safeguards. To the Consumer Financial Protection Bureau (CFPB), companies like Google, Apple, PayPal, or Block’s CashApp should all be under the same supervision rules regarding their privacy protection mechanisms. In total, the proposal would affect 17 organizations that together manage more than 13 billion payments annually.

The move was already expected since Big Tech companies have been under scrutiny in the U.S. Stricter regulations for data and privacy protection like those implemented by the European Union have been discussed in recent hearings in the Senate² and by other government bodies.

The industry did not respond well. In January, Krisztian Katona, the head of regulatory policy at the Computer & Communications Industry Association (CCIA), whose members include Amazon, Meta and X, said in a statement that the proposal risked doing more harm than good “as broad, overly burdensome or heavy-handed digital regulation could significantly hinder new start-ups in this industry.” The Financial Technology Association, which represents companies like PayPal (also owner of digital wallet Venmo) and Block (parent company of Cash App), shared similar concerns in a separate statement³.

This dilemma between greater technological development and regulation for data and privacy protection might be one of the things standing in the way of FedNow, the real-time payment trail introduced⁴ by the Federal Reserve in July 2023.

The U.S. is the land of the Big Tech companies and where some of the first payment trailblazers emerged almost two decades before anywhere else in the Americas. Most of the innovative initiatives in the field had the private sector as protagonists, not a regulator.

The launch of FedNow largely follows this ethos, providing an interbank clearing and settlement platform that supports a wide range of solutions but leaves fraud prevention tools, for example, as optional features. The FED does not appear to have any intention of forcing the participation of financial institutions and fintechs in the new scheme, which could be counterproductive since, depending on the wishes of each participant, the interoperability required to make FedNow a long-range real-time payment system, capable of replacing other traditional trails, may not materialize. Things tend to continue to develop in niches.

Venmo was the first same-day peer-to-peer payment solution to be launched in the U.S. in 2009. It took almost a decade for a consortium of the largest banks to launch the competitor Zelle – the closest the U.S. produced to Brazil’s Pix. Currently, over 2,100 institutions (handling 80% of U.S. deposit accounts) participate in Zelle. The platform transacted USD$ 629 billion in 2022 and USD$ 378 billion in the first half of 2023.

Cash App, in its turn, is a spin-off of a P2P service launched by Square in 2013.  Over time, it took on a life of its own, adding new services that compete to some extent with Square’s — the lack of interoperability between Block’s companies portrays the environment of competitiveness and non-cooperation between companies in the industry.

A year before Zelle’s launch, the Clearing House, owned by the country’s leading banks, implemented Real-Time Payments (TCH RTP), considered the U.S.’s first new core banking system in 40 years, with nearly 400 banks participating today (representing 65% of US checking accounts). Since 2022, Zelle has used TCH RTP as its settlement network, something that could have led to interoperability between the two trails, but they continue to operate independently — as the other more than 350 insured banks and credit unions using the service.

In July last year, the Clearing House RTP network reached a milestone of 500 million transactions⁵. If they followed the same operational standard, the institutions participating in the network could have made it reach a much greater mark. Costa Rica’s Sinpe Móvil, the mobile real-time service created within the country’s interbank electronic settlement network in 2015, posted a similar volume in 2023 alone. Moreover, the peer-to-peer segment as whole is estimated to handle more than USD$ 1 trillion in payments.

Glass half empty

Linked to the issue of data protection is also that of fraud prevention — or the growing sense that digital wallets and P2P transfer schemes are failing at this⁶ given the increase in the number of scams and the lack of measures to prevent, e.g., the creation of false or duplicate accounts.

In response, authorities have been calling on the companies to adopt additional security measures, including imposing limits on transactions, requiring secondary verification of up to a day, and better monitoring of unusual activity. Curiously, facts don’t exactly support the media’s spotlight on fraud, but the matter has stoked consumer concerns. According to Zelle, for example, less than one tenth of one percent of transactions within the platform are reported as fraud or scams.

The U.S.’s high rate of bank account ownership (94%) and the high penetration of legacy systems such as credit cards (59%) may also contribute to FedNow not taking off like its peers in other countries.

Moreover, fintechs cannot access FedNow clearing system directly — without stronger competition, banks will continue relying on legacy payment networks, which prevents them from developing more agile and competitive services on top of the new payment trail. And this may also be an obstacle for FedNow, as better user experience, even more than zero-fee transactions, is decisive for greater consumers’ adoption.

Current P2P services in the U.S. complete most transactions in minutes, sometimes hours. On Brazil’s Pix, transactions take 2 to 3 seconds to complete — certainly, a UX like this would be a big draw for FedNow to take off. Making the participation of institutions in FedNow mandatory would level the playing field and help the industry reach this level of service more quickly, but the FED has not shown any signs of doing so; in fact, it has introduced much more flexible implementation conditions, which will likely result in a slower pace of development.

Glass half full

The upside of the expectations around FedNow, however, is that even operating in close loops and amid a rising concern around fraud, the existing P2P solutions have been greatly adopted by Americans, proving market demand for RTPs. In fact, digital wallets overtook credit cards as the most used method for online shopping in 2022, accounting for 32% of payments, and continue to grow.

Also, the still low volume of P2P quasi-instant transactions within the Clearing House’s network means a lot of headroom for growth. Moreover, the current lower costs to use these services instead of traditional ones (with fees ranging from USD$0.045 to USD$1) tends to attract more users in 2024 and the following years — once again, a proven market demand for RPTs.

Sources

Cesar Boralli

Cesar is a renowned thought leader in the banking and fintech space in Latin America, having worked for some of the region´s most exciting companies including global banks such as Citi, J.P. Morgan, Bank of America and fintechs like Flywire, Rapyd, EBANX and XP Inc. He is a Portuguese native speaker as well as fluent in English and Spanish.

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