Why is Fintech disrupting ACH?

We have an intern at work and I am the primary person that he goes to for maintenance tasks that need his help. Today, I invited him to sit in on a call with a partner who was wondering why so many of their payments were being returned by their end recipient, or resulted in a stop-payment initiated by the funding party. Their primary funding mechanism is ACH, and I explained that one of the possibilities that we explored was that so many payments resulted in a stop payment is because our partner delayed submitting a payment to us until the funding had come through. In essence, this added 2-3 days (for funding) to a process that already takes 2-3 days (payment posting).

In essence, this makes an already slow process even slower! After I explained this to him, he expressed a great amount of surprise that even in this day and age, our interbank money transfer system still takes two to three days to transfer money. Of course, working in the payments industry, I just take this for granted and accept it, but he’s right. Why haven’t we come up with anything good enough to replace this very slow system? I can order things from Amazon and they appear in less time than it takes for ACH transfer to be applied to my account. Surely, the transfer of value from one actor to another is easier than the transfer of property?

Why is ACH so bad?

As it would turn out, the answer to that question is “yes and no”. The reason for this is because cash (and certain precious metals) are the only widely accepted stores of value that are liquid, whereas liquidity is not necessarily a factor in the provision of physical commodities to end users. Let’s break that down. Value is a relative term in that its scope can change. Certain things can be valuable at one point in time but not in another. Indeed, Merriam-Webster’s dictionary defines value as “relative worth, utility, or importance”. Indeed, things that are not cash can have value, but that value is not widely accepted. Paintings of horses can be valuable to you, but unless I also accept it as valuable it is of no importance to me.

The second component of the definition is liquidity. Liquidity is the degree to which an asset can be bought or sold without affecting its price. It’s hard to imagine a world where cash isn’t 100% liquid, but in fact cash (in the form of paper currency) is subject to its own forces of supply and demand when its exchange rate is allowed to float freely (or at least to some degree). However, because cash is backed by the strength of governments (fiat currencies) or convertibility into precious metals, it is far more liquid than such things as consumable resources or paintings of horses.

Since cash plays a role as such a central guarantor of value, it is the logical medium with which to reduce the risk of loss when dealing with electronic payments. However, therein lies the conundrum: cash is a physical good, not a digital one. While the transfer of information may take mere milliseconds, the physical transfer of cash, including manufacture, authentication, and security, takes much longer. In order to speed up the process; there is a solution: offering credit.

Offering credit entails the risk of non-payment. You may advance the application of value by offering credit, but you also run the risk that when the time comes to settle on your transactions thecash is not actually available. For better or for worse, fraud and criminality are components of human nature, and perhaps an unavoidable risk of doing business. As I’ve explained before, whole industries are built on the act of abstracting credit risk and charging for the provision of that service. However, even those services are built on a back-end of cash transfer. At the end of day, a few men driving armored cars will be delivering the net amount of cash that one bank owes to another.

Compare this to the act of Amazon delivering a product to you. There is a low risk that you won’t accept the product, because you ordered it. Even if you don’t accept the product, it is returned to Amazon and they just eat the cost of shipping, and they can sell it again. Thus, liquidity isn’t an issue. Neither is the shared definition of value. Specifically because you requested the item, it has inherent value to you.

How do you disrupt a system of physical goods?

Taking all this into account, it is clear why ACH is the target of so much disruption. It checks the boxes in that it is complicated (in execution) and expensive (in time). Given this, entrepreneurs have targeted ACH as the next big thing to improve. Even the National Automated Clearing House Association (NACHA), the trade group for ACH, understands this to some degree. on May 19, they announced that their membership body had approved a scheme for making Same Day ACH payments.

When we think of recent developments that seek to disrupt the use of cash as a liquid medium for the transfer of value, the thing that usually comes first to mind is Bitcoin. Bitcoin is based off of a public ledger of transactional activity called the “blockchain”. Value is derived from continuously verifying the integrity of the blockchain. That way, we can be sure that nobody has tampered with its contents. In the physical world, the guaranty of governments (or convertibility) provides this same assurance. We know that we will always be able to spend a piece of physical currency because we trust (to a sufficient degree) the government that issued it. In the case of Bitcoins, we know that we are not exposing ourselves to credit risk when we accept a Bitcoin because its ownership has been verified in the blockchain, and its transfer from the original holder to us will also be recorded thusly.

The big question, however, is if Bitcoin is liquid. Can you use Bitcoins without affecting its price? The general acceptance (or lack thereof) of Bitcoin suggests that it is not as liquid as it could currently be. Extreme fluctuations in the market valuation of Bitcoin also seem to bear this out.

Bitcoin Price vs. USD | FindTheBest

Given the importance of liquidity and value to our commercial culture, it is apparent that disruptors in Fintech, or at least those seeking to improve the payment process at a very base level, have a very high bar to meet. Creating a store of value that is accepted by even a niche community is hard enough, but establishing scale such that you can reliably turn an abstracted unit of value into a physical good is even harder.

Where to from here?

To some degree, the market is realizing that ACH (and card processing too) are a pretty old game. You can see this in the recent demise of payment processing startup Balanced Payments, which stopped accepting ACH debit requests on June 11. As early as 2012, they were called out for not innovating on payments infrastructure but instead just offering ACH alongside the usual card processing offering. Ironically, their customer transition plan involved facilitating the transfer of customers, payment information, and tokenized payment device data to Stripe, along with guaranteed acceptance in Stripe’s ACH processing beta program.

Indeed, one of the main reasons why it is so difficult to find adoption for a payment processing platform is because it’s simply already been done, and it already works fairly well. Merchant acquirers in the form of banks and other Independent Sales Organizations have been at it for decades and they have the experience largely dialed. Perhaps there are improvements to be made in the speed and ease of deployment, but I personally find it unlikely that developer evangelism is likely to ever beat out the pricing of scale in the long term. In other words, because the core functionality of payment processing is already so well defined and optimized (albeit slow), any improvement in the user experience is only marginal. Two to three days is the standard, but the difference between 2-3 days and same day and same day and truly real-time appears to be much larger than previously thought.

Only when somebody invents a easy way to effect realtime settlement of funds will we see the next competitor to ACH.