Markman Capital Insight

Apple Pay Tips To New Era Of Fully Digitized Money

The new iPhone 6 all by itself is a pedestrian mobile phone. Nice looking, a big upgrade over the iPhone 5, but it has nothing that Android phone users have not seen or been enjoying for a few years.The new Apple Pay system though is quite interesting and it is too early to make snap judgments on whether it is important or not. There was some...

The new iPhone 6 all by itself is a pedestrian mobile phone. Nice looking, a big upgrade over the iPhone 5, but it has nothing that Android phone users have not seen or been enjoying for a few years.

The new Apple Pay system though is quite interesting and it is too early to make snap judgments on whether it is important or not. There was some pretty good commentary and insights around the web on this subject that I want to share with you. (Disclosure: I own Apple shares).

The overall theme is that the way you pay for things is about to change again. The first major change in our parents' lifetimes was the development of the credit card. The first major change in my lifetime was the development of the debit card and ATMs, which I first used as a student at Duke University in the late 1970s, as North Carolina banks were pioneers.  The next big change was the development of online banking and online bill pay. And after that came non-bank online or mobile transaction systems such as PayPal.

Through all of these developments, we all still use paper checks, which is kind of amazing. My wife is fully modern in every way but still writes checks for health insurance, taxes and smaller items like our house cleaners. At my business I still issue checks to many vendors, even though I more commonly use bank auto-pay, debit cards, airline-linked credit cards, PayPal or Intuit Payment Network, depending on the size of the remittance and recipient. I wanted to pay the czar of my fantasy football league with my Venmo account or Google Wallet, but the guy -- who is an IT professional at a major fast food company -- insisted on a check, primarily because he did not want to provide personal bank account information to one of these firms.

My point is that there is already a wide variety of methods that we use to transact today, and Apple Pay will try to break in as a newcomer. It has a leg up, to be sure, as it already has 800 million credit cards on hand in iTunes, but it's going to be a hard sell. It announced Macy's as a partner, but  Best Buy  (BBY) and Wal-Mart (WMT) have said will not offer Apple Pay at their stores.

Still, Apple Pay represents the point of the spear, as financial institutions recognize that they face challenges from technology companies that are not eager to work with incumbents. Both of the biggest transaction networks, Visa (V) and Mastercard (MA), are on board. James Anderson, senior v.p. at MasterCard, told the New York Times: "There are schemes that don't respect and honor the payment networks. We want to invest in programs that respect our role in the ecosystem."

Banks are going to bear the brunt of Apple pay by offering it a lower rate than they normally accept from credit card transactions, according to the NYT report. The story said banks, which take the biggest chunk of credit card transaction fees, are hopeful that they will make up for the lower rates by processing new types of transactions that are currently being done with cash or other payment methods.

In contrast, the NYT reports that the big credit card networks will not have to pay any costs for working with Apple due to their clout. Still the emergence of Apple in this space could push down fraud costs, which could in turn push down credit card fees for everyone.

The NYT observes that the partnership with Apple is much more attractive than an initiative being led by some of the biggest retailers, known as the Merchant Customer Exchange, that appears to be looking to replace the card networks altogether. Not coincidentally, the two Apple Pay holdouts -- Best Buy and Wal Mart -- are major supporters of the Merchant Customer Exchange.

Apple Pay is going to try to set itself apart through a perception of greater security. The NYT reports that the major payment networks and banks have all been working on a system that allows customers to make a payment without handing over any personal details, using a kind of digital token that can be used only once. Apple Pay will be the first program to use the tokenization system on a widespread basis, and banks and card companies hope it will pave a path that allows them to remain key players.

The global head of strategic partnerships at Visa told the NYT: "We can show the world this is where it's all headed. This may be the inflection point where you can see a real improvement in what has been a clunky digital experience."

Still this is not a lock. Retailers have to buy and install special hardware to read the wireless NFC signal from Apple devices. And while these are popular in Europe and Canada, they just have not caught on in the United States despite a strong attempt to pioneer digital wallets by Google Checkout.

Another angle was explained in a New York Times op-ed piece by Edward Castronova, a professor of media at Indiana University, and Joshua A.T. Fairfield is a professor of law at Washington and Lee University. They said that if widely adopted, Apple Pay could usher in a new era in which virtual assets of all sorts -- traditional currencies, but also airline miles and retailer loyalty points -- are interchangeable, opening up enormous purchasing power for consumers and creating tough challenges for governments around the world.

They said that moving toward a digital wallet for dollars is only a marginal step forward. The real change is how the digital wallet technology facilitates the parallel emergence of virtual purchasing power. We don't think of things like loyalty points as currency, they argued, because virtual money has traditionally been locked down, in the sense that its use was strictly limited: If you earned points from Amazon, only you could use them, and you could exchange them for dollars only within the Amazon marketplace. The only currencies you could use everywhere in an economy were state-issued currencies, like the dollar.

But that distinction is eroding, the professors observed: The value of a currency lies in what you can buy with it, not in the fact that a government says it's worth something. "That's why a digital wallet, loaded with your dollars, credit and loyalty points, is such a revolutionary technology: It makes those transfers and transactions seamless and safe."

They add: "Frictionless exchange is a killer app. Some companies might lose value in their loyalty programs, but others will find enormous value in issuing their own currencies for advertising or data-tracking purposes, or even just because the creation of a successful virtual currency or digital wallet lets companies make money by making money. That's certainly Apple's bet."

Imagine you want to buy a shirt at Target, the professors go on. Your digital wallet can pay for it with dollars, your Target points or any other form of purchasing power that Target accepts. Wave your phone at the cash register, and Apple Pay could theoretically determine the best mix of currencies and non-currencies for that moment.

Apple did not announce this, and may not even be contemplating it, but fully digitized money and non-money currency in a smart virtual wallet would allow full fungibility of everything you consider valuable. That's scary, as well as cool, and probably not too far away.