By Theodoros Shim of Yale Economic Review
For far too many years, there has been remarkably little innovation in the payment network industry. Traditional and well-established payment transaction networks, such as Visa, MasterCard, Discover, American Express, and a host of their smaller brethren, have been the only major players in that market for the last half-century. These top players—including processors and various middlemen—dominate the payment industry. But in markets with only a few players, there is often room for innovative disruption by smaller and nimbler companies.
What stymies such innovation in the payment industry is government regulation. To the detriment of the payment industry, state regulatory frameworks are mired in the past. States have not taken into account how technological innovation, in particular the Internet, has changed the rules of the game and created new payment network possibilities. Bluntly, the older regulatory framework hampers growth.
The problem is this: regulations in 48 states require a state-specific money transmission license to do business in that state, and that license is valid only in that state. To operate in the US, a payment company would need to obtain all licenses from 48 states, which is expensive and cumbersome.
To understand this problem, we should briefly discuss first how the payments industry operates and is regulated. Any business that provides money transfer services or payment instruments is considered a money transmitter. In other words, if a business has to move money as part of its business model, it is a money transmitter. At the federal level, money transmitters fall under the category of “Money Service Businesses.” As such, they are required to register as a Money Service Business with the federal government. At the state level, money transmitters are required to obtain a money transmitter license for EACH state that the company serves customers in. Forty-eight out of the fifty U.S. states require that money transmitters have a money transmitter license if they serve customers in that state. Each state has a different set of requirements that have to be met to receive a money transmission license. Requirements range from minimum capital requirements to net worth requirements. Many of the states require a surety bond ranging from $25,000 to $1 million.
This regulatory framework has imposed an enormous barrier to entry in payment market, a barrier so high that few have attempted to innovate. Look at it this way: imagine that a driver’s license is valid only in the state in which it is issued; a valid license, in other words, does not authorize you to drive in any other state. Licenses in other states can be obtained, of course, but only one by one, state by state. Oh, and one more thing: the cost of each driver’s license is at least $5 million. Would that hamper growth and development? Does that interfere with interstate commerce?
Let me illustrate this problem with an example. A popular payments app today is Venmo, which allows its users to pay their friends and acquaintances back. It is simple, safe, and efficient. Unfortunately, it was operating illegally until quite recently. Only when Braintree purchased Venmo and paid all the state licenses that Venmo never paid did the app’s operations become legal. As a startup, Venmo could not afford to pay the licensure fess and thus operated illegally without all its transmission licenses. Despite operating illegally, it is undeniable that Venmo improved consumer welfare, and government should encourage, not stifle, such developments.
That said, money transmission licenses do not inherently hinder business. They serve the very important purpose of protecting people’s money. The problem is not the fact that licenses exist, but rather the current structure of how licensing works. the current legislative framework uses an outdated paradigm to regulate Internet companies and ends up restricting interstate commerce.
But state boundaries are as irrelevant to the Internet as they are to wind currents. Online companies, by definition, serve everyone, regardless of geographic location. Unlike traditional retailers, Internet companies, regardless of the product or service they offer, do not engage in face-to-face, geographically-localized commercial transactions. The difference is important: if a traditional retailer issues a gift card, it generally needs only a license or licenses for the state or states it operates in. As a retailer grows, it can slowly add licenses as it opens up branches in different states. But an online business operates everywhere from the start. As far as the payment industry is concerned, that means that before launching, a start-up must obtain forty-eight money transmission licenses, which run at least $5 million each— before it has generated even a dollar of revenue.
The process of obtaining a license generally takes about three years and costs anywhere from $5 million to $40 million. It is because of these burdensome delays and vast costs that there is little innovation in the payment industry. And it is because of these burdens that, like Venmo, many companies launch and run illegally until they have proven their value, and someone can pick up the regulatory tab for them. It is time to reform this archaic system, a system that predates the Internet by a commercial millennium.
In Europe, there are regulations similar to those of the United States. But there’s also a big difference. In Europe, if a company receives a money transmission license in one country, it is valid for all the countries in the European Union. America should follow suit. Strict but reasonable regulation is needed to minimize the danger of less-than-honorable money transfer businesses. But inordinately expensive and vastly duplicative licensing is little more than a Himalayan range of regulatory barriers erected by the government. The current regulatory framework blocks growth and development, stifles competition, and prevents entry into what should be a vital and changing industry.