How to evaluate open vs proprietary digital payment solutions

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Contactless payment cards are almost everywhere these days. Cryptocurrency coins and tokens are now being issued by many companies, especially via ICOs. Many parties are planning blockchain-based settlement solutions. At the same time plug-and-play type FinTech components can be easily integrated to any system to support new payment services.

As more companies look to adopt digital payment solutions, the trick is to match the right solution with the right service or scenario. Examples like London Underground tickets, paying digital music royalties, or a blockchain system to handle settlement between big companies might look very different from each other. But they actually face the same basic question in finding an optimal solution: Do we build our payment system with open public solutions, or do we implement a closed private solution?

To answer that question, we can highlight some important preliminary questions to inform that decision:

  1. What is the targeted user experience?
  2. What are the set up and transaction costs of different solutions?
  3. What is the transaction volume and expected operating costs based on?
  4. What are the costs for each user?
  5. Is the system used by a large number of people or companies, or is it more for qualified users?
  6. Is it important that anyone can start using the system easily?
  7. Are there significant exchange or value risks associated with the payment model?
  8. Are there special security requirements?
  9. How future-proof does it need to be?
  10. Which solution components are easily available?

Let’s take some examples.

In a public transportation system, we’re talking about millions of users and hundreds of millions of transactions annually. Consequently, the cost per user/transaction and operating costs become more important than the set-up costs. Typically, for example, debit and credit cards have transaction fees that are based on the value of a transaction with some minimum fee to a card processing company (e.g. Visa or MasterCard). But processing in a proprietary system also has its costs.

In this kind of system, the user experience is also very important. If a customer can use any card or mobile payment system, it is much easier for them to use the service than if they first have to get a proprietary card, pay a deposit for it, and then load money on it. A better user experience also increases usage and revenue.

A good example is Transport for London (TfL), which started with the Oyster contactless card payments almost 15 years ago, but nowadays it allows people to use their own existing contactless debit and credit cards, as well as mobile payments from Android Pay and Apple Pay. Why would expensive proprietary solutions make sense in this scenario?

For cryptocurrency coin solutions, one area where this is taking hold is music royalties. Traditional solutions to track and handle payments of music royalties have been complex, inaccurate and slow. Digital music is easier to track thanks to DRM but the payment mechanism is still complex. A blockchain-based token payment system would be able to track whenever a song is downloaded from iTunes, streamed on Spotify or licensed for an ad, and ensure that the proper fee is paid by the user and received by the rights holder.

This kind of system must be very easy to use and understand, it must support millions or billions of users, and the end-to-end flow of transactions needs to be efficient, which means significant transaction and operating costs.

Compare that to a system for logistics or finance companies to settle and pay each other based on how they use each other’s services globally. This kind of system might have only dozens of users, but individual payment amounts (and commission fees) can be significant. Here, a proprietary solution could be suitable, since ease of use for consumers is not a key factor.

One important point regarding cryptocurrency token systems is exchange rate risks. For example, if a token is linked to Ether, the value of Ether creates a risk for token owners, and there might also be restrictions to converting them back to ordinary (fiat) money. In principle, we could also say that a proprietary transportation card has similar risks – e.g. the transportation system stops accepting it or there is very high inflation. But typically, these risks are small, especially when we talk about small sums of money on the cards.

As we can see, selecting an optimal payment system requires a lot of complex evaluation that also must include also forecasts of future use and costs.

At the risk of oversimplifying, we could say that for systems supporting large groups of ordinary users, open systems are probably more cost-effective and offer a better user experience, but they should be based on systems that don’t come with significant exchange or future-proofing risks. A settlements solution supporting a smaller number of parties could be a closed system with access restrictions and no transaction fees for external parties.

FinTech also enables the ability to include plug-and-play type finance and payment components for many services. Things like external payments, tokenized or lending solution can be integrated to any service. It is possible to use cloud-based back offices, services over open APIs, and open source components. We have come to an era where it is possible to innovate finance services inside any service and easily implement it via standard components.

In any case, it’s important to evaluate which models make sense before deciding what payment system to adopt.

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