Crypto Means Business

What Netflix Tells Us About Our Sluggish Payment Network

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Venture capitalists and journalists often compare the burgeoning cryptocurrency movement with the early days of the Web. But the comparison also rings true between the current state of internet and our existing payment system. One network transports ones and zeros—the other, money. In both cases, the existential enemy is mediocrity.

While internet access is both reliable and ubiquitous in the US (with the exception of a few rural areas)—the speed and cost of that access is far from competitive on a global scale. “The United States, the country that invented the Internet, is falling dangerously behind in offering high-speed, affordable broadband service to businesses and consumers,” the New York Times reported last December:

In terms of Internet speed and cost, “ours seems completely out of whack with what we see in the rest of the world,” said Susan Crawford, a law professor at Yeshiva University in Manhattan, a former Obama administration technology adviser and a leading critic of American broadband.

The Obama administration effectively agrees. “While this country has made tremendous progress investing in and delivering high-speed broadband to an unprecedented number of Americans, significant areas for improvement remain,” said Tom Power, deputy chief technology officer for telecommunications at the White House.

Just how “out of whack”? The US is ranked 35th out of 148 countries in internet bandwidth, according to the World Economic Forum. Tokyo, Seoul, and Paris all have faster, cheaper broadband access than their American metropolitan counterparts. In fact, the cost of 150Mbps connections in major US cities costs 100 percent more than it does overseas.

This poor, “third-world” performance isn’t for lack of government effort or spending. By some estimates, taxpayers have spent $200 billion (as part of the 1996 Telecommunications Reform Act) in tax breaks and friendly regulatory amendments for a faster internet infrastructure. Whether due to technical setbacks or conflicting profit incentives, those initiatives failed to deliver as envisioned.

Global Internet Speeds

US internet access is relatively slow and expensive. Source:

Exacerbating the issue is a complacent, powerless populace. Despite middling performance and price, broadband customers generally report a high degree of customer satisfaction, according to studies by the Federal Communications Commission and Joint Center for Political and Economic Studies from 2010—with 90 percent or more either somewhat satisfied or very satisfied with their service. For major ISPs like Comcast and Time Warner, consumer apathy is a signal that cheaper, faster access isn’t necessary.

“We’re in the business of delivering what consumers want, and to stay a little ahead of what we think they will want,” said Time Warner Cable’s Chief Financial Officer Irene Esteves, when asked about the lightning speeds delivered by Google Fiber at the at the Morgan Stanley Technology Conference in February last year. “We just don’t see the need of delivering that to consumers.”

Comcast executive vice president David L. Cohen echoed these sentiments in June. “The issue with such speed is really more about demand than supply,” Cohen wrote, referencing Google Fiber’s gigabit access. “Our business customers can already order 10-gig connections. Most websites can’t deliver content as fast as current networks move, and most US homes have routers that can’t support the speed already available to the home.”

What the country’s major ISPs have apparently concluded is that customers don’t want (or need) faster, cheaper access. And even if they had it, most online services today don’t require thicker pipes. In other words, our current system is good enough.

But if the question were phrased another way, no one in their right mind would refuse faster, cheaper service. It’s also a chicken and egg situation. If people had faster connections, services would evolve and innovate. Naturally, parties who don’t stand to directly profit from providing access—whether it’s the White House, the FCC, or even Google—intimately understand the need for faster internet. It’s obvious.

What’s holding us back, however, is a lack of choice. Two-thirds of households have only two choices or less when it comes to broadband access while one-third have no choice at all. Without competition, it’s unclear that market forces can be relied upon—and in some cases, there are even explicit efforts by industry incumbents to stifle progress and municipal efforts.

Such monopolistic tendencies have worrying implications for the network itself, serving as a tax on innovation—the most prominent example being the recent traffic deals Netflix cut with Comcast and Verizon to ensure the streaming service’s growing bandwidth needs are met. It’s a scary precedent that undermines (or essentially kills) network neutrality—the ideal by which everyone’s internet data is treated equally—says Tim Wu, the Columbia professor and former FTC advisor who coined the term—and ushers in the era of “net discrimination.” By forcing innovators to pay-to-play, the end result is a two-tiered network (much like our current two-tiered stock market)—further entrenching current players while raising the barrier for less-capitalized startups and the Netflix of tomorrow.

So what does any of this have to do with payments? For one, the factors holding both centralized systems back are nearly identical—as are the consequences. As with internet access, payment networks in the US are dated and inefficient relative to systems abroad—limiting services, innovation, and competition within the space.

While Automated Clearing House (ACH), the primary mode of money transfers in the US, typically takes 1-2 days to settle payments, places like Mexico and the UK are operating close to real-time.

Similarly, the benefits of and need for a real-time (or at least faster) system are clear. The Federal Reserve was explicit in its call for improvement in a public consultation paper released last fall:

The Federal Reserve Banks believe that a near-real-time payment capability may ultimately be a beneficial improvement to the payment system that supports economic activity in the United States. This belief is based in part on the emergence of near-real-time payment systems in several other countries, and the expectation that demand for transactional immediacy in the United States will continue to grow. Benefits of near-real-time payments include the ability to make last-minute payments of all types; enhanced cash management for consumers, businesses, and governments due to quicker confirmation of good funds; reduction in fraud for both banks and end users; and a quicker alternative to paper checks for personal transfers. Moreover, a near-real-time payment platform may spur other innovations, particularly in mobile payments, and may enhance U.S. global economic competitiveness.

Faster, cheaper, and smarter payments would lower the cost of liquidity for interbank settlement by removing collateral and reserves requirements. Nearly every business would see improved operational efficiency and greater access to working capital. What trickles down to consumers from these cost and risk reductions is less fees and more choice, along with the innovative spectrum of products and services suddenly made possible. And the country as a whole benefits from the economic gains of a more modern and competitive system.

But serving the role of custodian, the Federal Reserve can only do so much on its own. Adoption for their same-day ACH system in 2009, for instance, fell well below expectations—and networks aren’t particularly useful without the participation of key players. Facebook is only useful if your friends are on it. Improving the country’s underlying payments plumbing, then, requires broad industry consensus.

And much like the case of internet connectivity, the payments space faces parallel problems—including upfront costs as well as the potentially dissonant incentives at play.

In place of cable companies, we have the big banks, which wield outsized influence as members of NACHA, the industry group that oversees one of two ACH networks in the US—the other is managed by the Fed. With cable providers, faster and cheaper data internet access theoretically undermines their existing business model—in this case, bundled television content. For banks, widespread industry access to faster and cheaper payment rails would cannibalize existing revenue streams, like wire transfers, while opening them up to outside competition. Why would banks (or ISPs) want to invest in infrastructure improvements if it threatens their business?

A leading innovator struggling with the system’s barriers is Square, Twitter co-founder Jack Dorsey’s mobile-payments startup, which the Wall Street Journal reports is discussing a potential sale after recording a $100 million loss last year. Despite impressive market penetration and brand recognition, the mathematics of razor-thin margins simply don’t compute.

Without access to a universal platform, Square relies on Visa and Mastercard’s payment rails, which means that four-fifths of their modest 2.75 percent fee is spoken for by financial intermediaries. Just as Netflix now pay dues to internet service providers, Square is beholden to the arbiters of the existing network.

Consumer demand for promising new services is meaningless without the possibility for viable business models—nipping progress in the bud. It’s a concerning dilemma—because it’s natural market forces that brought us here and there’s little indication that this direction will change anytime soon. Rather than fostering competition and innovation, the market stymies it while further strengthening incumbents, who conceivably have little incentive to invest in and create a more open and efficient platform. And to be perfectly fair, who can blame them? They can only be expected to act on their own best interests.

And that’s the real problem, says Susan Athey, a prominent economist and board member at Ripple Labs. There’s really no one to blame.

“It seems clear that innovation is needed, right? So it must be right around the corner? Likely, the relevant government regulators are just being slow. Right? Wrong. Rather, some key industry players don’t want to change, and even among those that do, it will take many years to reach consensus for how to change,” Athey explained to me.

So what can be done? There are, unfortunately, no easy answers. What’s clear, however, is that something needs to change.


Follow Alec on Twitter: @sfnuop

Photo: Mohammad Ashfar

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