How Digital Money Really Works

If you have a burning question about how money works, Patrick McKenzie probably has the answer. The software engineer/blogger/vaccine database founder

McKenzie started his career as a “salaryman” in Japan, working 19-hour days before quitting to work for himself; now he advises payment processor Stripe Inc. in addition to software and writing work. His real passion, though, seems to be making sense of what happens when you tap “pay” on your phone. Our conversation with him has been edited for clarity and length.

What’s the difference between a bank and a digital wallet on my phone?
In the mists of prehistory, there was essentially one place to hold money. It was in an account at a bank, and all of your ways to access the money were mediated by that bank. Life has become much more complicated, with a plethora of apps that present different things on your phone, but that to the user feel like very similar experiences—tap, tap, tap, my money moves. But under the hood, there are complicated legal and technical substrates that are different from each other.

What’s most misunderstood about financial transactions?
People broadly assume their money is sitting in a vault somewhere, and it’s something they own, but their money is usually a debt by some other party in the economy to them. That confusion between money as an asset and money as a debt—and how money is sometimes simultaneously an asset and a debt—drives a lot of the confusion among nonspecialists about how the financial ecosystem works.

What are the consequences of people assuming their money is just sitting in a vault somewhere?
I think it informs a lot of discourse about the banking sector. People both in broader society and financial technology circles are critical of the banking sector, particularly after 2008. It’s not that banks have never done any wrong, but if you assume they’re simply supposed to be guardians that count up the money going in and out of the vault, you would, one, assume they’re getting paid exorbitantly for doing this, and, two, ask why we have to keep bailing them out. The answer is they’re not simply vault guardians. They’re doing a fairly complex form of alchemy to turn large portions of the economy into money—into this thing we can access at will, on our phones and by our cards.

Are there big differences between sports gambling sites like FanDuel and a stock trading app like Robinhood?
I think innovation in financial technology is largely pro-social. I think it was a true fact that many banks in the US, for a variety of structural and technical reasons, did not really invest in giving users beautiful, easy-to-use affordances for accessing their own money. And I think that has improved rapidly over the course of the past 10 years. However, not everything you can put a beautiful application and design on top of is actually in the customer’s interests.

Robinhood is a gambling app that wears the clothes of a responsible financial institution. It was abundantly obvious from the way they used to talk about the product. It was abundantly obvious from their advertising campaign. And it’s abundantly obvious from reading their quarterly and annual reports and seeing how their bread is actually buttered—where, for example, a large portion of revenue is due to options trades, which retail consumers, and particularly the retail consumers Robinhood attracts, should not be making. [In a statement to Bloomberg, Robinhood Chief Brokerage Officer Steve Quirk said that any comparison between Robinhood and gambling apps is a “complete mischaracterization” and that the app is designed to help users make informed investment decisions.]

When you buy something online, you have all these card and payment options in front of you when you check out. Why are there so many different ways to pay?
That number is going to increase over time. For a very long time in the US, there were 2.5 logos. It was Visa, Mastercard and then maybe Amex. We’re going to see more logos, because facilitating commerce is fundamentally a very valuable business to be in. And increasingly, over the last couple years, businesses that did not construe themselves to be truly in the financial industry have discovered that if you have a business which is well-loved by consumers, that facilitating their ability to make payments to you and others is just an excellent, excellent business to be in. Both because of the direct fee you can charge either to the consumer or someone else, and because the users who engage with you in payments are going to intensify their engagement with you.

Historically, only the largest companies in capitalism could afford to do this. Apple and Google, most famously, discovered that they have this wonderful piece of glass and plastic that people have in their hands every day for large portions of the day, and that if they put payments into that piece of glass and plastic, then that both causes them to have a direct revenue line associated with payments and causes the user to transact more of their economic life onto the surface the tech company controls.

So even if Apple and Google were able to charge zero for transactions, they would prefer those transactions to occur over the internet on devices they controlled, connected to their advertising ecosystems, versus having those transactions occur off the internet. That logic applies to the largest firms in capitalism. But because the scale you need to launch a new payment method and to get it accepted by various places has been decreasing over time, that on the margin brings more firms to this business.

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Posted: to Wealth Management News on Thu, Jul 11, 2024
Updated: Mon, Jul 29, 2024