Investors love payment companies because they have the potential to capture a percentage of a massive flow of funds. Of course, that is easier said than done when much of the payments infrastructure in the U.S. has already been built and the companies that control payment rails are well-capitalized incumbents (now including Stripe!). Many new entrants are trying to add value at the margin, offering vertical solutions, improved workflow or addressing fraud and identity management.
So when something new happens at the infrastructure level in payments it’s worth a look. The new thing is the Federal Reserve’s FedNow, a real-time payment system. The idea of FedNow is to enable real-time, anytime (365 days/24 hour) payments cheaply. It is a service that is meant to be adopted and used by U.S. financial institutions, so that they can enable real-time fund transfers for account holders (both individuals and businesses).
FedNow is in a testing phase today with 35 banks and 16 service providers using the system (out of 5,000 FDIC insured banks in the U.S.), and a meaningful impact will require broader adoption of the FedNow rails for account holders to benefit.
Why is it important?
There is still room to improve current payment rails and workflow, especially for businesses (we’re B2B investors). Today, there are three core payment options that enable the massive U.S. B2B payments market, which was sized at greater than $300B (with transaction value which is in the 10s of trillions). These payment options are not as easy or cost effective as consumer options nor what is becoming available in other countries:
- Wire transfers, which are generally same day but expensive ($15-25 per transfer).
- ACH (automated clearing house), which are much less expensive ($0.25 – $0.50 per transaction), but slower, taking 1-3 days to complete.
- Paper checks, which are super slow and expensive with costs ranging from $2-4 to write or $1-2 to receive. This is still 40-50% of payment volume, and much higher in certain industries.
Other geographies have already introduced real-time payment rails, including TIPS in the European Union, UPI in India and PIX in Brazil to name a few. The European rollout has been slow, but by all accounts India’s UPI and Brazil’s PIX systems are growing beyond expectations, which provides a future view of what could be in the U.S.
Does it matter for start-ups?
Often consumer use cases lay the groundwork for business adoption, and Zelle/Venmo may be the forerunners of a shift in the B2B world. Both services have done a pretty fantastic job of enabling real-time payments for consumer P2P, penetrating the market and making the benefits of real-time online payments accessible to a large number of users. Zelle specifically has shown what’s possible with low-cost account-to-account (A2A) transfers if your bank is part of the network.
FedNow and the real-time payment movement (including the RTP Network, which now has 60-70% coverage) have the potential to enable a similar shift in the world of business-to-business transactions. Plaid Tranfer’s real-time payment product is a good example of this in action. But account to account real-time business payments aren’t just the domain of the banks and service providers, they need to be wrapped with better workflow software, which is where we see the most opportunity to leverage new payment technologies including FedNow.
We view FedNow as a good first step to reducing U.S. based payment friction, but we aren’t holding our breath on the rollout. In the meantime we are looking for great founders who are building applications one layer up and will be able to take advantage of the improvement of payment rails – founders working in areas including payment orchestration, AR and AP solutions, and trade finance infrastructure.