Online Payments are a Disaster, Can Bitcoin Save Us?

Online payments is a complex mess that fails to meet the needs of customers, vendors or developers. BitCoin may be the first viable digital currency and could provide simpler and more straight forward ways to solve this problem. In this article we look at the shortcomings of the existing payment solutions and look at the benefits and drawbacks of BitCoin as the basis for alternatives.

Let’s start by defining the problem. Most people who use the Internet have probably not thought much about how payments work. If you trust a site you give it your credit card number these days and mostly things work, but for anyone who has actually lifted the lid there is a can of worms underneath that apparently straightforward functionality.

Why Payments Suck for Customers

Let’s start with the customer experience. The biggest problem with the payment experience is the need to continually enter billing information. Every time I want to buy something I am presented with a long and tedious form asking me the same questions. This gives vendors, like Amazon, or Apple who already have my payment details a big advantage over smaller companies that I have not used before. PayPal provides a solution that helps avoid all that form filling, but their unnecessarily long validation flows are almost as bad.

The risk of fraud and the difficulty of knowing whether to trust a site are further problems that face a consumer although the ability to have your credit card company “charge back” fraudulent payments is a big help from the consumer point of view. At the end of the day though all that sits between you and a series of unexpected charges on your credit card is the secrecy of that 16 digit number.

Then there is a lack of control around recurring payments. The fact that you can set up recurring payments against a credit card is very convenient for everybody. However, there is very little control in the system. Suppose you buy a subscription product from me for $10 per month. There is nothing to restrict me to ensure that I stick to our deal. I could charge $100 per month, or $10 four times a month. In fact I can charge what I want, when I want to and the only control you have is to scrutinize your monthly credit card statement to check. Of course deliberately placing random charges on your card is illegal but billing errors happen far more frequently than people realize and only a small fraction of them are noticed by customers.

Finally, what happens when your card is lost or stolen. This recently happened to a friend of mine who figured out that he had over 20 companies to look up or call to provide new payment information. This kind of manual data entry by the customer is dangerous, error prone and a waste of everyone’s time.

Why Payments Suck for Vendors

The first reason that payments suck for vendors is that they suck for consumers. All the reasons in the previous section represent friction points that significantly impact sales and trial starts. You would like customers to be able to sign up for your e-commerce solution as easily as buying an iPhone app.

Fraud is a big problem for vendors, of course. You want to make sure that the customer payments are genuine. And of course the key fraud prevention mechanism for customers, chargebacks, can cause huge problems. Months after a credit card payment has gone through, the customer can phone their credit card company and say that they did not authorize and have it reversed. Technically the customer can only trigger a charge back if they did not authorize the payment, but in practice they may have forgotten about a recurring charge they set up, or feel frustrated at the vendor’s customer service.

Charge backs are expensive, not just because they represent reversed payments but there is a significant charge levied by the credit card companies (around $15) for each chargeback and if you experience too many chargebacks the credit card company will raise their fees or eventually drop you as a merchant because you will look like a fraudster.

Finally credit card charges are expensive. There is a lot of infrastructure, much of it very manual, set up to support all the customer care, fraud prevention, chargebacks etc. With credit cards, the vendors have to foot that bill.

Why Payments Suck for Developers

You would have thought that in this day and age it would be relatively easy to set up a payment solution. Unfortunately that is not the case. The companies that run payment solutions tend to be conservative and change happens very slowly. The technology running Payment Gateways is antiquated and non-starndard. With very few exceptions, the payment solutions out there are quirky, poorly documented and difficult to test. Payment Gateway integration is one of the most unpleasant development activities out there, it is boring, difficult and critically important to get right.

Worse still, when you execute a payment you are talking to a gateway at the top of the chain of other systems. The gateway can talk to multiple intermediate systems before the payment request eventual reaches your bank. Each step in the process introduces its own quirks. For example, different banks will return different error codes for the same kind of payment failure. Some banks will return “Insufficient funds” or “Lost/Stolen Card” which is useful because you can use that to figure out whether its worth retrying the charge. Other banks will simple return “Do Not Honor” which gives you no information about what the problem is.

Stripe is an interesting example of a company making a business out of addressing the developer pain around payments. Their slogan is “Payment for Developers” and their focus is to make the integration as straightforward as possible. They provide a great example of how simple it can be.

What I have outlined here is really just the tip of the iceberg. I didn’t talk about the pain of setting up merchant accounts or international payments and I focused pretty much exclusively on Credit Cards. The payments picture is actually much more complicated. In several countries, like Japan and Germany, Credit Cards are much less widely used and there are other local payment schemes based on bank transfers and cash payments that need to be supported. Each of these systems has its own challenges, timelines and chargeback issues that make the whole picture for an international business very complicated.

Can BitCoin save us?

There are a lot of alternative payment solutions out there that attempt to address some of these short comings. PayPal was one of the first and most successful but their inability to innovate and keep up with change has lead to them falling behind and becoming less and less relevant. There are many others, Square, Dwolla, LiqPay, but none of them has the adoption or growth that makes them look like they will replace credit cards any time soon.

In this article we are going to focus on a new payment phenomenon, BitCoin. BitCoin is not a payment solution per se, it is actually the most successful digital currency to have emerged so far. There were previous attempts at digital currencies that looked very promising, such as the eCash solution produced by DigiCash, that could have had a huge impact nearly 20 years ago.

Like eCash, BitCoin is a system of digital cash that uses a sophisticated cryptography to record transactions and ensure that a user cannot spend the same coin multiple times. Unlike eCash, or any other digital cash system, BitCoin has no central controller, the system is entirely distributed on a peer-to-peer network. Its a little like Napster for payments.

The genius of BitCoin is all in the algorithm that is used by the peers to validate each transaction. All the software that is being run is open source, so there are no “secrets” that someone could know or discover to get rich and undermine the system.

BitCoin has recently shot to prominence in the press. Spurred by regulatory interest from the US government and speculation that it represents a safe haven for money amid the European banking crisis, BitCoin’s valuation has leapt from around $12 at the start of the year to over $90. The value of BitCoins in circulation, now exceeds $1B which makes it larger than several smaller national currencies

BitCoin for Online Payments

The advent of a viable digital currency could be very disruptive for both online and offline payments. BitCoins are not just numbers they are validated balance sheets. I can (and should) back up my BitCoins, but if I trigger a payment transfer to you that validated balance sheet gets updated and I have irrevocably transfered that value to you.

The benefits are that to make a payment, no identity information needs to be exchanged, and all the participants need to do is to validate that the BitCoins are real. BitCoins transactions are final so there’s no way for customers to trigger chargebacks. This is good news for vendors but opens the door for customer’s to get ripped off. What if the product doesn’t arrive, or is broken etc.?

BitPay is a payment solution that is built on top of BitCoin. It provides an escrow service that can hold BitCoins for the vendor until the customer confirms receipt of the goods. BitPay will also settle in up to 30 different national currencies. So, the customer pays in bit coins, but the vendor can receive Euro.

This sounds like a great solution that has the potential to cut through a lot of payment problems, but there are still several issues the will need to be resolved before BitCoin provides a consumer ready solution. Here is my list:

  • Volatility – BitCoin just doubled in price in two weeks. That makes setting prices in BitCoin pretty challenging.  BitPay offers a solution to this by allowing you to set prices in a National currency and charging the customer the current BitCoin rate. They even guarantee to provide the vendor with that amount regardless of currency fluctuations.
  • Validation time – BitCoin payments are not immediate. They take 1-1.5 hours to validate.
  • Wallet sync – If you want to store your BitCoins on your local computer (rather than have a third party store them for you), you have to download a piece of software called a Wallet and have the wallet sync up with all the relevant BitCoin transactions it needs to know about. This sync process only has to happen once but it took my computer several hours to download and validate over 3.7Gb of transaction data bfore I could start using it.
  • Hard to obtain – To my surprise you can’t just pull out your credit card and buy bitcoins. Why? Because BitCoins are cash and credit card purchases are reversible. So you have to use Western Union or some other payment system like Dwolla to take your credit card payment and transfer cash to the bitcoin exchange. This is inconvenient and expensive.
  • No recurring solution – With no chargebacks, setting up a recurring arrangement that lets a vendor dip into your BitCoin wallet at will seems inadvisable. So, like BitPay’s escrow system, there is another layer of control that will be needed to make recurring payments work.
  • Government Regulations – BitCoin is still very young. The US government just clarified how some of its money laundering rules apply to virtual currencies like BitCoin. It is still possible that government authorities could introduce regulations that would make it unviable.
  • Abuse – anonymous digital cash has huge potential for illegal activities. If BitCoin became the monetary  vehicle for criminal activities it would make it harder for ordinary people to trust and could ultimately undermine it.

Conclusion

It feels like online payments is ready for a shakedown. Something will come along that will disrupt this industry. BitCoin represents and exciting new technology in this area that has the potential trigger some big changes. However, even if it can ride the test of government scrutiny and remain legitimate and trustworthy, there is a lot of work to do yet to turn this digital cash into the consumer payment experiences that will challenge credit cards and PayPal as the dominant payment solutions for the Web.