1、APRIL 2020 CHINAS DIGITAL PAYMENTS REVOLUTION AARON KLEIN TECHNOLOGY 1 EXECUTIVE SUMMARY While America spent the past decade upgrading its bank-based magnetic striped cards with chips, China experienced a retail payment revolution. Leapfrogging the card-based system, two new payment systems have com

2、e to dominate person-to-person, retail, and many business transactions. Chinas new system is built on digital wallets, QR codes (two-dimensional bar codes), and runs through their own big tech firms: Alipay running through Alibaba (Chinas version of Amazon) and WeChat Pay running through Tencent (Ch

3、inas version of Facebook). Chinas system largely disintermediates banks from payment transactions, robbing banks of an important and long-standing source of revenue. It creates an alternative payment ecosystem with different incentives between merchants, consumers, and payment system providers. It c

4、hallenges the long-standing placement of payments on the side of banking as opposed to commerce. In doing so, this system creates new incentives that could realign existing business models and relationships between merchants, banks, and technology providers. Chinas new payment system exploded in und

5、er a decade, growing from inception to dominance. With over a billion users on each platform, the power of network incentives has been unleashed. The new payment system has replaced cards and cash at registers, how families give gifts, and even how beggars ask for money, with QR codes replacing tin

6、cups. What does this mean for the future of Chinas payment system and Americas response? First, Chinas new payment system is here to stay. It will continue to grow domestically and globally, following Chinese travelers and consumers abroad. Second, new technology makes possible the movement of the p

7、ayment system away from banking and into technology and social networking. This means that technology and social network firms with sources of data on which to base financial decisions such as providing credit will be able to provide alternative underwriting that is likely to follow. Third, the ince

8、ntives created by moving the payment system from banking to technology firms are substantial and potentially concerning. The potential for anti-competitive behavior and privacy concerns by tech platforms by using the payment system and data generated from it are real. However, it is not clear whethe

9、r these concerns can and would be remedied by effective regulation. Finally, the same economics that make Chinas system beneficial for merchants but bad for Chinese banks are why the Chinese system is unlikely to catch on in America, but may be more viable in other countries with less-developed bank

10、ing systems. While America led the global revolution in payments half a century ago with magnetic striped credit and debit cards, China is leading the new revolution in digital payments. In the past decade, China has leapfrogged magnetic cards, moving to a system based on smartphones and QR codes. B

11、ut the changes from this system go far beyond just a new technological form. The Chinese payment system has done something far more revolutionary: It has largely disintermediated the banking system. In America, and most developed economies globally, the payment and banking systems have been intertwi

12、ned for centuries. The connection between the two is clear: Who is better equipped to intermediate GLOBAL CHINA CHINAS DIGITAL PAYMENTS REVOLUTION TECHNOLOGY 2 payments between parties than the financial institutions that hold those parties funds? Yet new financial technology and its application in

13、China have created a viable alternative payments model where banks play a far less central role, and in the extreme, possibly none. This new payment form requires greater analysis to appreciate the benefits, costs, and implications from a new model. Understanding this model will help answer key ques

14、tions and inform policy decisions. Will the American-led invention of magnetic stripes and card readers be globally replaced by digital wallets using QR codes to transfer funds external to the banking system? Will banks continue to play the central role in operating payment systems or will new tech

15、disintermediate banks? If disintermediation occurs, what are the ramifications of combining payments with commerce instead of banking? UNDERSTANDING THE CHINESE SYSTEM: STARTING POINTS China seemed an unlikely candidate to develop a new payment system. The nation boasts strong banking rates for its

16、citizens, largely as a result of the governments substantial role in providing benefits to citizens through the banking system. Many Chinese citizens have at least two bank accounts, as the government provides subsidies for different benefits through different banks.1 Additionally, Chinese banks wor

17、ked collaboratively to create UnionPay, a Chinese- based card network. China has the largest card network2 in the world with 7.6 billion cards.3 According to the Peoples Bank of China, the vast majority 6.9 billion are debit cards, while only 686 million are credit cards. Protected from foreign comp

18、etition by the Chinese governments refusal to allow market access to Visa, MasterCard, or American Express, it seemed plausible that UnionPay would develop into the dominant payment system within China, mimicking the card-based system in other large economies. However, adoption of the card-based ter

19、minals among Chinese merchants ran into opposition. First, merchants did not like the fees. The idea of paying even 100 basis points for processing payments met with opposition. Merchants were slow to adopt card readers, reluctant to either absorb the costs or pass them along to customers. Second, c

20、ard readers require either a wired telephonic system or a wireless system to communicate. Both require merchants to integrate that technology and pay those costs. Again, merchants showed little interest in doing so, which helps explain why there were only just over 34 million point-of-sale terminals

21、 in China at the end of 2018.4 Cash remained a dominant method for exchange. However, cash has its drawbacks. In China, the highest circulating note is the 100 yuan, worth roughly $15. This is a relatively low value note for the highest in circulation, compared to the U.S. $100 bill and the 500 euro

22、 note. As a result, cash transactions, particularly for higher value goods and services, are more cumbersome. It is not uncommon for Chinese stores to have a cash-counting machine to facilitating transactions and protect against counterfeit notes. With merchants resisting cards and challenges with c

23、ash, the usage of an alternative system becomes more likely. The strong growth of smartphone adoption created room for an alternative system to develop. Smartphones provide a new network of communication that can compete with card readers that require landlines or wireless internet/Voice over Intern

24、et Protocol (VoIP). The second component of this revolution is the QR code. In the card-based system the customer is not required to be online, and the merchant provides the terminal and a connection. The customer then provides the payment instrument (the card) and swipes. The adoption of a QR code,

25、 much like the bar code before it, allows merchants who are not connected via phone or internet to still access the payment system, as only one party needs to be connected for the transaction. This feature flips the prior card system where merchants were responsible for providing the connection. The

26、 QR allows for the customer to provide the connection. All the merchant has to produce is a bar code that can printed on a simple piece of paper. The consumer can leverage the smartphone to both scan the QR code and go online to process the transaction. This lowers merchant costs even further, parti

27、cularly for those who do not have easy access GLOBAL CHINA CHINAS DIGITAL PAYMENTS REVOLUTION TECHNOLOGY 3 to telecommunications. It even allows for person-to- person transactions for folks who have codes but not smartphones. This is even how beggars on the streets are now asking for and receiving m

28、oney5 tin cups have been replaced with QR codes in China! Chinas transformation Given where China began the decade, today is stunning. The rise of two major digital payment platforms, Alipay and WeChat Pay, has transformed Chinas payment system, reaching near ubiquity in under a decade. Starting fro

29、m zero at the beginning of the decade, these two payment platforms are now the largest system in China and among the largest in the world. Alipay has perhaps surpassed WeChat Pay in active users. Alipay reached 1.2 billion monthly users in 20196 and WeChat Pay surpassed one billion users in 2018.7 T

30、hese two forms of payment dominate the Chinese market. Over 90% of people in Chinas largest cities use WeChat Pay and Alipay as their primary payment method, with cash second, and card-based debit/credit a distant third.8 FIGURE 1: ALIPAY VS. WECHAT PAY: NUMBER OF ACTIVE USERS (MILLIONS) Source: Sta

31、tista, Xinhua, China Plus, Tech in Asia9 100 190 270 450 520 900 355 500 697 889 989 1097 0 200 400 600 800 1000 1200 2001620172018 AlipayWeChat Pay GLOBAL CHINA CHINAS DIGITAL PAYMENTS REVOLUTION TECHNOLOGY 4 Mobile payments in China have reached over $41 trillion (277 trillion yuan) ann

32、ually.11 More than 92% of the mobile payments are made over the two dominant platforms: Alipay (53%) and WeChat Pay (39%).12 This rise is even more stunning when considering its rapidity. HOW ALIPAY AND WECHAT PAY WORK Alipay and WeChat Pay integrate technologies that are widely available but not co

33、mmonly used in the United States. Doing so allows each an easy, low cost, method to transmit payment between parties nearly instantly. The technologies are those of a digital wallet and QR codes. Understanding each is necessary for understanding how the system works. A digital wallet stores one or m

34、ore of a consumers payment credentials electronically and allows consumers to electronically transmit funds in multiple settings.13 The wallet is generally funded either by transfer from another digital wallet, or directly by linking a bank account and transmitting funds. This concept is different f

35、rom a digital representation of a credit card, like what is commonly done on Apple Pay. A digital wallet stores money, whereas a digital representation of a card simply substitutes the physical card for a virtual one. Each entity in the Alipay and WeChat Pay ecosystems is assigned a unique QR code.

36、Individuals have them for their accounts, merchants have them for their stores, and even specific payment points such as a parking garage have them. FIGURE 2: MOBILE PAYMENT TRANSACTION VOLUME Source: Peoples Bank of China, Caixin Data, CEIC10 300 250 200 150 100 50 0 Trillions of yuan 20

37、01620172018 GLOBAL CHINA CHINAS DIGITAL PAYMENTS REVOLUTION TECHNOLOGY 5 The payment starts when one party scans the others QR code. It does not matter if this scanner is the payer or the payee. The scan can be done by one smartphone to another, or by a smartphone to a QR code that is digitally repr

38、esented or physically printed on a piece of paper. The payer can total the amount due into the transaction for the payee to scan, or the payee can scan the code and insert the amount to be paid. This is analogous to swiping a credit or debit card into a card reader and either accepting the amount sh

39、own or entering an amount you want to pay. One advantage of this system is that the card-reading terminal has been cut out completely. The Chinese system works instead directly from account to account via WeChat Pay or Alipay, without a processor in between the sender and receiver. This increases sp

40、eed (as anyone who has waited for a credit card terminal to process can attest) and reduces cost. It also explains why China has so few point-of-sale terminals and one of the strongest digital payment systems in the world. Cutting out the middleman saves time and money. How to fund a Chinese digital

41、 wallet The simplest and most common way to get funds onto your digital wallet is to upload them from your bank account. Customers link a bank account and can upload funds instantly from their bank account to either platform. In general, this service is provided at no cost to the consumer. If the se

42、nding bank charges a fee, it is usually paid by the digital wallet provider for funds being uploaded; downloaded is a different proposition as will be discussed later. Prefunding digital wallets makes the Chinese system similar to debit and prepaid cards in the U.S. context. The Chinese wallets gene

43、rally do not function on a revolving line of credit system and should not be thought of as substitutes for credit cards. Thus, the simplest model is for users to link bank account(s) to digital wallet(s) and then upload funds as needed. Those funds survive in the ecosystem and can be augmented by fu

44、ture uploads or other funds received in transfers from other persons or businesses, with consumer digital wallets more likely to be replenished by personal transfers, and business digital wallets likely to be filled by new revenue. Digital wallets still require funds to be moved into the banking sys

45、tem for banking purposes. Digital wallets themselves do not pay interest, as they are not interest-bearing bank accounts. For the user to generate interest s/he must move funds into a money market, bank account, or other investment account. Investing requires customers to move funds out of the Alipa

46、y/WeChat Pay wallets and back into the banking system. This is commonplace and can done quite easily through both applications. Of course, the products available, and banks able to offer services on those platforms are a function of the relationships and partnerships between the tech platform parent

47、s and other institutions. Originally, the parent company could and did use customer funds for their own purposes to park in overnight funds and earn interest for the business. The Chinese government took steps to crack down on this, beginning in 2017 with a requirement that 20% of customer funds had

48、 to be kept in a custodial account at a Chinese bank that did not bear interest.14 That figure was subsequently raised to 50% in 2018 and then to 100% beginning in 2019. The result is estimated to transfer $1 billion in interest being earned by Alipay and WeChat Pay back to the banking system. This

49、move was interpreted as an attempt by the Chinese government to either reign in the mobile payments and/or support Chinese banks.15 Origins of WeChat Pay and Alipay still impact usage and business models WeChat Pay and AliPay differ in how funds are spent. The difference is largely derived from the origin and purpose of each system. WeChat Pay is based on a social media platform, Tencent (think Facebook), and is heavily engaged in person-to-person payments. Alipay is rooted in a digital commerce platform, Alibaba (think Amazon), and hence more likely to receive busine