Common Elements
There are three common elements to any digital payment:
- An information flow: where participants must communicate about how much money is moving and to and from what accounts.
While a cash payment is a physical process, a digital payment is a communications process. - A clear rulebook: a set of standards and rules are required to govern the terms of payment.
- A central ledger: a way for money to move, which requires an intermediating ledger. Say A needs to pay B. A central ledger,
C, is required to broker the transaction. A. If C is a bank in which both A and B have accounts, then no money would leave C’ s hands during the payment; this is a
closed loop payment. B. Payments outside of a closed loop necessitate the involvement of a central banking authority.
Real-world digital payments, anchored in these basic elements, play out over three steps.
- Authentication: the process through which parties provide and verify the necessary information about the exchange
- Clearing: when information about an authenticated payment is translated into a packet of instructions for how to execute the
payment - Settlement: the actual execution of the payment, when the central ledger updates all records and payee has access to funds
Payment Types
Digital payments can be understood via three factors:
1. The Payment Rail
The payment rail is the pipeline through which payment information flows. Three types of rails are:
- Account transfers, for example Wire or ACH
- Card payments, for example credit cards. These are mostly used for commerce, and the fees are higher, paid by the merchant
- Digital wallets, which include pass-through wallets (like Apple Pay) that simply carry and passes along card or account details or staged wallets like Venmo, PayPal, or AliPay that allow for closed-loop payments
2. The Payment Zone
The payment zone is either domestic or cross-border. Cross-border payments lack the authority of a single central bank, requiring alternative ledger solutions.
3. The Payment Segment
The payment segment characterizes who the payer and payee are.
There are 4 segments:
- C2B - consumers paying businesses (i.e., commerce). Commonly cards.
- C2C or P2P (peer-to-peer) - individuals paying individuals. Commonly account transfers or via staged wallets like Venmo,
Paypal. International P2P payments are called remittances. - B2B - businesses paying businesses. Usually done via account transfers.
- B2C - businesses paying individuals (e.g., salaries). Usually done via account transfers.
Account Transfers
There are several types of account transfers:
Domestic Account Transfers
Real-time gross settlements (RTGS) - Each payment is settled independently, in a matter of minutes, for a fee. Example: US Wire transfer,
operated by the FedWire.
Batched payments. Payment information is gathered and then periodically cleared and settled in batches. Slower than RTGS (can take 1-2
days) but often free. Example: US ACH, operated by a third-party clearinghouse (NACHA).
Instant Payments - any type of payment that makes funds available nearly instantaneously (seconds vs. minutes). Examples include:
- Closed loop payments, such as intra-bank transfers or P2P apps like Venmo can be instant
- Dedicated instant payment rails, which operate under their own rulebooks and protocols, with 24-7 operations. E.g., FedNow and Real Time Payments (RTP) in the US, or the SEPA Instant Credit Transfer in the EU.
- Payment schemes that build on existing rails to create nearly-instant payments
Example: Zelle in the US. An ecosystem established by US banks. Banks make funds available instantly, even before settlement by pre-approving participants. Example: Request to pay (R2P) in the UK and EU, also brings pre-approved participants into a common scheme
Cross-border Account Transfer
- SWIFT-based, meaning when payments move through the international banking system, leveraging multi-national banks (e.g., Citibank) as an intermediary.
- Via transfer providers, like Western Union or Wise, that create closed-loop payment ecosystems
Frequently Asked Questions
