PayPal (PYPL) and Square face a dangerous new competitor, the Federal Reserve System.
The Fed plans to launch its instant-payment app, FedNow, in July 2023. Like PayPal and Block Inc’s CashApp, FedNow makes instant payments. The different is FedNow could make instant payments from one bank account to another. These account-to-account (A24) transfers will go through the banking system.
FedNow will offer customers an app that allows them to make payments from their 24 hours a day and seven days a week. Users can pay bills and transfer money with the app.
What is FedNow?
The Fed claims FedNow will offer many services for financial institutions, businesses, and individuals. Those services include:
- Accounts Payable & Accounts Receivable Services
- Treasury Management Systems
- Business-to-Business (B2B) Payments
- Bill Pay
- Core Banking Platforms
- Correspondents and Bankers Platforms
- Digital Wallets
- Government Services (such as tax payments)
- Government-to-Consumer (G2C) payments
- Mobile Apps
- Peer-to-Peer (P2P) payment apps
- Payments
- Payment Networks
- Payroll Processing
- Risk Management
- Account-to-Account (A2A) payments
- Business-to-Business (B2B) payments
- Consumer-to-Business (B2C) payments
- Business-to-Consumer (C2B) payments
- Consumer-to-Financial-Institution Payments
- Financial-Institution-to-Consumer Payments
How FedNow Works
FedNow enables payments by connecting to FedLine. FedLine is the Federal Reserve’s web platform that connects users to business services that include Accounting, Checks, FedCash, and FedACH (automatic clearing house) services.
FedCash ensures that banks have sufficient supplies of cash to meet public demand. The FedCash E-Manifest Service electronically processes payments and deposits at Federal Reserve Banks.
FedACH provides cheap batched payment services to banks thorugh the Automatic Clearing House (ACH) network. Hence, the Fed already operates an extensive payments platform: FedACH. I consider FedNow an effort to expand FedACH’s capabilities.
FedNow connects with FedLine by sending an ISO® 20022 message. It sends these messages by having an app interface with an IBM MQ Client. Or Que Manager. The MQ Client is a software development kit (SDK) that lets developers connect programs.
Thus, FedNow creates a direct connection between the Federal Reserve and users. FedNow users communicate with the Fed via ISO® 20022 messages.
ISO 20022 is an international standard for financial transactions. The ISO 20022 standard comprises a modeling methodology for transactions, a dictionary of financial communications terms, and a set of XML and AS.1 design rules for engineers and designers. Financial institutions worldwide use ISO 20022 for many transactions.
Interestingly, FedNow does not offer access to the FedWire Funds Service. FedWire allows the Fed to send money to participating banks.
Who is Using FedNow?
FedNow will be available to financial institutions and FinTech providers. Third Party Service providers can offer FedNow services.
FedNow reminds me of Zelle and other payment solutions some banks already offer. The difference is that FedNow overs a direct connection with the Federal Reserve, America’s central bank.
Around 100 financial institutions and businesses participate in FedNow. Those entities include: BNY Mellon (BK), MasterCard, FICO, Quicken, and Oracle. However, most of FedNow’s users are smaller and more obscure companies such as Blossom.
Conspicuously, most of America’s largest banks and FinTech providers are absent from the FedNow lists. Notably, Visa (V), PayPal (PYPL), JPMorgan Chase (JPM), Goldman Sachs (GS), Apple (AAPL), and Bank of America (BAC) are not in the FedNow’s Service Provider ShowChase.
I suspect smaller banks and credit unions will be FedNow’s principal users. However, I predict retailers such as Walmart (WMT), Amazon (AMZN), and Kroger (KR) will also use it. For example, they could add Kroger Pay to the Kroger will can allow Kroger to compete with banks. Employees could get paychecks sent directly to a Kroger account they can use to pay for groceries.
Notably, Walmart and Amazon have been experimenting with payments and offering payment apps for years. Walmart Pay even works at some gas stations, including Exxon-Mobile.
FedNow is unoriginal
FedNow is neither original nor revolutionary. Instead, it adapts long-existing private technology for government use.
Notably, PayPal (PYPL) America’s best known payments app has been around since 1998. Block Inc.’s Stripe began in 2010 and Zelle premiered in 2017.
The Fed is following the long-existing central bank practice of adopting private technologies. For example, private banks issued most American banknotes until the US Treasury Department begin printing dollars during the Civil War. Wire transfers were first made by Western Union in the 1870s before being adopted by the Federal Reserve in the early 20th century.
Hence, the Fed is expanding its power and reach through FedNow. I think FedNow is an effort to give the Fed more control over instant payments and the digital economy. The instant payments market is growing fast.
Why FedNow?
For example, the number of PayPal users grew from 184.3 million in 2020 to 209.3 million in 2022, Oberlo estimates.
The number of PayPal users could grow to 223.3 million in 2023, 236.7 million in 2024 and 249.9 million in 2025. Similarly, the number of US Apple Pay users could grow from 45.4 million in 2022 to 48.7 million in 2023 to 51.5 million in 2024, 54.2 million in 2025, and 56.7 million in 2026, Oberlo estimates.
Thus, a liquidity crisis at Apple Pay could deprive 45 to 58 million Americans of the ability to pay for things like groceries. Fed managers want the ability to inject cash into Apple Pay to keep it from collapsing.
One fear at the Federal Reserve is that something like PayPal or Apple Pay could run out of money, leaving millions of people and thousands of businesses without cash. For example, 1.657 million companies were using PayPal in 2023, enlyft estimates. In particular, thousands of small business people rely on PayPal funds to pay bills and buy groceries.
Hence, Fed leaders want the capability to inject cash into PayPal and similar systems to keep the economy moving. For example, panic could result if Apple Pay were to run out of money.
I think the Fed could force Apple or PayPal to add FedNow to their payment solutions in a panic. History shows such panics can develop and spread fast.
The Strange Politics of FedNow
FedNow is generating a strange political controversy. For example, second-generation presidential candidate Robert F. Kennedy Junior (D-New York) tweets FedNow is the “first step toward a CBDC.”
A CBDC is a central bank digital currency. Essentially, a CBDC is a cryptocurrency that a central bank issues. Thus, a CBDC offers the same value as paper fiat currency. For example, the Reserve Bank of India’s Digital Rupee is worth one rupee.
Conspiracy theorists, such as RFK Jr., think governments and central banks will use CBDCs to track individual transactions. Additionally, many conspiracy theorists believe Central Banks can use CBDCs to keep government opponents from participating in the financial system.
Kennedy plans to announce his candidacy for the Democratic presidential nomination on 19 April 2023. RFK jr. is famous because he is the son of assassinated presidential candidate US Senator Robert F. Kennedy Senior (D-New York) and the nephew of President John F. Kennedy Sr. (D-Massachusetts) and US Senator Ted Kennedy (D-Massachusetts).
Kennedy is not alone. Governor Ron DeSantis (R-Florida) a probable Republican presidential candidate, is tweeting about “unaccountable institutions” imposing a CBDC on Americans.
DeSantis and Kennedy are attacking CBDCs to appeal to conspiracy theorists. The two hope to replicate former President Donald J. Trump’s (R-Florida) successful appeals to conspiracy theorists in 2016 and 2020.
The War on FedNow
Another reason Kennedy and DeSantis are attacking FedNow is to get donations from the FinTech industry. I think some FinTech providers fear a cheap or free Federal Reserve alternative. For example, the payment processors who charge Americans $2 to $3 to pay federal taxes and phone bills with a credit card.
FedNow could process those payments for free and take away the processors’ revenue source. Predictably, those processors will finance politicians who attack FedNow.
Expect to see the battle against FedNow grow as DeSantis and Kennedy battle for votes and campaign donations. If either man succeeds, many politicians will jump on the bandwagon.
FedNow is both a threat to FinTech companies and a political controversy. Investors need to watch FedNow carefully because it could change the payment processing and FinTech industries beyond recognition.
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